Sub Prime Ppt


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Sub Prime Ppt

  1. 1. Presented By: Kaushambi Ghosh Manish Madhukar Mohit Almal Pankaj Agarwal
  2. 2. Agenda Subprime •Traditional Model Vs Subprime Model •Players in the Game Bubble •Housing Bubble Why it burst? Global Crisis Impact Events Indian story Bailouts What Next?
  3. 3. Subprime
  4. 4. Traditional Model Vs Subprime Model
  5. 5. Players in the GAME
  6. 6. Players Player 1: Fed -- Fed kept the interest rate low during much of 1990s and particularly 2001-2005 (low oil prices, and low inflation prompted the policy), fueling the market -- During the 2001-2005, FFR was in the 1% to 3% range, and mostly in the 1% range -- Fed encouraged more risky ARM lending (Greenspan) Player 2: Mortgage Salespersons -- Worked on commission based on the number of arms successfully twisted
  7. 7. Contd.. Player 3: Primary Lenders -- No incentives for judicious lending Banks no longer needed to hold on to the mortgage, as use of mortgage-backed securities made risk taking more appealing -- Use of ARMs with low teaser rates (below market rates for a while, followed by much higher rates tied to index, LIBOR + some %). Teaser rates are popular when long-term interest rates are at historical lows (like much of this period), as they help lenders benefit from ARMs as rates rise -- Net Effect: Many loans were made to NINJA’s (people with No Income, No Jobs or Assets).
  8. 8. Contd.. Player 4: Other Financial Institutions -- Freddie Mac and Fannie Mae issued many Mortgage Backed Securities -- Other financial institutions that traded in these as well as derivatives based on real estate assets. Many of these were global institutions
  9. 9. Contd.. Player 5: Credit rating Agencies and Analysts -- Lack of market for many of these securities, so models were used to price them -- Inflated ratings, mostly in A range (similar to T-Bills) -- Conflict of Interest: Investment bankers’ analysts were rating investment bankers’ clients (scandal) -- For example, 3 months prior to its demise, AIG was rated strong buy (8 analysts), buy(3), hold (10))!!! Player 6: Home Buyers (Taking Excessive Risk) -- Home buyers were enjoying the ride -- New ones were joining the ride, even if unqualified -- Home ownership up from 60% in 1990s to 70%
  10. 10. Bubble
  11. 11. Historic Bubbles Dutch Tulip Mania (1630s) South Sea Bubble (1710s) British Railway Bubble (1840s) US Railway Bubble (1880s) Roaring Twenties (1920s) Multi Bubble (1960s) Internet Bubble (1990s) Housing Bubble (2000s)
  12. 12. Structure of a Bubble Displacement (diffusion of new technology starts) Take off (stock prices show abnormal increase) Exuberance (stock prices grow at very high rate) Critical Stage (stock price growth slows down) Crash (stock prices start tumbling)
  13. 13. Population Dynamics in the Course of a Bubble
  14. 14. Housing Bubble
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  16. 16. Why housing bubble burst????
  17. 17. Process of Securitization
  18. 18. Recap: Causes Boom and bust in the housing market High-risk mortgage loans and lending practices Securitization practices Speculation
  19. 19. Contd.. Inaccurate credit ratings Government policies Policies of central banks Financial institution debt levels and incentives Credit default swaps
  20. 20. How bubble burst led to crisis???
  21. 21. How did this turn into a crisis ? Step 1 - The housing boom in the US started fading out in 2007 Step 2 - Boom had led to massive increase in supply of housing Step 3 - Thus House prices started falling Step 4 - This increased the default rate among sub-prime borrowers Step 5 - These borrowers were no longer able/willing to pay high price for a house that was declining in value Step 6 – Security/Guarantee being the house being bought , this increased the supply of houses for sale while lowering the demand, thereby lowering prices even further and setting off a vicious cycle
  22. 22. Ripple Effect-Suck Everything The housing bubble Defaults & write A hole in the bubble Banks go belly-up Banks get sucked in
  23. 23. How it Unfolded???
