GLOBAL FINANCIAL CRISIS

Dr. V. N. BRIMS
 Structure
• Genesis – Amit Gautam & Pratik Purav
• Subprime Crisis- Rupali Mehta
• Bailout package- Jay Lodhaya
• Paul Krugmann on global financial crisis- Saidas Naik
• Europe and Japan- Saurabh Shinde&Poorva Adkar
• Impact on India- Prachie Agarwal&Bijal Shah
• Impact on Chinese economy and Indian markets- Gaurav
Kothari
• Whither Capitalism- Kartik Baranga
 Financial Crisis

“A financial crisis is a disturbance to financial

markets that disrupts the market’s capacity to
allocate capital – financial intermediation and
hence investments come to a halt”
- Richard Portes
Professor of Economics, London Business School
and
President, Centre for Economic Policy Research
All Crises are ‘Crises of Success’ (Portes and
Vines, 1997)
The initial capital inflow that ultimately proves
unsustainable (and perhaps unprofitable) is
both a sign and - for a time - a cause of
economic promise and success.
 Financial Crises Features
• the role of ‘fundamentals’

• the relative importance of bank and securitised debt

• the relative importance of private and sovereign debt

• exchange rate regimes and history

• underlying structure and dynamics

 Major Financial Crises Since 20th
Century
• 1910: Shanghai rubber stock market crisis
• 1980s: Latin American debt crisis, beginning in Mexico
• 1989-91: United States Savings & Loan crisis
• 1990s: Collapse of the Japanese asset price bubble
• 1992-3: Speculative attacks on currencies in the European Exchange Rate Mechanism
• 1994-5: 1994 economic crisis in Mexico: speculative attack and default on Mexican
debt
• 1997-8: Asian Financial Crisis: devaluations and banking crises across Asia
• 1998: 1998 Russian financial crisis: devaluation of the rouble and default on Russian
debt
• 2001-2: Argentine economic crisis (1999-2002): breakdown of banking system
• 2008: Global financial crisis and USA, Europe: spread of the U.S. subprime mortgage
crisis
Great Depression
(1929-1939)
 Timing And Severity
• Great Depression began in the summer of 1929

• Real output and prices fell precipitously

• Industrial production in the United States

declined 47 percent and real GDP fell
30 percent

• Wholesale price index declined 33 percent

 Causes

Uneven Distribution of
Farm Depression of the 1920s
The Stock Market Crash Income
Prices of farm products
Stock values dropped rapidly Industrial production
declined upto 40% in 1920-
on Oct. 24,1929; now known increased about 50% but the
1921 and they remained low
as Black Thursday wages of the industrial
through the 1920s
workers rose far more slowly
German Hyperinflation
 Genesis: Financial Crises 2008
• September 11/2001 – federal reserve started a long period of interest
rate reduction

• Induced by declining price level as large US imports from china and other
low-cost producers

• This declining interest rate had two effects: first, it induced a search for
alternative investment vehicles providing higher rates of return; and,
second, it allowed new homebuilders to enter the home mortgage market
on lower credit ratings but with higher interest rates — this phenomenon
now known as subprime credits

• The two effects lead to an increase in credit spiral

 Sub Prime Crisis…
… and its rippling effects on the global economy
“We were at the brink of something that
would have made anything that's happened
in financial history look pale. We were
very, very close to a system that was
totally dysfunctional and would have not
only gummed up the financial markets but
gummed up the economy in a way that
would take us years and years to repair”
-Warren Buffet
What is SubPrime lending?

 Lending to borrowers with a weak or substandard

credit history

 Subprime loans include the financing of homes,cars,

credit cards etc.

