Presented By:
Pankaj Agarwal (President)
Mohit Almal (Secretary)
Kaushambi Ghosh ( Co- Secretary)
Manish Madhukar (Member)...
2
Agenda
Subprime
  •Traditional Model Vs Subprime Model
  •Players in the Game
Bubble
  •Housing Bubble
     Why it burs...
Subprime



           4
5
6
Traditional Model Vs Subprime
            Model



                                7
8
Players in the GAME




                      9
Players
Player 1: Fed
   -- Fed kept the interest rate low during much of 1990s
      and particularly 2001-2005 (low oil ...
Contd..
Player 3: Primary Lenders
 -- No incentives for judicious lending
       Banks no longer needed to hold on to the ...
Contd..
Player 4: Other Financial Institutions
 -- Freddie Mac and Fannie Mae issued many
Mortgage Backed Securities

 -- ...
Contd..
Player 5: Credit rating Agencies and Analysts
 -- Lack of market for many of these securities, so
         models ...
Bubble



         14
Historic Bubbles
Dutch Tulip Mania        (1630s)
South Sea Bubble         (1710s)
British Railway Bubble   (1840s)
US...
Structure of a Bubble
 Displacement      (diffusion of new technology starts)

 Take off          (stock prices show abn...
Population Dynamics in the Course of
             a Bubble




                                   17
Housing Bubble



                 18
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babfabfbafbababf
bafbabfabfba...
20
21
Why housing bubble
    burst????



                     22
23
Process of Securitization




                            24
25
Recap: Causes
Boom and bust in the housing market

High-risk mortgage loans and lending practices

Securitization pract...
Contd..
Inaccurate credit ratings

Government policies

Policies of central banks

Financial institution debt levels a...
How bubble burst led to
      crisis???




                          28
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...
Ripple Effect-Suck Everything
The housing bubble

  Defaults & write

    A hole in the bubble

      Banks go belly-up

 ...
31
How it Unfolded???


                     32
33
34
Impact




         35
Banks             Writedown($ billion)                 Actions
      Citigroup                  55.1           Bailout by ...
Crashing Stock Indices
        30000
        25000
        20000
Value




        15000
        10000
         5000      ...
List of events




                 38
Date             Events

8th September    Fannie Mae/Freddie Mac placed into conservatorship by U.S.
                 Gove...
Date             Events
25th September   Washington Mutual is seized by FDIC; assets sold to JPMorgan for
                ...
Loss in crisis
1000


 900


 800


 700


 600


 500
                                                                   ...
IMF raises the loss amount to
      1.4 trillion dollars




                                42
Country wise Action
United kingdom
Has lined up a $850-billion rescue plan, May nationalise Royal Bank of Scotland

Will...
Contd..
Belgium
The government took partial control of the struggling Fortis Bank


France, Belgium and Luxembourg stump...
Contd..
United states
May pick up ownership in failing US banks (Morgan Stanley is reported to be one)


Fed ready to le...
Contd..
Singapore
 Eased monetary policy for the first time since 2003 after sinking into its first
  recession in six ye...
Contd..
Spain
Will spend 50 billion Euros ($68 billion) to buy bank assets, almost a third of the
proposed 2009 central g...
Bailout Ben




              48
Rationale for the Bailout
Stabilise the Economy

Improve Liquidity           Second
                            Bailout of...
50
When the music stops in terms of liquidity, things will
 get complicated. But as long as the music is playing,
 you've got...
Now What???




              52
Liquidity Crunch
The reduced availability of liquidity
   Interest rate premiums
      U.S.: Banks not lending to each oth...
Overview of Credit Exposures and Estimated Losses
                    (September 2008; billions of US dollars)

          ...
Estimated Costs of Banking Crisis
         Country            Period    Estimated Cost as % of
                           ...
Is Depression Imminent:
During the Great Depression
  Combined GDP of 7 largest economies dropped by
   20%
   during 19...
57
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Subprime Ppt

  1. 1. Presented By: Pankaj Agarwal (President) Mohit Almal (Secretary) Kaushambi Ghosh ( Co- Secretary) Manish Madhukar (Member) 1
  2. 2. 2
  3. 3. Agenda Subprime •Traditional Model Vs Subprime Model •Players in the Game Bubble •Housing Bubble Why it burst? Global Crisis Impact Events Bailouts What Next? 3
  4. 4. Subprime 4
  5. 5. 5
  6. 6. 6
  7. 7. Traditional Model Vs Subprime Model 7
  8. 8. 8
  9. 9. Players in the GAME 9
  10. 10. 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 10
  11. 11. 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). 11
  12. 12. 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 12
  13. 13. 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% 13
  14. 14. Bubble 14
  15. 15. 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) 15
  16. 16. 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) 16
  17. 17. Population Dynamics in the Course of a Bubble 17
  18. 18. Housing Bubble 18
  19. 19. fafafafjafkajfajfabf afbabfabfabfabfaf bajfbajabfabfabfa bfabbafbafabfbafb afbafbababfbafbaf babfabfbafbababf bafbabfabfbafbab ababfbafbabababf ababfabfabfbabfa bfbafbafbabfbafba fbabffabfbafbafba bfbafbabfabfabfab fbabfabfbafbfabfa afaaafafafafaffafaa a 19
  20. 20. 20
  21. 21. 21
  22. 22. Why housing bubble burst???? 22
  23. 23. 23
  24. 24. Process of Securitization 24
  25. 25. 25
  26. 26. Recap: Causes Boom and bust in the housing market High-risk mortgage loans and lending practices Securitization practices Speculation 26
  27. 27. Contd.. Inaccurate credit ratings Government policies Policies of central banks Financial institution debt levels and incentives Credit default swaps 27
  28. 28. How bubble burst led to crisis??? 28
  29. 29. 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 29
  30. 30. Ripple Effect-Suck Everything The housing bubble Defaults & write A hole in the bubble Banks go belly-up Banks get sucked in 30
  31. 31. 31
  32. 32. How it Unfolded??? 32
  33. 33. 33
  34. 34. 34
  35. 35. Impact 35
  36. 36. 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 36
  37. 37. Crashing Stock Indices 30000 25000 20000 Value 15000 10000 5000 17th Jan' 2008 25th Nov' 2008 0 Indices 37
  38. 38. List of events 38
  39. 39. 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 39
  40. 40. 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) 40
  41. 41. 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) 41
  42. 42. IMF raises the loss amount to 1.4 trillion dollars 42
  43. 43. 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 43
  44. 44. 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 44
  45. 45. 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 45
  46. 46. 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 46
  47. 47. 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 47
  48. 48. Bailout Ben 48
  49. 49. 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
  50. 50. 50
  51. 51. 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 51
  52. 52. Now What??? 52
  53. 53. 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%. 53
  54. 54. 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 54
  55. 55. 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 % 55
  56. 56. 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 56
  57. 57. 57

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