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Global Economic Crisis 2008

Global Economic Crisis 2008

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Published by Puneeth Munoth

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Published by: Puneeth Munoth on Jun 08, 2010
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Economic ProjectOn
Global EconomicCrisis 2008
 Name: Puneeth .P. MunothClass: 2
sem B.com µF¶Roll no: 09DC1571
The global financial crisis, brewing for a while, really started to show its effectsIn the middle of 2008. Around the world stock markets have fallen, large financialinstitutions have collapsed or been bought out, and governments in even the wealthiestnations have had to come up with rescue packages to bail out their financial systems.
n the one hand many people are concerned that those responsible for the financialproblems are the ones being bailed out, while on the other hand, a global financialmeltdown will affect the livelihoods of almost everyone in an increasingly inter-connected world. The problem could have been avoided, if ideologues supporting thecurrent economics models weren·t so vocal, influential and inconsiderate of others·viewpoints and concerns.When the financial crisis erupted in a comprehensive manner on Wall Street, there wassome premature triumphalism among Indian policymakers and media persons. It wasargued that India would be relatively immune to this crisis, because of the ´strongfundamentalsµ of the economy and the supposedly well-regulated banking system.This argument was emphasized by the Finance Minister and others even when otherdeveloping countries in Asia clearly experienced significant negative impact, throughtransmission of stock market turbulence and domestic credit stringency.These effects have been most marked among those developing countries where theforeign ownership of banks is already well advanced, and when US-style financialsectors with the merging of banking and investment functions have been created.If India is not in the same position, it is not to the credit of our policymakers, who hadin fact wanted to go along the same route. Indeed, for some time now there have beencomplaints that these ´necessaryµ reforms which would ´modernizeµ the financialsector have been held up because of opposition from the Left parties. But even thoughwe are slightly better protected from financial meltdown, largely because of the stilllarge role of the nationalized banks and other controls on domestic finance, there iscertainly little room for complacency.The recent crash in the Sensex is not simply an indicator of the impact of internationalcontagion. There have been warning signals and signs of fragility in Indian finance forsome time now, and these are likely to be compounded by trends in the real economy.As the current financial crisis continues to evolve globally, there are a seeminglyinfinite number of questions emerging about how the crisis developed and spread, howit is impacting financial institutions as well as other companies, what governments aredoing to address the crisis, and what companies must do to secure their own futures.
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The financial meltdown had its origin in the U.S. mortgage market of the early and mid-2000s. At the time, the economy was booming, the U.S. government was intent on
making home ownership affordable to more people, financial institutions were awashwith liquidity, and real estate values were rising endlessly. Competition among mortgagelenders led to innovation ² teaser-rate adjustable mortgages and other non-traditionalmortgage terms such as no- and low-documentation loans ² that opened up the realestate market to borrowers who previously would not have qualified for credit, i.e.,subprime borrowers.All was well, provided that interest rates did not rise and housing prices continued toescalate. In 2004, however, the Federal Reserve began to raise interest rates. In2006, housing prices started to taper off after rising nearly 50 percent between 2000and 2006.As the market declined, borrowers who had expected to refinance theirmortgages when their loans re-priced to higher interest rates coupled with highermonthly payments found they were not able to do so. Consequently, these borrowerswere unable to meet payment requirements, leading to defaults that escalated as realestate values continued to decline.Concurrent with the growth in mortgage lending, significant financial innovation wasoccurring in the financial markets. Pools of mortgage loans, including those extended tosubprime borrowers, were aggregated into portfolios of structured products based onthe cash flows of the underlying assets ² in other words, these loans were securitized.These securities/investments/derivatives were marketed to both institutional andretail investors. To enhance the marketability of these instruments, credit defaultswaps (CDS) were issued, and the growth in the CDS market paralleled the growth inthe underlying mortgage market. While some of these financial instruments ended up inhedge fund portfolios, due to the significant volume of this market and the underlyingassets as well as considerable investor appetite, these instruments became widelydistributed throughout the global financial system to buyers ranging from governmentsponsored enterprises (GSEs) and financial institutions to mutual funds/money marketfunds, pension funds and retail investors.Given the sponsorship of instruments and retention of key risk components by a numberof the large financial firms and the retention of key risk components of theseproducts, concerns over the safety, soundness and credit worthiness of a number ofkey market participants (including Lehman Brothers, AIG and Merrill Lynch) began toimpact the market negatively as the crisis began to unfold. Since many of theinstruments involved are complex and lack transparent market pricing, they not only arehard to price, but illiquid, further exacerbating the funding and capital issues of anumber of financial organizations.A similar picture then emerged in other developed countries as the combination ofcompetition, innovation, readily accessible credit, and the ballooning of securitizationand resulting leverage created a massive systemic susceptibility to falls in globalresidential property values and mortgage defaults, in addition to huge losses incurredon exposures to the U.S. subprime market. News of massive losses by institutions mostexposed to such risks evolved and escalated, eventually creating a crisis of confidence

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