 Lower Credit Score

FICO less than 620
(Fair Issac Corporation)
The bubble Inflated….
POST 2001

 The boom was led by:

 Housing prices
interest rates
 financial innovation viz.
MBS -Mortgaged backed securities
CDO-Collateralized Debt Obligation
CDS - Credit Default Swaps
The bubble burst….
POST 2006
 Housing prices in USA began to
drop:
 Interest rates
Rise in subprime mortgage
delinquencies
Resultant defaulter/foreclosure
 Result: The housing bubble burst
in Aug 2006
Source: Sub Prime Crisis - Presentation by Astha - May 2008
 Sequence of events
Triggered borrowing
Triggered borrowing Growing Demand
Cut
Cut in
in Interest
Interest and availability
and availability of
of led to irrational rise
Rate
Rate cheap money
cheap money Fed
Fed in price
11thSept
11thSept 2001
2001 Fund Rate
Fund Rate around
around HPI – 2001 Q4
2% in
2% in 2001
2001 314.25

Lending industry
Lending industry Assumptions that
Assumptions that
Prices fell
Prices fell and
and situation will
will remain
remain
resorted to
resorted to exotic
exotic situation
the housing
the housing the same
same and
and
loans &
loans & riskier
riskier the
bubble collapsed
bubble collapsed refinancing would
would
practices (to
practices (to keep
keep refinancing
in Aug
in Aug 2006
2006 be possible
possible
this boom
this boom going)
going) be

Default/Foreclosure
 FED RATE 2001-2007
5%

4%

4%

3%

3%

2%

2%

1%

1%

0%
4/19/2001 9/1/2002 1/14/2004 5/28/2005 10/10/2006 2/22/2008 7/6/2009
US Housing Price Index
 Impact of sub prime in usa
Bankruptcy
of Lehman

Bear Closure of
Sterns was Washington
acquired Mutual

Sub
prime
crisis in
$700bl USA
industry
bail out Emergency
package by loan to AIG
US gov by FED
Acquisition reserve
of Merrill
Lynch by
BOA
 • The problem with investment bank balance
sheets is that on the left side nothing is right
and on the right side nothing is left 

• What's the difference between a guy who just

lost everything in Las Vegas and an Investment
Banker? A tie 
Year of Bailouts
 How did Regulators Respond?
“Nobody trips over mountains. It is the small pebble that causes you to
stumble. Pass all the pebbles in your path and you will find you have crossed
the mountain”

Infusion of liquidity to the interbank

market (Fed) – liquidity provided in
exchange for securities that “nobody
else wants”

Lowering interest rates (Fed) – with the

objective to prevent a sharp recession
in the U.S. and to ease conditions in
the mortgage markets
 Contd…...

Recapitalization of
large,systemically important
banks –substantial role of the
so called sovereign wealth
funds

Business Stimulus to bailout

mortgage finance giants like
Fannie Mae& Freddie Mac,
AIG, FORD, GM
 Contd……

Bailouts of failed banks –

nationalization in case of
Northern Rock, takeover
(by JP Morgan Chase) in
case of Bear Stearns, with
the objective to contain
systemic risks
 Contd……
Measures to improve the conditions in
the mortgage market (U.S.) –
moratorium on loan repayments,
increased authority for intervention by
government sponsored enterprises
(GSEs), fiscal stimulation

Reconsidering the role of regulation

and supervision of nonbank financial
institutions and off balance sheet
conduits and investment vehicles
 Recapitalization

Write-down of
Date of Financial Amount &
financial Investors
Announcement Institutions % of stake
institutions

Nov 6,2007 Citigroup $6 bn Q3,2007 Abu Dhabi $7.5 bn

Investment authority (4.9%)

Govt of Singapore $10 bn

Dec 10, 2007 UBS $18 bn 2007 (10%)
investment authority

$4.4 bn
Dec 21,2007 Merrill lynch $8 bn Q3 2007 Temasek holdings (9.4%)
 Recapitalization

Financial Write-down of Amount & % of

Date of Institutions financial Investors stake
Announcement institutions

Korea
investment
$14.1 bn Q4 authority &
Jan 15,2008 Merrill lynch $2 bn (3.2%)
2007 Kuwait
investment
corporation

Abu Dhabi &

Kuwait $6.8 bn (3.7%)
Jan 15,2008 Citigroup $18 bn Q4 2007
investment $3 bn (1.6%)
corporation

Qatar
Feb 18,2008 Credit Suisse $2.85 bn investment Approx $500
mn (1% to2%)
Authority
 Questions?
“ Learn from yesterday, live for today, hope for tomorrow. The important thing is
not to stop questioning”
Albert Einstein

