Meaning of Global Financial Crisis The term financial crisis is applied broadly to a variety of situations Usually, some financial institutions or assets suddenly lose a large part of their value– Banking Panics (and recessions)– Stock market crashes– Bursting of financial bubblesAnd biggest organizations
How Did All This Happen? From 1820 to 1970, every decade U.S. workers experienced a rising level of wagesIn the 1970s this came to an end; real wages stopped rising and they have never resumed sinceU.S. workers became more productive, but got paid the same; wages began to stagnate and declineThe gap between labor and capital grew bigger
Contd…The large corporations made huge profits and had much money at their disposalThey bought other corporations (mergers and acquisitions) and they put their money into banksThe banks loaned that money (with interest) to workers who didn’t have money to consumeThis was done to raise their purchasing power because their wages weren’t enough to buy things
Then What ?Since employers no longer raised workers’ wages, the workers had to go into debt to surviveDebt went up and up and things got out of controlThe banks continued to loan money through new loans (secondary mortgages) at high interest rates, and this was a profit bonanza for the banksAs corporations increasingly began to invest abroad (outsourcing production and services), U.S. workers lost their jobs, and this led to greater unemployment and underemployment
Summing upProximate causes Sub-prime lending Originate and distribute model Financial engineering, derivatives Credit rating agencies Lax regulation Large global imbalances Fundamental cause Excessively accommodative monetary policy in the US and other advanced economies (2002-04)
Timeline• Fed ignores pleas for investigating sub-prime lending – 2001 to 2004• HSBCs Mortgage chief resigns after losses hit $10.5 Billion – Feb. 2007• Bernanke says the housing sector "is a concern, but at this point we dont see it as being a broad financial concern or a major factor in assessing the course of the economy." - Feb. 2007
Timeline• UBS shuts sub-prime lending unit and GMAC announces huge mortgage related losses – May 2007• Countrywide Financial (largest US mortgage lender) avoids bankruptcy by taking $11.5 Billion loan• Freddie Mac posts $2 Billion Loss – Nov. 2007
2008Banks face losses of $900 Billion• Jobs lost across the board across many industriesCollapse of major Wall Street firms begins with Bear Stearns and continues thru to Leyman Brothers. Others?Global liquidity issues know no boundariesOil and commodities go thru the roof and then crater
Current scenario of USA GDP 2011- 1.8% 2012- 2.3% 2013- 2% (P) US housing market remained in depression From 6.5% of GDP To 1.9% of GDP President Obama declared Cut in Government spending by $85 billion Cutback in defense spending by 13% Cutback in non defense programs by 9% Fall in durable goods orders by 5.8% The US government has created over 100,000 jobs but still well below required 200,000
Cash flow and interestHigh oil prices are presenting a significant headwind to US economyWhile the federal reserve continues to try to stimulate it with durable near zero interest ratesOverall GDP growth , income , consumption all are in positive but are growing at below trend ratesPresident Obama recently presented his fiscal budget which would likely to increase deficit
The republicans encountered the budget to cut spending and reform entitlementsThe payroll and bush tax cuts are set to expire just as reduction in jobless benefitsThe debt ceiling may need to be lifted again the growth impulse contribution from foreign trade was positive for a while in year 2011While trade and current account balances risks remaining in strong under combination of US demands for imports and rising oil prices
Impact on the UKUnemployment increased by 164,000 between May and August 2008; almost a 10 % rise from 1.63 millionMost hard hit is London where number of jobless looking for jobs increased by 42 % in September 2008Some estimates put 1.5 million additional unemployment generated by end-2010 leading to an unemployment rate of 10% from current 5.7 %.
