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FALL SEMESTER BAHRIA UNIVERSITY 2011

Project Report
Global financial crisis of 2008-2009
19th December 2011

M Zain Ul Abidin Khan Sajeel Zaman Khan M Ahmed Qureshi M Farhan Anjum Syed Hasan Raza
BBA-07-B Comparative Management Submitted to

Sir Shahid Haq

BAHRIA UNIVERSITY
zainkhan_13@hotmail.com For Feedback

FALL SEMESTER BAHRIA UNIVERSITY 2011

EXECUTIVE SUMMARY
In 2008, a sequence of bank and insurance company failures set off a financial crisis that in actual fact stops the progress of global credit markets and required beyond compare government involvement. The term financial crises is broadly used for many things but mainly means if a great loss happens then its called financial crisis but its mainly related to banking panics. Other situations in which we often use this term is in stock market crashes. The global financial crisis really started to show its effects in the middle of 2007 and into 2008. Around the world stock markets have fallen, large financial institutions have collapsed or been bought out and governments in even the wealthiest nations have had to come up with rescue packages to bail out their financial systems. The crisis has its roots in real estate and the subprime lending crisis. The crisis rapidly developed and spread into a global economic shock, resulting in a number of European bank failures, declines in various stock indexes, and a large reduction in the market value of equities and commodities. Pakistan is another country in South Asia that has been severely affected by the financial crises. In fact, Pakistan seems to be one of the hardest hit with this global crisis. Its economy is already in crises. Pakistan is also facing a serious liquidity crunch, with the only solution being international support. Saudi Arabia has refused to give Pakistan a financial concession on the oil trade, as well. The only option for Pakistan is to approach international monetary fund, which will set highly stringent conditions for the nation. But the point to be noted is that comparing to the international banking market; Pakistans banking sector is still stable and is not effected like the way other banks got affected. In this report we will find the key facts in banking failure, also the real examples of people working at that time, comparison of different cultures, government intervention and all factors which assist in crash of the financial markets and in addition how different economies are dealing with the issue is also our main focus. 2

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Problem Statement
Comparative study of international Economy American Banking crisis and comparison of other international Banking market

Objectives
Effect of Financial crisis and how it happened? Rise & Fall of International banking management. Financial crisis occurred because of the poor management or American culture of living on credit system. Socio-cultural dimensions, enterprise environment and internal work culture (Task-driven Assumptions and employee related assumptions) linking with the problem. Lack of management quality or greed of making more money. US government investment & consequences of bailout. American banking system versus Pakistani Banking system. How much people are aware of the recent financial crisis.

Crisis Overview
Easy access to credit: Falling interest rates and rising availability of mortgages, combined with rising housing prices encouraged consumers to buy homes. Relaxed lending standards: To cater to the growing number of mortgage seekers, lenders relaxed standards and issued a large number of sub-prime loans. The rise of these massive institutions represented a profound change in the financial system and a powerful new source of systemic risk. Yet they didnt update their regulatory policies in responsea critical mistake. Although there were obviously many causes of the current crisis (including irresponsible lending and borrowing in the mortgage markets, asset securitization carried to a dangerous extreme, a severely dysfunctional credit-rating system, and excessive leverage 3

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Throughout the financial system), perhaps the biggest culprits of all were the supersized financial institutions. At root, this was a crisis of big institutions. As asset prices rose, many of the huge financial conglomerates played a pivotal role in inflating the bubble. They used their perfect credit ratings (and their illusion of durability) to access cheap funds on a tremendous scale, and they employed those funds in support of countless high-risk transactions and investments. Once the bubble began to reduce, it was many of these same huge (and hugely leveraged) firms that helped rushed downward as they all began desperately trying to sell troubled assets simultaneously. And when the bubble finally burst, federal officials concluded that they had to save these very same institutions from collapse, because the failure of any one of them could have triggered an sudden large amount of losses, potentially threatening the financial system as a whole.