• Capitalizing Profits and socializing losses

• Using tax payers money for providing

bonus during crisis and now bailout
from losses

• Tinkering with market forces without

regulation
 PAUL KRUGMAN
Noble laureate (Economics)

ON
GLOBAL FINANCIAL CRISIS
 Charlie Rose:
A Conversation with Paul Krugman
October 24,2008
 Lou Dobbs Tonight, November 7, 2008
It was a polite debate between Paul and Lou Dobbs
on the American financial crisis, where Paul argues
for fiscal stimulus and now it is not the time to worry
about deficits

• “The epicentre of the earthquake has shifted from the

financial system (Wallstreet) to the working system
(Mainstreet)”

• “The economy would need four to five percent of GDP,

which is basically saying $600 billion to $700 billion
of stimulus”
 The Rachel Maddow Show, November 19, 2008

Alison Stewart interviews Paul, and he argues why the Big Three
U.S. auto makers need to be rescued
• “It`s not that it`s special. It`s just that it`s big and that it`s on the
verge of failure, the economy is in a nose dive. And this is
something that will greatly accelerate the nose dive. If GM goes
under, which looks like a real possibility, then that`s a huge blow to
huge anti-stimulus program at exactly the wrong moment. If this
was 1999 and we had four percent unemployment and the credit
markets were working, I would say, let it fail and let bankruptcy do
its work. But this is not a good time to be having a really major
industry just turn belly-up”
• “Estimates run from one million to three million jobs lost if GM
goes under”
 Krugman at Stockholm University
December 8,2008
Discusses the worst case scenario on the Global
downturn
• "A scenario I fear is that we'll see, for the whole
world, an equivalent of Japan's lost decade, the
1990s ,we'll see a world of zero interest rates,
deflation, no sign of recovery, and it will just go on
for a very extended period"
• "We can easily be talking about a world economy that
is depressed until 2011 and maybe beyond"
Europe and Japan
 Financial Crisis
Opens international financing path

s
ct
Decreases the cost of capital

e ffe
vei
sit
Po Increases investment opportunities
FINANCIAL
Maximize shareholders funds
LIBERALIZATION
OF EQUITY Also, may lead to:
MARKETS
Ne A decline in credit’s portfolio quality
g at
iv ee
ffe An increase in financial fragility
c ts
Macroeconomic volatility to external
shocks

FINANCIAL CRISES AND LOSSES

 The financial crisis is now global

• Recession in all major industrial regions

• World trade and global capital flows falling
• Emerging markets facing ”sudden stop”

• Emerging Europe particularly threatened

• Asian countries also feeling the heat
 Emerging Europe affected

• Banking sector severly affected

• Real sector: Industrial production
dropping
• Fiscal capacity to respond limited
• IMF packages (Hungary, Ukraine,
Serbia...)
 Failures of EU financial architecture made
Europe vulnerable
• EU members forced to deregulate their capital accounts

• Households and firms joined the Euro zone

• Countries which did not join the Euro zone

faced forex exposure

• Regulation and supervision through home-host

country coordination failed

• Lack of centralized financial regulation and supervision at the EU

level
 United Kingdom : Effects
• Rising Oil Price
• Credit Market Crisis
• House Price Dropped 8.1 %
• Manufacturing Activity Declined
• Unemployment Over 1.8 Million
• Bank Rescue Package of £500 Billion

Real GDP Growth

2008 Mar Jun Sep Dec

2.4 1.5 0.3 ---
2007 2.9 3.0 3.3 2.9

Interest Inflation GDP Trade Unemployment

Rate Rate Growth Balance Rate
3.00% 5.20% 0.30% -2587.00 3.00%
 Germany : Effects
• Entered Recession in 3rd Quarter
– GDP Growth: - 0.4 % in 2nd Quarter
- 0.5 % in 3rd Quarter
• Industrial Output Down 2.4%
• Current Account Impact
– Export accounted 30% of Euro Economy
• Unemployment Rate Raised

