The document summarizes the origins and growth of the 2007-2008 US financial crisis. It discusses how a combination of low interest rates, risky lending practices, and financial engineering of mortgage-backed securities led to a housing bubble. When the bubble burst in 2007, it triggered a wider financial crisis as large banks and financial institutions suffered huge losses from their investments in these toxic assets. The crisis saw the collapse of major firms like Lehman Brothers and AIG, freezing of credit markets, and global economic slowdown. In response, the US government implemented a fiscal stimulus package in 2009 to boost the economy.

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…….