What Really Failed? Some Say the Financial Crisis is a Failure of Risk Management No Governance Fail-safe? Then The 2008 Financial Crisis Is a Wake-up Call

FALL SEMESTER BAHRIA UNIVERSITY 2011

The Recent Financial Turmoil


The key development of the second half of 2008 has been a dramatic worsening of the first of the dimensions mentioned above; the financial crisis based on the accumulation of debt. The main cause of this has been growing recognition that the quantity of bad debt in the system was much larger than was previously thought. This in turn led to confusion amongst the US ruling class about the way to respond to the rising number of loan defaults. Unwillingly forced to nationalize the mortgage companies Fannie Mae and Freddie Mac (largely as a result of pressure from Chinese and Japanese investors in these companies) they then switched abruptly to allowing a leading investment bank, Lehman Brothers, to fold. This threw the banking system into a deeper crisis in three ways. First, the rising tide of bad debt threatened the solvency of the banks. Second, the apparent change in Federal Reserve policy from the earlier rescue of Bear Sterns created a panic in the inter-bank lending market. Uncertain of which banks would survive banks ceased to lend to anyone at all in this market causing the system as a whole to seize up. Thirdly, stock market investors also panicked sending bank shares into free fall. Since bank regulation is based on the idea that loans can only be a certain multiple of bank capital and since the decline in shares reduced capital significantly, this looked likely to lead to a massive decline in bank lending, which would have further threatened the stability of the system. While these problems were first apparent in the US and UK, where housing booms and bank deregulation had been especially strong, it quickly became clear that banks from many countries, particularly Continental Europe, had also made loans in these markets so that the banking crisis affected the major industrialized countries as a whole. The result of this has been an abrupt change in policy towards bailing-out the banks. The form of this has varied across countries. The US response, led by Treasury Secretary Henry Paulson, who is rooted in Wall Street, has been particularly shameless (the original proposal by Paulson was simply that the US government, funded by taxpayers, would buy up the worthless debt from the banks a straightforward subsidy with no control over future bank behaviour whatsoever). The UK government plan, which has effectively been adopted by the EU, provides some potential leverage for political debate in that it involves buying shares in the banks. This allows for discussion about the nature of state control over the banking system and about who should pay for the crisis. But it is clear that the initial aim of the government was to have the minimum amount of state involvement in the financial sector and to provide funds which would then be used to restore the banks to profitability in the hope of a quick sale of the governments stake. The model was the Scandinavian restructuring of the banks following the financial crisis there in the early 1990s.

Who Pays for the Crisis?


The immediate effect of the recognition of the bad debt in the housing market is that a large amount of capital which was valued at a certain amount, on the basis that the housing loans would be repaid in full, is no longer worth what was originally envisaged. This capital falls into two categories. Firstly, there is the capital directly tied up in providing housing linked to subprime mortgages, both the loan capital used to provide the mortgages and capital employed in construction and housing development. Secondly, there is the capital in other industries which has been invested in the expectation of demand originating from a booming housing market; in particular that which depends on high levels of demand resulting from homeowners

FALL SEMESTER BAHRIA UNIVERSITY 2011 borrowing against the equity in their houses something now unlikely to happen in the foreseeable future. Any revalorization of capital of this kind raises the question of who will pay for the loss capital or labor. The financial sector has been quite brazen about trying to shift the cost of the crisis onto labor even to the extent of formulating plans to use taxpayers money to maintain bonus payments. The mechanisms for ensuring this shift include the following: Direct subsidies for the banks funded by the taxpayer

Rebuilding of the profit base by refusing to pass on interest rate cuts to borrowers. This may well be made easier by mergers like the Lloyds-HBOS merger, which will reduce competition and increase the dependence of households on a small number of large institutions An attack on the job security, wages and conditions of bank staff in order to cut costs. Again, state-sponsored mergers may help this process by providing the means to close branches. Reduction of the interest rate paid out to savers and depositors To the extent that the state has attempted to act as something other than an agent of capital and to enforce terms on the banks, the banks have responded by threatening to bring the system down if they dont get their way. This has led to some conflict between the government and the banks, particularly with regard to the enforcement of cuts in interest rates. However, the cuts which have been achieved here have come at the expense of even larger cuts in rates paid to savers which have serious implications for both current and future pensioners. In addition, the bail-out as a whole has resulted in a considerable ideological cost both in terms of the reputation of the financial sector within society as a whole (which is probably now at an all-time low) and in terms of the increased legitimacy of regulation and even state ownership.