  24. 24. Impact
  25. 25. Banks Writedown($ billion) Actions Citigroup 55.1 Bailout by Fed Reserve($326 billion) Merrill Lynch 51.8 Taken over by Bank of America UBS 44.2 $5.3 billion Swiss government bailout HSBC 27.4 Wachovia 22.5 Wells Fargo Bank of America 21.2 Royal Bank of Scotland 14.9 Morgan Stanley 14.4 bank holding companies JP Morgan chase 14.3 Lehman Brothers 8.2 Files for Bankruptcy AIG 18.5 bailed out by Federal reserve
  26. 26. Crashing Stock Indices 30000 25000 20000 Value 15000 10000 5000 17th Jan' 2008 25th Nov' 2008 0 Indices
  27. 27. List of events
  28. 28. Date Events 8th September Fannie Mae/Freddie Mac placed into conservatorship by U.S. Government 14th September Bank of America agrees to purchase Merrill Lynch for $35B 15th September Lehman Brothers declares bankruptcy 16th September Reserve Primary Fund “breaks the buck” U.S. government seizes control of AIG in $85B bailout 18th September Treasury Secretary Paulson announces bailout plan 19th September Governments worldwide announce short selling restrictions Treasury establishes Temporary Guarantee Program for money market funds 21st September Fed allows investment banks Goldman Sachs and Morgan Stanley to become bank holding companies 23rd September Warren Buffett announces $5B investment in Goldman Sachs
  29. 29. Date Events 25th September Washington Mutual is seized by FDIC; assets sold to JPMorgan for $1.9B 29th September Citigroup agrees to acquire Wachovia with FDIC guarantee; a private transaction with Wells Fargo is later announced First bailout bill is rejected by U.S. House of Representatives 3rd October - Congress passes TARP legislation FDIC temporarily increases deposit insurance to $250,000 7th October Fed announces Commercial Paper Funding Facility (CPFF) 8th October Coordinated rate cut by central banks around the globe 13th October Mitsubishi UFJ finalizes $9B equity investment in Morgan Stanley 14th October Mitsubishi UFJ finalizes $9B equity investment in Morgan Stanley Treasury announces TARP Capital Purchase Program 21st October Fed announces Money Market Investor Funding Facility (MMIFF)
  30. 30. Loss in crisis 1000 900 800 700 600 500 Expon. (Series1) 400 300 200 100 0 savings and loan crisis(1986- Banking crisis(1990-99) Banking Crisis(98-99) Subprime crisis(2007-present) 95)
  31. 31. IMF raises the estimated loss amount to 1.4 trillion dollars
  32. 32. Country wise Action United kingdom Has lined up a $850-billion rescue plan, May nationalise Royal Bank of Scotland Will recapitalise banks by up to $88 billion. Abbey, Barclays, HSBC, Llyods, Standard Chartered, HBOS and Nationwide Building Society can draw from an aggregate of $44 billion to boost their Tier 1 capital Bank of England will infuse liquidity of $351 billion through loans The government will guarantee $439 billion worth of short-and-medium term debt Britain has seized control of mortgage lender Bradford & Bingley Earlier this year nationalised Northern Rock Alarm: The total liabilities of Barclays of £1,300 billion (leverage ratio of over 60), surpass Britain's GDP
  33. 33. Contd.. Belgium The government took partial control of the struggling Fortis Bank France, Belgium and Luxembourg stumped up $93 billion to recapitalise Dexia, a French-Belgian lender that ran up huge losses in its US operations Alarm: Fortis Bank's liabilities are several times larger than the GDP of Belgium (leverage ratio of 33) Iceland The government has nationalised three of Iceland's biggest banks Accounts in these banks stand frozen
  34. 34. Contd.. United states May pick up ownership in failing US banks (Morgan Stanley is reported to be one) Fed ready to lend directly to stressed companies Germany Has guaranteed all bank deposits Has organised a credit lifeline of euros 35 billion for blue-chip commercial real estate lender Hypo Real Estate Holding Alarm: The total liabilities of Deutsche Bank (leveraging ratio of over 50) amount to 2,000-billion euro, which is more than 80 per cent of the GDP of Germany
  35. 35. Contd.. Singapore Eased monetary policy for the first time since 2003 after sinking into its first recession in six years, hit by the meltdown in financial markets The government revised its 2008 growth forecast to around 3 per cent from an earlier estimate of 4 to 5 Italy UniCredit Bank has announced plans to raise its capital ratio by spinning of property assets Ireland Has guaranteed all bank deposits
  36. 36. Contd.. Spain Will spend 50 billion Euros ($68 billion) to buy bank assets, almost a third of the proposed 2009 central government budget Japan Yamato Life Insurance failed with $2.7 billion in debt The government may revive a bank-rescue law of the 1990s banking crisis Tokyo may set up a $100-billion fund to prop up smaller lenders Alarm: Real estate companies are folding up, forcing regional banks to raise reserves against bad loans
  37. 37. Indian Story
  38. 38. Impact of Subprime Crisis in India No direct impact: Structured finance undeveloped No deleveraging On the contrary India and China were seen as saviors of a ‘decoupling’ global economy Result: Capital influx, currency appreciation, stock market boom