Real GDP Growth in Euro

2008 Mar Jun Sept Dec

2.1 1.4 0.7 ---
2007 3.2 2.6 2.6 2.1

Interest Inflation GDP Trade Unemployment

Rate Rate Growth Balance Rate
3.25% 3.20% 0.70% -9333.80 7.50%
Europe as vulnerable to the financial crisis as
US
Ta b le 1. A sco re ca rd fo r cou nt rie s' vu ln e ra b ilit y to t he fina ncia l cris e s
Curre nt Ho us e ho ld Equity Total
S tocks * S core Ho us ing * S core acco unt** S core de bt*** S core capital** S core S core
S pain 146.7 7 76.3 8 -9.8 8 **** 8 96.9 4 35
UK 67.7 1 46.4 6 -2.9 6 30.6 7 151.4 8 28
France 97.6 4 67.4 7 -1.3 4 14.0 5 104.0 5 25
US 68.4 2 45.6 4 -5.6 7 25.9 6 115.2 6 25
Canada 110.2 5 46.1 5 1.9 3 5.4 3 128.6 7 23
Italy 84.0 3 37.1 3 -2.0 5 10.5 4 52.6 1 16
Japan 111.4 6 -17.2 1 4.7 2 -2.1 2 95.4 3 14
Ge rmany 176.8 8 9.3 2 6.0 1 -7.2 1 65.4 2 14

India 293.3 2 -2.1 4 147.2 4 10

Brazil 394.7 4 0.8 3 120.5 2 9
Russ ia 340.9 3 5.9 2 88.6 1 6
China 187.4 1 11.7 1 127.9 3 5

* % change e nd 2002 to m id-2007

** 2007
***Change be tw ee n 2002 and 2006
****We did not find com parable hous e hold de bt ratios for Spain, but available indicators pointe d to an increas e eve n greate r
than in the UK.
Source : OECD, Have r, DB Global M arkets Re s e arch
 Japan
• Japan is the 3rd largest economy in the world
• Accounted for 6.6% of the gross world product in 2007
• One of the highest GDP per capita, almost $34,000,
according to the International Monetary Fund

Current Japanese Economic Situation

Interest Inflation GDP Trade Unemployment

Rate Rate Growth Balance Rate
0.30% 2.10% 0.70% 88.50 4.00%
 Japan : Effects
• Japanese economy

• June 2008, exports 1.7 % (first time in about 5 years)

• Exports to the US & EU

15.4 % 11.2 %

• Japan's trade surplus $1.28 Bil

90 %

• Japan's economy 0.7 % in the 3rd quarter of 2008.

IMPACT OF
CRISIS
ON INDIA
It is often said that when the
US sneezes the rest of the
world catches cold
US SUB-PRIME
IMPACT ON INDIA
 All you need is cash
The increasingly desperate search
LIQUIDITY
CRUNCH
Why and how Indian
crisis occur?

Drying up of overseas financing

Constraints in raising funds
Decline in internal accruals of the corporate
RBI’s attempts to stabilize the Rupee
Banks increasing holding of liquid assets
Domestic credit market,
Employment,
Growth.
IMPACT ON VARIOUS SECTORS
 FINANCIAL SECTOR
 Transparency against the complex derivative
product
 Financing structured products
 Due diligence
 To eliminate the drawbacks of the “originate-to-
distribute” model
 Universal Banking
 INDUSTRIAL SECTOR

Trends in IIP during Apr-Sep, 2007 Vs Apr-Sep,

2008
12
10

10.6
9.9
8
% growth

6
4

4.2
4.1

2
0
General IIP Index grow th Manufacturing IIP

2007-08 2008-09
Real Estate
BANKING SECTOR
Exposure to sub-prime mortgages
Hedge funds sell
To reduce leverage and meet calls
To meet redemptions
Short – to make return
 Financial services Chakra – view…….Exposed??

