The document discusses the history and underlying causes of the global financial crisis. It outlines the decades of deregulation in the US financial system since the 1980s, including the removal of restrictions on savings and loans and the repeal of Glass-Steagall. This led to excessive risk taking by financial institutions through practices like subprime lending, securitization of risky assets, and credit default swaps without adequate oversight. The crisis impacted global economies through reduced demand and interbank lending seizures. The US implemented rescue packages totaling over $1.5 trillion to stabilize financial markets and stimulate the economy.

1. The Global Financial
Crisis
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3/16/2009 Jay Prakash jay@strategicfocus.com 1
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2. Table of Contents
• What is the crisis?
• Underpinnings of US Financial Crisis
– A history of deregulation
• Financial deregulation of S&L’s in the Regan era, 1980’s
• Bank deregulation of 1994
• Repeal of the Glass Stegal act in 1999, Clinton era
• SEC publishes Regulation ―B‖ in 2004
– Violation of Net Capital Rule
– Excessive leverage by Hedge Funds, Private Equity & Mortgage Companies
– Credit Default Swaps
– Failure to police sub-prime
– Packaging & selling of bonds backed by risky sub-prime loans
• Global Impact
• The changing nature of the Rescue Package
– Key Issues that need to be addressed
– Initial Package
–
3/16/2009 Current Package 2

3. What is the crisis?
Foreign Investors
Large Money Flow
Federal Reserve
US Banks
Bank Failure Low Interest Rates
Easy Credit
Positive Consequences
Consumer
--Cars --Home --College
Borrowing
--Entrepreneurs --Small Businesses
Borrowing
3/16/2009 Negative Consequences 3

