Global Financial Crisis 2008

 Financial crises and accompanying economic recessions have
occurred throughout history. Periodic crises appear to be part of
financial systems of dominant or global powers.
 The United States is the epicentre of the current financial crisis.
Enjoying a unipolar moment following the collapse of the Soviet
Union and the failure of Communism, the United States was
confident that economic liberalization and the proliferation of
computer and communications technologies would contribute to
ever-increasing global economic growth and prosperity.
 Globalization contributed to the extraordinary accumulation of
wealth by a relatively few individuals and created greater
inequality.
 In an effort to reduce inequality in the United States, the
government implemented policies that engendered the financial
crisis.

 Financial globalization contributed to the unprecedented
growth and prosperity around the world.
 China and India became significant economic powers, and the
industrializedcountries grew even richer.
 Closely integrated into the financial system are banks and
investment firms. When the financial system is in crisis, banks
reduce lending, companies often face bankruptcy, and
unemployment rises. Ultimately, as we saw in the financial crisis of
2008–2009, many banks fail.
 The financial crisis triggered a global economic recession that
resulted in more than $4.1 trillion in losses, unemployment rates
that climbed to more than 10 percent in the United States and
higher elsewhere, and increased poverty. Stock markets around
the world crashed.

Consumers reduced their spending, manufacturing
declined, global trade diminished, and countries adopted
protectionist measures, many turning their attention inward
to focus on problems caused by the financial crisis. Given
the central importance of finance to virtually all aspects of
globalization, issues such as trade, the environment, crime,
disease, inequality, migration, ethnic conflicts, human
rights, and promoting democracy are affected.
Furthermore, the financial crisis weakened some countries
more than others, thereby engendering significant shifts of
power among countries, especially between the United
States and China.
American investors lost roughly 40 percent of the value of
their savings.

REASONS FOR THE CRISIS
Housing price increase during 2000-2005, followed by a
levelling off and price decline.
Increase in the default and foreclosure rates beginning in
the second half of 2006 due to the Fed’s manipulation of
interest rates during 2002-2006
Collapse of major investment banks in 2008.
Collapse of stock prices in 2008.

HOUSE PRICE CHANGE
 Housing prices were relatively stable during the 1990s, but they
began to rise toward the end of the decade.
 Between January 2002 and mid-year 2006, housing prices increased
by a whopping 87 percent.
 The boom had turned to a bust, and the housing price declines
continued throughout 2007 and 2008.
 By the third quarter of 2008, housing prices were approximately 25
percent below their 2006 peak.

INCREASE IN INTEREST RATE
 Fed's prolonged Low-Interest Rate Policy of 2002-2004 increased demand
for, and price of, housing.
 The Fed injected additional reserves and kept short-term interest rates at 2%
or less throughout 2002-2004
 Due to rising inflation in 2005, the Fed pushed interest rates upward.
 Interest rates on adjustable rate mortgages rose and the default rate
began to increase rapidly.
 Default rate reached 5.2 percent during the third quarter of 2008.
 Starting in 2006, there was a sharp increase in the foreclosure rate.

COLLAPSE OF INVESTMENT BANK
 An SEC Rule change adopted in April 2004 led to highly leverage lending
practices by investment banks and their quick demise when default rates
increased.
 The rule favoured lending for residential housing.
 Based on historical default rates, mortgage loans for residential housing
were thought to be safe. But this was no longer true because regulations
had seriously eroded the lending standards and the low interest rates of
2002-2004 had increased the share of ARM loans with little or no down
payment.
 When default rates increased in 2006 and 2007, the highly leveraged
investment banks soon collapsed.

COLLAPSE OF STOCK PRICES
 As of mid-December of 2008, stock returns were down by 37 percent since the
beginning of the year.
 This is nearly twice the magnitude of any year since 1950.
 This collapse eroded the wealth and endangered the retirement savings of many
Americans.

IMPACT ON MARKETS
The global financial crisis affected virtually all areas, including
the process of globalization. Housing prices crashed; foreclosures became
commonplace; unemployment reached 10 percent in the United States and higher
levels in Europe and elsewhere; manufacturing declined sharply, especially in the
automotive industry; students were faced with higher costs as colleges suffered
financial losses; finding jobs after college became more challenging; and a global
recession created widespread hardships. On the other hand, many developing
countries that took a prudent approach to finance and saved money were not as
badly damaged. In fact, countries that did not fully embrace financial liberalization
were less affected than those that gave in to American pressure to fully engage
in financial globalization. We also saw a global power shift, with the United States
losing ground to China, India, Brazil, and other developing countries.

