Transcript Subprime_crisis_Final_450125120

SUBPRIME CRISIS
Presented by:
Shruti Tiwari
Financial Crisis-Meaning
 Situation in which financial Institutions or
assets loose a part of their value.
 It includes stock market crash, currency crisis
& busting of other financial bubbles.
Types of Financial crisis :
 a) Banking Crisis :Sudden rush of withdrawal
by depositor (bank run)
 b) Wider Economic Crisis
 Recession: Downturn in economic growth
lasting several quarters or more
 Depression: Prolongated recession
 Stagnation: Long period of slow but not
negatively growth.
Reasons for Financial Crisis
 Strategic Complementary in Financial Market
 Asset- Liability Mismatch
 Regulatory Failure :Regulators make sure
that institutions have sufficient assets to meet
out obligations
 Contagion: Financial crisis spread from one
institution to another.
Key Terms
 Credit (Debt)
 Credit Squeeze :Control of money supply by
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govt.
Liquidity Crisis : business experiences lack of
cash required to meet out its debt obligation
Freezing of economic activity: Investment
sentiments go down, banks are unwilling to lend
Monetary policy & Fiscal Policy
Investment Banking
Mortgages
 Bailout : Act of loaning or giving capital to a
failing business in order to save it from
bankruptcy ,insolvency.
 Securitization: Pooling & Repackaging of
Cash Flow producing financial assets into
securities that are sold to investors
 Collateral Debt Obligation :Security backed
by diversified pool of debt obligation such as
bonds loans or structured instrument.
Advertisements in US
 "No repayment for
first 2 years“
 "Want to be rich ? Buy
Property!“
 "Money no enough?
Borrow from me!”.
 "Zero down payment"
 "Low rate guaranteed"
Introduction
 Borrowers are rated either
as 'prime' - indicating that
they have a good credit
rating based on their track
record
 As 'sub-prime', meaning their
track record in repaying
loans has been below par.
 It is the poor and the young
who form the bulk of subprime borrowers.
How it Started..??????
 In the mid 90s, there was a push to ease the
rules for first time home purchasers under the
Clinton administration’s National Home
Ownership strategy .
 Expanding home ownership was also a
center piece of George Bush’s agenda as
president.
 2000 dot com bubble
 Almost every rule was relaxed.
 Proof of income for loans was reduced from
five years to three.
 Houses were offered with low or no down
payment.
 “Teaser rates” (where interest rates were as
low as 1% initially but then went up to 8%).
 “Liar mortgages” (in which the information
provided by applicants was not checked)
Sub-prime crisis
 The sub-prime mortgage crisis is an real
estate crisis and financial crisis triggered by a
dramatic rise in mortgage delinquencies and
foreclosures in the United States .
 Major adverse consequences for banks and
financial markets around the globe.
 Approximately 80% of U.S. mortgages issued
in recent years to sub-prime borrowers were
adjustable-rate mortgages.
Contd..
 As interest rates started falling due to excess
liquidity, house prices started rising rapidly, creating a
pool of wealth in the hands of Americans, which they
unlocked by contracting mortgage loans.
 It benefited them in two ways — they got huge
liquidity at inflated housing prices and at interest
rates that were practically lowest in the last 20 years.
 This became a virtuous cycle, resulting in a very high
consumer spending and obviously fuelling global
growth .
Sub-prime crisis contd….
 Securities backed with sub-prime mortgages,
widely held by financial firms, lost most of
their value.
 It has started causing problems for Americans
in the form of job losses, less consumer
spending and the fears of a slowdown.
What was the interest rate on sub-prime
loans ??????
 Interest rate charged on sub-prime loans was
typically about two percentage points higher than
the interest on prime loans.
 The higher interest rate additionally meant
substantially higher EMIs than for prime
borrowers, further raising the risk of default.
 New instruments were devised to reach out to
borrowers
 Instruments which asked borrowers to pay only
interest payments were devised.
Federal Fund Rate in the US
How did this turn into a crisis?
 One major reason was that the boom had led to a massive
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increase in the supply of housing.
Thus house prices started falling
This increased the default rate among sub prime borrowers
Many of whom were no longer able or willing to pay the
collateral is typically the home 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.