  39. 39. Impact on India-Second Round The second round effect of Sub Prime + spike in oil prices was devastating for Asian countries, including India But for the macroeconomic cushion of low external debt Ratio and fiscal deficits and comfortable reserves this had the ingredients of a classic currency crisis
  40. 40. The Devastation Oil shock – worsening current account balance India’s merchandise trade deficit in April-July 2008 increased by 50% BRIC may split – prospects of Brazil/Russia brightened& that of India/China darkened Sharp increase in inflation – food & oil the culprits Governments could no longer fully insulate consumers from increase in retail oil prices Spike in food prices through biofuels link Higher weightage of food and oil in the consumption basket of developing world July 2008- CPI at 9.41% and WPI at 12%+ Increase in fiscal deficit Government absorbed part of the increase in oil and food prices – lower savings EAC’s estimate of off balance sheet deficit on account of rising food and oil prices – 4.5% of GDP Threat of credit downgrade Decline in Capital flows Sharp decline in stock market capitalization and bearish markets Rupee under pressure – feeds inflation Decline in Growth [EAC’s estimate for 2007-08 : 7.7%] Rising interest rates hurt consumption and investment Rise in fiscal deficit and decline in corporate profits result in fall in savings
  41. 41. U.S Soudi Arabia The Devastating effect Consumer price inflation Russia Brazil M… U.K. Germany South Korea China India Thailand 16 14 12 10 8 6 4 2 0
  42. 42. 10000 11000 12000 13000 14000 15000 16000 17000 18000 19000 20000 21000 January 2007 February 2007 BSE Sensex and FII Equity March 2007 April 2007 May 2007 June 2007 July 2007 Sensex Close August 2007 Contd.. September 2007 October 2007 November 2007 December 2007 FII Equity $M January 2008 February 2008 March 2008 April 2008 May 2008 June 2008 July 2008 August 2008 0.00 1000.00 2000.00 3000.00 4000.00 5000.00 6000.00 7000.00 -4000.00 -3000.00 -2000.00 -1000.00
  43. 43. 39 40 41 42 43 44 45 46 January 2007 February 2007 March 2007 April 2007 May 2007 US Dollar - Indian Rupee Exchange Rate June 2007 July 2007 Contd.. August 2007 September 2007 October 2007 November 2007 December 2007 (RBI) January 2008 February 2008 March 2008 April 2008 May 2008 June 2008 July 1 2008 August 1 2008 September 10 2008
  44. 44. Emerging economies adversely impacted by demand destruction in ‘global consumer of the last resort’: US major trading partner for India (15% of exports), Brazil and China (20% of exports)
  45. 45. Can India and China rescue the world? Emerging markets have borne the brunt of the second round impact and are themselves bearish
  46. 46. Lessons of the sub prime crisis for India You cannot decouple from the world’s biggest economy in a fast integrating world Sophisticated structured finance products can become ‘weapons of mass destruction’ Moral hazard and financial sector liberalization RBI must rethink the concept of Universal Banking Focus on ‘Credit Discipline’ as a corrective to financial inclusion Reconsider basing monetary policy entirely on movements in consumer prices alone
  47. 47. Bailout Ben
  48. 48. Rationale for the Bailout Stabilise the Economy Improve Liquidity Second Bailout of Comprehensive Strategy $800 billion Immediate and Significant announced yesterday Broad Impact by FED Investor Confidence Impact on Economy and GDP
  49. 49. When the music stops in terms of liquidity, things will get complicated. But as long as the music is playing, you've got to get up and dance. We're still dancing. - Chuck Prince, Citigroup
  50. 50. Now What???
  51. 51. Liquidity Crunch The reduced availability of liquidity Interest rate premiums U.S.: Banks not lending to each other ROW: London Interbank Offered Rate (Libor) Libor is used to set rates on the $360 trillion of financial products worldwide. Three month Libor set an all time high last week at 5.34%.
  52. 52. Overview of Credit Exposures and Estimated Losses (September 2008; billions of US dollars) Amount Outstanding Estimated Losses Residential Credit: Depository Institution Loans $2,889 $308 Non-Agency Securities $2,531 $523 GSE Exposures $4,807 $76 Subtotal $10,227 $907 Non Residential Credit: Loans $7,670 $195 Non-Agency Securities $5,440 $475 Subtotal $13,110 $670 Total $23,337 $1,577
  53. 53. Estimated Costs of Banking Crisis Country Period Estimated Cost as % of GDP United States 1980 2.5 % Japan 1990 20.0 % est. Norway 1987-89 4.0 % Korea 1997 60.0 % p Indonesia 1997 80.0 % p U.S.A. 2007-2010 $700 billion = 5.0 % $1600 billion = 11.4 % $3200 billion = 22.8 %
  54. 54. Is Depression Imminent: During the Great Depression Combined GDP of 7 largest economies dropped by 20% during 1929-1932 There were no deposit insurance, so people withdrew money from banks and many banks failed Fed increased interest rate (!!) and reduced liquidity U.S. imposed heavy tariffs and other countries reciprocated lowering world trade by 70% The situation is much different as a lot is learned from experiences of the Great Depression