Problems in Euro ZoneStarted in-Oct 2009 in GreeceIts immediate causes lie with the US crisis of 2007-09Greek GDP had its worst decline with -6.9% in 2011The result in euro zone was sovereign debt crisisPIIGS->Portugal ,Italy ,Ireland ,Greece ,SpainInterest rate surged on government bonds
In July 2011 European leaders agreed to cut rate of interest which Ireland was paying on its EU/IMF bailout loan from 6% to 3.5%In Feb. 2012 ECB & IMF agreed to provide a second bailout package of €130 billionEuro group on 9 June 2012 grants Spain a financial support package of up to €100 billionLower tax returns and higher budget deficitOn July 26 Ireland returns to financial market by selling €5 billion in long-term government bonds
MeasuresAusterity measures like higher taxes and lower expenses Bailout packages from ECB & IMF for stabilizing their economiesPaying less than 4% on new debt which is incurringPrivate sector rescheduling and restructuring
Other measuresGovernment responded swiftly and decisively to save the systemCentral banks stepped in and provided liquidity to the banking system to keep it functioningExpanded the money supplyGovernment provided bailout for major financial institutions to avert their collapseGovernment also cut taxes and raised spending to prevent economy from falling into recession
Impact on India•$16 Billion outflow from India in 2008•Inflation at 12%•$291 Billion – Indian FX reserves as of 03 Oct.•Indian Oil Corp costs to rise 70% to $45 Billion•Industrial growth plummets to 1.3% in August•Sensex down ~50% in 2008•Sensex up ~50% from 2004 Indian Rupee depreciated 1$=55
What not happened here • No subprime • No toxic derivatives • No bank losses threatening capital • No bank credit crunch • No mistrust between banks
Our Problemsflows Reduction in CapitalPressure on BoPStock marketsMonetary and liquidity impactTemporary impact on MFs/NBFCs (Sept-Oct)Reduction in flow from non-banksPerceptions of credit crunch Contd.
Impact on Developing NationsTrade And Trade Prices:Growth in China and India has increased imports and pushed up the demand for copper, oil and other natural resources, which has led to greater exports and higher pricesRemittances:Remittances to developing countries will decline. There will be fewer economic migrants coming to developed countries Contd.
Foreign Direct Investment (FDI) And Equity Investment : while 2007 was a record year for FDI to developing countriesCommercial Lending:Banks under pressure in developed countries may not be able to lend as much as they have done in the past.
Summing upWeaker export revenueFurther pressures on current accounts and balance of paymentLower investment and growth ratesLost employmentThere could also be social effectsLower growth translating into higher poverty
Current Scenario Across the GlobeThe world is trying to recover from aftermath of great recession with India and China leadingThe world bank projects global GDP to expand between 3.3 and 3.7% in 2012Developing economies are expected to grow between 6.7 and 6.2%High income countries expected to grow at 2.4% and 3%
Measures taken by RBIExpanding rupee liquidity Reduction in CRR (400 bps) & SLR (100 bps) Special Repo window under LAF for banks on-lending to NBFCs, HFCs & MFS Special Refinance to banks without collateral Unwinding of MSS – buyback OMOs – pre-announced calendarCut in repo (425 bps) and reverse repo (275 bps) rates.Existing instruments – enough flexibility Contd.
Managing Forex liquidity NRE and FCNR(B) deposits: interest rate ceilings raised ECB norms relaxed Allowing corporates to buy back FCCBs Rupee-dollar swap facility for banks with overseas branchesEncouraging Flow of credit
Lessons From Crisis Avoid high volatility in monetary policy Appropriate response of monetary policy to asset prices Manage capital flow volatility Look for signs of over leveraging Active dynamic financial regulation − Capital buffers, dynamic provisioning − Look for regulatory arbitrage incentives/ possibilities
(Re)SourcesBusiness Week, What will the crisis mean for venture capital?, Sarah Lacy, 09 Oct. 2008 http://bit.ly/3A43xXYahoo Finance Charts and Historical dataMeltdown 2008, TerranceDC, Oct. 2008, http://bit.ly/4gRiwhSequoia Capital Presentation to Portfolio Companies - http://bit.ly/16F8WKGoogleRBI WebsiteTeknatus Blog http://www.teknatus.com/blog/pjainwww.imf.com