US-Financial Crisis

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Summarizes the current global financial turmoil that originated from USA.

Summarizes the current global financial turmoil that originated from USA.

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  • 1. Bhaskar Bhattacharya, Debashis patra PGP 2008-10, Indus World School of Business US Financial Crisis
  • 2. The Origins
    • Growth of the Housing Asset Price Bubble
    • Further fuelled by the collapse of the Dotcom Bubble
    • A combination of low interest rates and cheap money
    • Widespread lending to subprime borrowers
    • Change from Fixed Rate Mortgages to Adjustable Rate Mortgages
    • Securitizing these into Mortgage Backed Securities
    • The creation of CDO’s and CDS’s by Investment Banks through financial engineering
    • Banks and Financial Institutions investing and trading in these high-risk high-return securities
  • 3. The Subprime Saga
    • What is “Subprime” ?
    • Subprime lending and the creation of the subprime market
    • Rapid increase in subprime lending by Banks and Financial Institutions
    • Consumption led boom coupled with savings rate/disposable income falling from 5.0% to 2.0%
    • Speculation rather than economic fundamentals driving the Housing market
    • Collapse of the Stock Bubble fed the Housing Bubble even further
  • 4. The Crisis unfolds
    • Housing Bubble bursts in mid 2007
    • By the end of 2007, Housing prices had fallen between 15% to 30% across various locations in the US
    • Home loan defaults rose rapidly by the weaker income groups across the US – The main beneficiaries of subprime lending
    • 320,000 foreclosures declared by the end of 2 nd quarter of 2007 as against 225,000 during 2001-06
    • Exposure of Banks, Pension Funds and Financial Institutions to CDO’s and SIV’s
  • 5. Mayhem in the Markets
    • Increase in Subprime Defaults – Trigger for Financial Meltdown
    • Falling Real Estate prices+ Slowdown in Construction and Real Estate Sector = slowdown in the Economy
    • Mounting losses contributed to shrinkage of lending capacity
    • Banks and Financial Institutions exposure to bad debts grew by the day
    • Leveraged investors selling MBS and other such holdings in panic – Further drops in prices and more losses
    • Drying up of secondary market and availability of short term finance
  • 6. Blood on Wall Street
    • I-banks heavy exposure to overrated CDS’s and MBS’s
    • Reduction in valuation of MBS’s- $ 14.5 trillion as of 2008
    • Weak Regulatory System
    • Precursor- Repeal of Glass-Steagal Act(1933) by Gramm-Bleach-Bliley Act(1999)
    • Notional value of CDS’s in 2007 = $45 trillion
    • Northern Rock, Bear Stearns, Merrill Lynch, Lehman Brothers, AIG, Washington Mutual – They all fall down
    • The remaing I-banks, Goldman Sachs and Morgan Stanley become Bank Holding companies after being bailed out
    • Citigroup tottering on the brink
  • 7. Fiscal Stimulus Package 2009
    • Officially known as – American Recovery and Reinvestment Act of 2009
    • Signed into law on Feb 17 th by President Barack Obama in Denver, Colorado
    • Federal Tax Cuts,Expansion of Unemployment Benefits,and other social welfare provisions
    • Also includes increased domestic spending in Education, Healthcare and Infrastructure
    • Larger than the bailout package or Economic Stimulus Act 2008
    • Final Bill - $ 787 billion with 64% devoted for social sector
  • 8. References
    • http://www.thehindubusinessline.com/2007/08/14/stories/2007081450040700.htm
    • The Subprime Crisis A Primer-MIHIR RAKSHIT ,ICRA Bulletin , Money and Finance ,June 2008
    • “ Deal Struck on $789 Billion Stimulus”. New York Times. February 11, 2009.
    • “ Why Bankers Got So Reckless” by Prof Amar Bhide, Business Week February 9,2009
    • “ Managing US Financial Crisis” – Dr Satyendra Nayak, Indian Banker, Dec 2008
    • “ The Run-Up in Home Prices: Is It Real or Is It Another Bubble? ” Dean Baker, CEPR, August 2002
    • Lehman Files for Bankruptcy; Merrill Is Sold" article by Andrew Ross Sorkin in The New York Times September 14, 2008
    • And many more…….
  • 9.