FORECLOSURES
 People could no longer afford to purchase homes, which meant that
homebuilders were forced to abandon construction projects.
 This resulted in a fall of demand of goods required in construction.
 All of the industries that produced these products generally
experienced declining sales.
DECLINE IN MANUFACTURING
 Manufacturing, already in decline, fell dramatically.
 This especially was the case in the automotive industry, with General
Motors and Chrysler declaring bankruptcy after closing many factories
and dealerships, despite unprecedented financial support from the
U.S. government.

GLOBAL POWER SHIFT
Another major impact of the global financial crisis is a
global power shift.
Although most countries were negatively affected by
the financial crisis and global recession, some
emerged stronger than others.
 Brazil, Russia, India, and China, also known as the BRIC
countries, enhanced their power vis-à-vis the United
States, Western Europe, and Japan.

HOW DID INDIA MAKE IT THROUGH?
 In sharp contrast to the policies adopted by the U.S. Federal Reserve
under Chairman Alan Greenspan, the Reserve Bank of India, led by Y .
V. Reddy, rejected many financial innovations and limited the
participation of foreign investors in India’s financial system.
 Instead of believing that markets are self-regulating, as many
Americans do, the Indian government favoured regulations and was
quick to recognize financial bubbles.
 Reddy restricted bank lending to real estate developers, increased
the amount of money banks had to set aside as reserves, and blocked
the use of some derivatives.
 This conservative approach enabled India to largely avoid the global
financial crisis.

EFFECTS OF ECONOMIC
CRISIS 2008 ON THE
GLOBAL ECONOMY

 The historic meltdown of the global capital markets, and sharp
economic downturn, is systemic in nature, and is conditioned by the
contradictions, and vulnerabilities, of the current level of economic
organization, with the world economy unable to develop further in the
old manner.
 The global systemic crisis, which itself has built up over decades, will not
be overcome until the vulnerabilities/ and contradictions that caused it
are resolved effectively.

• While the crisis felt more acutely in some regions, it was a
global systemic crisis. The initial epicenter of the crisis was in
the United States, but the crisis was a world crisis which
affected the whole world system and disrupted the
production process. The crisis was felt much stronger in the
USA, and also in countries which are heavily integrated within
the US economic and strategic sphere.
• The crisis was global in nature, and affected all countries that
are part of the world economy, but not necessarily at the
same time and to the same extent. How and when it
affected each country varied. Collapse of several large
international banks, corporate collapses and industrial
shutdowns occured unevenly and at different times in various
countries.

 The crisis produced a handful of winners and help to reinforce global
powerful monopolies controlling nearly all production, commerce
and finance in the world economy. The importance of medium and
small-size business declined still further. The world economy became
increasingly monopolized, and numerous corporate takeovers took
place. Most small-size enterprises were unable to survive.
 After contracting during the crisis, energy consumption resumed its
growth. The global revival will need cheap energy, produced in
greater quantities than before.

 There were already indications that the crisis will possibly encourage
more internally centered economic growth in China, India, Russia
and the rest of the emerging economies, strengthening domestic
markets, but hence reducing their contribution to world trade during
the crisis
 As a result of the deepening of the global economic crisis, social
inequality increased, but inequality of incomes between workers in
the developed economies and the emerging economies lessened.

 The crisis was destined to bring about fundamental changes in
the world economic system. In order to develop further, the
world economy needs qualitative changes. There are limits to
reform in the current global economic system, but at no other
time in the last half-century have those limits seemed more
flexible.
 As a result of the serious collapse in global markets, and also
because of the relative strength of their banking sector, it is
quite possible that the emerging economies will increasingly
shape the future of global finance just as they are already
shaping the direction of global trade

IMPACT ON STOCK MARKET
 The immediate impact of the US financial crisis has been
felt when India’s stock market started falling. On 10
October, Rs. 250,000 crores was wiped out on a single
day bourses of the India’s share market.
 The Sensex lost 1000 points on that day before regaining
200 points, an intraday loss of 200 points. This huge
withdrawal from the India’s stock market was mainly by
Foreign Institutional Investors (FIIs), and participatory-
notes.