4. What is the crisis?
Negative Consequences
• Over extended borrowers
• Home foreclosures
• Declining home values; home owners caught in a vicious
cycle
• Credit crunch for qualified borrowers including businesses
• Bank & other financial institutions failure due to non-
repayment of loans
• Loss of confidence
• Declining demand for goods & services in US markets
• Global Economies sliding into recession or reduced growth
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5. Underpinnings of the US Financial Crisis
History of Deregulation
• Financial de-regulation started with S&L’s in the Regan
era in 1980’s
• Many restrictions on the activities of S&L’s limiting to the
home loan market were removed.
• The result was an orgy of speculation, profiteering and
outright plundering of assets, culminating in collapse.
• This resulted in the biggest bailout in US history prior to
the current bailout costing the Federal government more
than $500 billion
• Clearly the lessons from these lax regulations had not been
learnt.
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6. Underpinnings of the US Financial Crisis
History of Deregulation
• Bank deregulation of 1994
• This allowed bank holding companies to operate in more
than one state.
• The result was a rash of merger & acquisitions of regional
banks and an appetite for new markets & new sources of
revenues.
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7. Underpinnings of the US Financial Crisis
History of Deregulation
• Repeal of the Glass Stegal act in 1999.
• Under the Glass Stegal act, banks, brokerage and insurance companies
were effectively barred from entering each other industries --
investment banking and commercial banking were separated.
• Act passed in 1933 in response to:
– 5000 bank failures,
– loss of $7 bil in depositors money,
– 600,000 foreclosures from 1930-1932 --all due to manipulation of the
market by giant banking houses.
• Single most damaging and most consequential act of the Clinton years.
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8. Underpinnings of the US Financial Crisis
History of Deregulation
• Repeal of the Glass Stegal act in 1999.
• Under the Glass Stegal act, banks, brokerage and insurance companies
were effectively barred from entering each other industries --
investment banking and commercial banking were separated.
• Act passed in 1933 in response to:
– 5000 bank failures,
– loss of $7 bil in depositors money,
– 600,000 foreclosures from 1930-1932 --all due to manipulation of the
market by giant banking houses.
• Single most damaging and most consequential act of the Clinton years.
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9. Underpinnings of the US Financial Crisis
History of Deregulation
• Clinton and the Republicans agreed to the deregulation of the US
Financial system in October 1999.
• Most sweeping banking deregulation bill in US history
• Lifted all restraints on the operation of giant monopolies which
dominate the financial system.
• No restrictions on the integration of banking, insurance and stock
trading imposed by the Glass Steagal act of 1933.
• Huge wave of mergers, ex. Citibank buying Travelers Insurance
creating one stop shop for Financial Services
• Law was passed due to pressure from the banks which sought more
profitable outlets for their capital especially in the stock market.
• In 1990 JP Morgan was allowed to engage in stock market operations
up to 10% of revenues. This was increased to 25% in 1994 and in 1999
it was abolished.
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10. Underpinnings of the US Financial Crisis
History of Deregulation
• SEC voted in June 2004 to publish
Regulation B.
• This allows banks to engage in certain
Securities activities without first registering
as brokers with the SEC.
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11. Underpinnings of the US Financial Crisis
Violation of Net Capital Rule
• SEC allows certain broker-dealer firms to legally violate existing net capital
rules that limits debt-to-net capital ratio to 12 to 1 by providing them with
exemptions.
• In 2004 the SEC granted an exemption to five firms—Goldman, Merrill,
Lehman, Bear Stearns, and Morgan Stanley.—which allowed them to leverage
up to 40 to1.
• Three of these firms have blown up. This reckless leverage has led to the
current crisis.
• The so called Net Capital Rule was created in 1975 to oversee broker dealers
that traded securities for customers as well as their own accounts.
• The rule requires that firms value all their tradeable assets at market prices,
and then it applies a hair-cut to account for market risk. The hair cut is 15% for
equities and 6% for Treasury securities because they are less risky. The net
capital rule requires that they limit their debt to capital ratio to 12 to 1 and are
forced to stop trading if they exceed it.
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12. Underpinnings of the US Financial Crisis
Excessive Leverage by Hedge Funds, etc.
• Failure to stop excess leverage. Excess
speculation with borrowed money.
• Typical leverage for a hedge fund and
private equity is 30:1.
• For sub-prime mortgage company the
leverage is infinite because there is no
capital.
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13. Underpinnings of the US Financial Crisis
Credit Default Swaps (CDS)
• CDS are credit derivatives of Mortgage backed securities.
• CDS is a fancy name for insurance. It is not called insurance because
regulatory laws require large capital reserves for losses.
• CDS was sold as an insurance for mortgaged backed securities and
were used to persuade investors to buy the securities in a declining
market.
• When the securities failed, the investors tried cash into the insurance
and this made a run on the bank’s inadequate reserves resulting in a
collapse of these investment firms.
• CDS is the key reason for failure of AIG, Bear Stearns, Merrill Lynch,
Lehman Brothers, etc.
• Regulation of CDS was opposed by Clinton Treasury Secretary Robert
Rubin & Greenspan in 1999
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14. Underpinnings of the US Financial Crisis
Failure to police Sub-Prime
• The core idea of bank regulation:
– Is to examine the banks books;
– Ensure that there are not too many loans behind in interest
payments; and
– Force the banks to raise more capital if needed to cover the losses.
• Regulators basically waived the rule of adequate capital
for the new wave of mortgage lenders who created sub-
prime.
• Many of the mortgage companies were not banks who
made the loans only to sell them off to Wall Street.
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15. Underpinnings of the US Financial Crisis
Packaging & Selling of Bonds backed by Sub-Prime Loans
• Unregulated agencies such as Moody’s and S&P
to rate these bonds.
• In return for a hefty fee, these agencies helped
manipulate the bond so it qualifies for a AAA
rating.
• Fannie Mae & Freddie Mac which purchased the
loans from the banks financed its operations by
selling such bonds.
• By selling the loans to FM & FM, it freed the
banks to issue even more sub-prime mortgages.
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16. Global Impact
• Loss of confidence in inter-bank lending.
• Severe credit crunch even for borrowers with good
credit history
• High interest rates.
• Increased number of home foreclosures, reduced
auto sales, reduced consumer spending
• Declining home values
• Emerging economies such as India & China hit
with lower growth rates because of declining
demand in the US markets
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17. Rescue Package
Key Issues
• Guaranteeing inter-bank lending
• Guaranteeing mortgage backed loans by
Fannie Mae & Freddie Mac
• Delay home foreclosures; allowing
refinance at lower fixed rates.
• Increasing money supply
• Increasing consumer & investor confidence
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18. Rescue Package
Initial Package
• $700 bil initial package from US Govt
• Bail out large institutions such as AIG
• Cleanup balance sheet of financial
institutions by buying up bad debt ie
mortgage based assets.
• Objective was to free up the companies to
make loans again.
• It is too early to tell if this is working!
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19. Rescue Package
Stimulus Package: $787 billion
• Infrastructure - Rebuilding our highways, bridges,
schools, etc. alongside creating more renewable energy
(39% of total)
• State Relief - Helping the states with unemployment
benefits, budget shortfalls, medicaid, and the like (13% of
total)
• Struggling Citizens - Increase food stamps,
unemployment insurance coverage, and provide insurance
for the jobless (12% of total)
• Tax Cuts - Tax cuts to individuals and business (36% of
total)
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20. Rescue Package
Stimulus Package: Detailed Breakdown
• Construction projects: $90 billion.
• Education: $142 billion.
• Renewable energy: $54 billion. Double production of
alternative energy in the next three years.
• Medicaid: $87 billion.
• Unemployment benefits: $43 billion.
• Middle-class tax cut: $145 billion.
• Tax cuts for companies suffering losses: $17 billion over
10 years.
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