Sub-prime crisis and its potential impact on European and Asian Markets The document discusses the sub-prime crisis, its causes, and potential impacts. It analyzes trends in sub-prime lending and defaults that led to the credit squeeze. It examines how the crisis could recouple or decouple economies in Europe and Asia. The crisis may negatively impact European markets through re-coupling of credit, commodity, and currency markets. However, Asian markets like India's regulated economy and local consumption may make it more resilient to effects of the crisis.

1. Sub-prime crisis and its potential impact on European and Asian Markets Flow Sub Prime lending leading to credit squeeze Trends of Sub Prime lending and defaults – Where are we heading? Known causes of the crisis What NEXT? Re-coupling or decoupling with other economies A different perspective Sources Nitin Agarwal [email_address] +91 99001 38830

2. US: A society of “economic freedom” - Credit Squeeze explained Tranche Prime Sub prime Individual Borrower US Housing Boom Mortgage Lender Commercial Bank Walls Street Lender Hedge Funds, Pension Funds other FI SIV Collateralized Debt obligations Mortgage Backed Securities Structured products Financial Counterpart / lender Central Banks Rating Agencies Inducting Money Interest Only Principle Only Z Bond Sub prime Loans NegAm Fannie & Freddie

3. Numbers and trends Note: Data exclude home equity loans. Source: United States Government Accountability Office Growth in Sub Prime lending Sub Prime foreclosures maximum Default and foreclosure increasing. They increase in recessing economy Sub Prime home purchasing increase Market Shares of the Minority Submarket for Home Purchase Mortgages ( in terms of number of loans) Default and foreclosure trends

4. Numbers and trends % of securitized loan balances increasing Interest Only loans and NegAm loans

5. Known Causes of the Crisis Proximate Causes: Unsustainable boom in house prices  easing of underwriting requirements Price collapse  marked rise in defaults Price declines and rising defaults cause drastic tightening of underwriting requirements hence no refinance available Factors Contributing to Defaults: Voracious loan providers Dysfunctional principal/agent relationships Toxic and poorly understood mortgages Grossly inadequate disclosures Accommodative appraisals

6. Causes of the Crisis (Con’d) Factors Contributing to Metastisization New instruments, especially CDOs Colossal lack of judgment by credit rating agencies Losses in this market have always bunched Why was the system so unprepared – as indicated by the large number of firm failures? Complex loans –> Negative Amortization loans – good for short term but hurt in long term Shadow banking system – Off balance sheet vehicle of banks Unregulated banking system, hedge funds, private equity players Complexity increased with HIGHLY leveraged positions  margin calls  defaults

7. What NEXT? - Account for variable CHANGE Markets are unknown unknowns (Satyajit Das) No one can predict the way they behave – also governed by emotion and perception Black Swan A rare event With high-impact Hard to predict (pattern attributed post event) Hedge funds and private equity firms to be the next ones to get hit Government to intervene Is it justified to use the tax payers money? 700Bn $ package announced. Move to regulate the economy Revamp accounting systems and financial markets Selectively start Regulating the economy Rating agencies and Risk standards to be strengthened Strengthen the underwriting standards

8. Re-coupling or Decoupling with other economies European Markets Fairly coupled with US Re-coupling of the economies Commodity prices Currency market Credit market The financial situation to move to Europe – negative ripple effect Bond yields to go down Companies invested in complex derivative instruments with leveraged positions to be in trouble and hence clean their balance sheet Less liquidity  Inflation to rise Consumption to take a hit More regulated society – Government to come to rescue – as a last lender resort EU as a whole may still be less impacted due to growth coming from some sectors / geography Opportunities Companies with sound / healthy balance sheets to expand Credit crunch will give companies less room to borrow Indian companies with less leveraged positions and positive growth outlook within the country will get a chance to taste the European markets  TATAS – CORUS, JLR Once the balance sheet is cleaned and the borrowers are free of their mortgage debts they will have more money to spend and the markets will revive. TIMING cannot be stated USA EU/UK US corporation EU/UK corporation Subsidiary of EU/UK corporation Subsidiary of US corporation 100% Ownership 100% Ownership Source: Book - Traders, guns and money

9. Re-coupling or Decoupling with other economies Asian Markets – India Largely a regulated economy Absence of complex financial instruments Economy still will growth at good rate. Marked by local consumption and demand Growth may slow down due to re-coupling effect Inflation may be the problem to stay Tightening of monetary policy With the global turmoil the reforms in finance sector may slow down Growth of service sector to slow down a bit Faith in Dollar to be hit Due to less liquidity the SME to be impacted Opportunities Investors may have more faith in the positively regulated economies and with growth potential Time for consolidation and getting value picks in the Indian and foreign markets Cash rich companies can make the most of the opportunities – can do some value picking

10. A different perspective : An accounting crisis MTM losses to be accounted (made provision for) MTM profits not accounted – based on conservative principle of accounting There is lot of room for hocus pocus accounting hence the accounting system needs to be streamlined further Off Balance sheet SIVs

11. Sources www.Wikipedia.org www.FT.com www.rgemonitor.com – Nouriel Roubini www.investopedia.com www.economist.com The Black Swan – Naseem Nicholas Taleb Traders, Guns and money – Satyajit Das

12. Thank You