 IMPACT ON INDIA’S TRADE
The trade deficit is reaching at alarming proportions. Because of worker’s
remittances. NRI deposits, FII investment and so on, the current deficit is at
around $10 billion. But if the remittances dry up and FII takes flight, then
we may head for another 1991 crisis like situation.
 IMPACT ON INDIA’S EXPORTS
With the US and several European countries slipping under the full blown
recession, Indian exports have run into difficult times, since October.
Manufacturing sectors like leather, textile, gems and jewellery have been
hit hard because of the slump in the demand in the US and Europe.
Indian exports fell by 9.9 per cent in November 2008, when the impact of
declining consumer demand in the US and other major global market,
with negative growth for the second month, running and widening
monthly trade deficit over $10 billions

. IMPACT ON INDIA’S HANDLOOM SECTOR, JEWELRY EXPORT AND
TOURISM
 Again reduction in demand in the OECD countries affected the Indian
gems and jewellery industry, handloom and tourism sectors.
 Around 50,000 artisans employed in jewellery industry have lost their jobs as
a result of the global economic meltdown.
 Further, the crisis had affected the Rs. 3000 crores handloom industry and
volume of handloom exports dropped by 4.6 per cent in 2007-08, creating
widespread unemployment in this sector .
 EXCHANGE RATE DEPRECIATION
 With the outflow of FIIs, India’s rupee depreciated approximately by 20 per
cent against US dollar and stood at Rs. 49 per dollar at some point,
creating panic among the importers.

 IT-BPO sector
The overall Indian IT-BPO revenue aggregate is expected to grow by over 33 per
cent and reach $64 billion by the end of current fiscal year (FY200). Over the
same period, direct employment to reach nearly 2 million, an increase of about
375000 professionals over the previous year. IT sectors derives about 75 percent of
their revenues from US and IT-ITES (Information Technology Enabled Services)
contributes about 5.5 percent towards India’s total export. So the meltdown in the
US will definitely impact IT sector. Further, if Fortune 500 companies slash their IT
budgets, Indian firms could adversely be affected.
FII and FDI
The contagious financial meltdown eroded a large chunk of money from the
Indian stock market, which will definitely impact the Indian corporate sector.
Due to global recession, FIIs made withdrawal of $5.5 billion, whereas the inflow
of foreign direct investment (FDI) doubled from $7.5biilion in 2007-08 to $19.3
billion in 2008 (April-September).

 The FEDERAL RESERVE (Fed) has been extremely
active in making sure that the financial system
continues to function properly during the credit crisis.
 The Fed lowered its key federal fund rates to provide
additional liquidity to the financial system, expanded
the range of collateral it would willing to accept in
return for loans, and provided direct lines of credit to
a broader variety of financial institutions
 When Bear Stearns was on the verge of bankruptcy
the Fed also guaranteed a large portion of Bear
Stearns' liabilities in order to facilitate a takeover by
JPMorgan.
THE FEDERAL RESERVE

 The executive branch of the government has also been closely
involved in maintaining stability in the financial system.
 the Federal Housing Finance Agency (FHFA,) in conjunction with
the Treasury Department, placed Fannie Mae and Freddie
Mac under conservatorship as part of a four-part plan to
strengthen the housing agencies.
 Following the rescue of Fannie Mae and Freddie Mac, the
government chose not to rescue Lehman Brothers, instead
allowing it to file for bankruptcy on September 15.
THE GOVERNMENT RESCUES
PROMINENT FINANCIAL FIRMS

 Faced with the possibility of a systemic collapse of the
financial system, the Treasury proposed a $700 billion
plan that would involve the government's purchase of
impaired assets from the balance sheets of banks
 Initially refused,The Treasury subsequently revised its
proposal, and spurred by rapidly worsening financial
market conditions, the House voted to pass the bill on
October 3, 2008
 Similar plans have been implemented globally as part
of efforts to stabilize financial systems and stimulate
economic activity.
THE "BAILOUT PLAN"

 Following the stock market crash of 1929, policy
makers committed a trio of errors. They
tightened monetary policy, restricted fiscal spending
and failed to enhance confidence in the banking
system.
 It is widely believed that these mistakes exacerbated
the effects of the depression that followed.
 Policymakers have learned from these mistakes, and
those lessons were put to good use during the credit
crisis of 2008, during which the Fed provided
enormous amounts of liquidity to the financial system.
HOW EFFECTIVE WERE THESE MEASURES

 The government also increased its spending, thereby
providing fiscal stimulus to the economy.
 Finally, the government took extraordinary measures to
secure confidence in the financial system through a variety
of guarantees, insurance programs, loans and direct
investments.
CONTD.

Global Financial Crisis 2008

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