The declining value of the collateral means that lenders are
left with less than the value of their loans and hence have to
book losses .
The Deterioration of the Sub-prime
Market ..
 Combination of industry
trends and economic
and financial factors
combined to create the
current crisis in the
mortgage markets.
 Borrowers with financial
difficulties could not sell
their homes to pay off
mortgages
 In 2006 and 2007,
borrowers suffered
“Payment Shock” when
teaser rates on many
hybrid ARMs expired
and higher variable
rates became effective.
The Deterioration of the Sub-prime
Market
 Rising defaults on sub-prime and Alt-A
mortgages have caused rating agencies to
downgrade MBS and CDO bonds backed by
sub-prime mortgages.
 Investors in those securities have already
suffered substantial losses, and uncertainty in
the financial markets about the value of such
securities and potential losses has adversely
impacted liquidity in the financial markets.
Factors Responsible
 The immediate cause or trigger of the crisis was
the bursting of the United States housing bubble
which peaked in approximately 2005–2006.
 High default rates on "sub-prime" and adjustable
rate mortgages (ARM), began to increase quickly
thereafter.
 Once interest rates began to rise and housing
prices started to drop moderately in 2006–2007
in many parts of the U.S.
 Loans of various types (e.g., mortgage, credit
card, and auto) were easy to obtain and
consumers assumed an unprecedented debt
load.
 As part of the housing and credit booms, the
amount of financial agreements called
mortgage-backed securities (MBS), which
derive their value from mortgage payments
and housing prices, greatly increased.
Impact on US Economy
 Many Banks were closed down
 Bear Stearns near collapse shaken the confidence of
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public in its banking system.
September 2008 : Lehman brother( biggest
investment bank ) filed for bankruptcy .
Bailout Packages by US govt. were not enough
AIG was saved by providing $ 80 billion bailout by
govt.
Citi Bank was bailed out by $ 60 billion
UK : Northern Rock –Withdrawal of 2 billion pounds
 Many bailouts were given in European county
 Nationalization of bank was the step taken by
many country's govt. like Russia & Greece
Impact on Indian Economy
 Slowdown in external demand, reversal of capital
flow, growth in Industrial production decelerated
to 2.8% in 2008-09 from 8% previous year.
 Service sector remained largely in effected with
growth of 9.7% in 2008-09 as against 10.5% in
previous year.
 Real GDP growth slowed down to 6.7% in 200809 as against 9%.
 Slowdown in Exports.
Indian Stock Market in Last one year
Actions by central bank
 Cash Reserve Ratio brought down to 5% in
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January 2009 from 9% (September 2008)
injecting Rs.1600 billion is primary liquidity.
Repo and Reverse Repo rates are cut down from
9% to 4.75% and 6% to 3.25% respectively.
Banks were advised to step up lending to core
sectors.
Restriction on interest rate to bulk deposits.
Restrictions loosened on External commercial
borrowing by corporate.
Key Macro Indicators
Indicator
Period
2007-08
2008-09
Growth, per cent
Real GDP Growth
April-December
9.0
6.9
Industrial
production
April-February
8.8
2.8
Services
April-December
10.5
9.7
Exports
April-March
28.4
6.4
Imports
April-March
40.2
17.9
Stock Market
(BSE Sensex)
April-March
16,569
12,366
Rs.per US$
April-March
40.24
45.92
India’s Approach to Managing Financial
Stability
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Financial sector, especially banks, subject to prudential
regulation
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Both liquidity and capital.
Prudential limits on banks’ inter-bank liabilities
Asset-liability management guidelines
Basel II framework: guidelines issued.
NBFCs: regulation and supervision tightened - to
reduce regulatory arbitrage.
Lessons for Indian Investors
 The financial sector in India has a long way to go in
developing a sophisticated risk-minimizing strategy
by adopting complex financial instruments to limit the
sources of risk affecting their asset portfolios.
 It should adopt better standards to evaluate the credit
worthiness of potential borrowers..
 Investors should carefully evaluate the future before
taking new loans for asset purchases.
 As a globally integrated economy, international
events will leave its mark on our economy whether
we like it or not.