ICICI- reported exposure

of $80 mn, $12 mn
provisions
Expected loss at $ 28mn SBI- reported exposure
Emkay Global-
Lehman Holdings at $5 mn, expects to
at 4.05% recover 70%

PNB- reported
Edelweiss: 2.6% exposure at $5 mn
stake bought by Expected loss at $
Lehman 2 mn

Axis Bank- reported BOI- reported exposure

exposure $ 1.5 mn through of $ 11 mn
mark to market forex Expected loss of $ 5 mn
BOB- reported exposure
counter party deal. Impact
of $ 10 mn
negligible
Expected loss at $ 4 mn
 Measures taken by RBI
CRR, SLR, Repo rate
ECB norms relaxed up to 500Mn$
Buy back of MSS securities
Stimulus package announced to cut Cen VAT be 4%
Announced 4b$ fiscal package
Refinance facilities to all scheduled commercial
banks up to 1% of NDTL
 Banks can borrow up to 1.5 percent of their
deposits in cash
 JOB CUTS
Slowdown-hit PSUs chant the austerity mantra

India Inc cuts jobs, frills to

stay in shape
5 lakh jobs lost in three months
Foreign banks cut down gold supply
to India
Forget stock gains, you may lose dividends too
RBI opens doors to 10 VCFs amid
liquidity crunch
Demand meltdown dissolves 150 small sponge
iron units
Overseas borrowings via loan syndication dip
46% in ’08
 STIMULUS PACKAGES
• 7th Dec-First stimulus package
– To stimulate demand
– Expected price of goods to fall
– Indian exporters to be competitive
– Reduce unemployment

• 2nd Jan-second stimulus package

– Corporate to hunt for fund overseas
– Boosting local demand
– To kick start infrastructure projects
DEFICIT AND SURPLUS
INDIA CHINA
 LESSONS TO BE LEARNT
• Risk transfer needs closer supervision

• Reliable valuators

• Transparency and disclosures

• Regulatory scope

• Conflict of interest in rating agency

Impact of crisis
Chinese Economy
Indian Stock Market
 SLOWDOWN IN CHINA
Fourth largest economy
Exports growth
Interest Rate
 Announcement of stimulus package
 Focus on India
FDI and ECB

Signs of slowdown in FDI with inflows dropping 26% in October

ECB flows also on the decline, putting pressure on corporate
liquidity
 Stricter lending by banks further exacerbates funding troubles
 FII Flows

FII equity share exposure down 63% in over Dec.2007 to

Sept. 2008
Adjusted for net FII selling since Sep’08 , current exposure
is down to $US 85 bn
 Capital flows
Rs. Cr FII net Fresh ECB FDI % of
flows Equity GDP*
Issues
CY05 48,491 22,800 53,621 19,602 5.0%

CY06 34,790 24,700 104,203 63,954 6.9%

CY07 78,121 45,100 133,277 63,316 8.4%

CY08 -52,000 16,900 81,850 108,877 3.6%

Source: Bloomberg, RBI

Impact on Indian Stock
Market
FII
FII
Outflo
Outflo
w
w

Lehman
Lehman
nn
collapse
collapse

No. of
IPOs
 OTHER FACTORS

Commodity prices
Interest Rates
Oil prices
Inflation worries
 FAILURE OF SYSTEM
Unfettered Laissez Faire concept
 Derivative market

 Excessive leveraging

 Role of regulators

 Casino capitalism

 Crony capitalism

 No transparency in functioning

“Capitalism is the legitimate racket of the ruling class”.

- Al Capone
“Corruption is our protection.
Corruption is what keeps us safe and warm.
Corruption is why we win”

From the film Syriana-directed by Stephen

Gaghan.
 POLITICAL AND ECONOMIC VIEWPOINTS

 Regulate capitalism
 Modern capitalist states are welfare states
 Capitalism’s success is a mysterious triumph
 Capitalism is obsolete –Mao and Marx will be back
 Nationalization of banks
 Save capitalism from financial capitalist
 
“There are no atheists in foxholes and no ideologues in financial
crises,”
- Mr. Ben Bernanke
The development of Modern Industry, therefore,
cuts from under its feet the very foundation on
which the bourgeoisie produces and appropriates
products. What the bourgeoisie, therefore,
produces, above all, are its own grave-diggers. Its
fall and the victory of the proletariat are equally
inevitable. ”  

— (The Communist Manifesto)