The Internationalization of the Crisis


The growth of debt over the last two decades in countries like the USA and UK has been dependent on international flows of capital which in turn have resulted from a significant degree of exchange rate stability compared to the turbulence of the early 1980s. Conversely, a move towards a different pattern of accumulation will inevitably put great strain on global monetary arrangements. So far the crisis has mainly manifested itself in domestic monetary developments in the largest economies, although countries like Iceland, Ukraine, Hungary and the Baltic States have been driven to seek IMF or EU help. But this is now changing and the crisis is being internationalized in three ways. The first of these is the effect of current developments on so-called `emerging market economies. Nobel Prize winning economist Paul Krugman gives the example of Russia where `while the Russian government was accumulating an impressive $560bn hoard of foreign exchange, Russian corporations and banks were running up an almost equally impressive $460bn foreign debt...This truly is the mother of all currency crises and it represents a fresh disaster for the worlds financial system .The unwinding of the `carry trade (where financiers borrow in markets with low interest rates such as Japan and lend abroad) is beginning to have a devastating effect on such currencies. Secondly, countries like the UK and USA which have been at the Centre of the crisis see their currencies in danger of sliding, both because their governments need to borrow abroad and because of a general lack of confidence. At the time of writing the dollar remains relatively strong simply because of the weakness of other currencies, but sterling has fallen dramatically against both the dollar and the euro.

FALL SEMESTER BAHRIA UNIVERSITY 2011 The third factor is increasing pressure on countries to devalue their currencies in order to boost exports at a time of falling demand. Even the Chinese government is now considering this to American consternation. All of these developments are likely to herald a period of much greater turbulence for exchange rates and capital flows. Yet underlying the immediate changes in currency values is a deeper disagreement about future strategies amongst the international capitalist class. The central long-run task for capital is to develop a strategy of accumulation which does not depend on the build-up of unsustainable debt (Martin Wolfs article in the Financial Times of November 5 entitled `Why agreeing a new Bretton Woods is vital and so hard is in many ways a manifesto for this process). This process involves a wide range of different potential conflicts but one issue in particular is seen as increasingly central. This is the rebalancing of world economic growth away from the USA (and UK) towards the surplus economies of Asia and elsewhere, especially China. The more far-seeing representatives of capital, such as Wolf, are very clear that if the current pattern of global imbalances persists, so will recurrent financial crises of the kind we have seen recently. Large flows of funds into the US and UK will result in risky lending whatever the regulatory structures created. The only way this can be avoided is through a shift towards domestic consumption in countries like China and a move away from consumption towards investment and, especially, exports in the US. This kind of strategy is extremely difficult to implement in practice because the unplanned, spontaneous nature of capitalism makes this kind of rebalancing very destabilising and risky. This was shown in the mid-1980s when the decision to co-ordinate a rise in the value of the yen and shift the Japanese economy towards domestic demand and away from exports triggered a speculative frenzy of lending resulting in a slump lasting almost two decades. Yet, an even more serious problem today is that there is no clear agreement on the way forward between the representatives of different national capitals. That has been shown within Europe with regard to the arguments between the German and British governments over the degree to which government spending and fiscal deficits are an appropriate response to the crisis. More serious, however, are the underlying tensions between the US and Asian governments. These tensions reflect not just economic concerns, but also shift in the balance of power within international capitalism.

Economy: UK recovery slow, but fiscal consolidation must continue Spending cuts will curb government consumption, investment and household income growth over the 2011-12 periods, but will bring long-term gain. The OECD says that pushing through key reforms will address fiscal sustainability concerns and help bring about a long-term rebalancing of the UK economy. By taking hard, though necessary, decisions now, the UK is ensuring that it can continue to provide the British people with effective government services in the future, OECD Secretary-General Angel Gurra said during the surveys release in London. To counter some of the negative impact, monetary policy should remain expansionary to support the recovery, even if headline inflation is currently above target. The UK VAT system is one of the least efficient in the OECD area, with less than 60% of potential revenues actually collected. Targeted support should be introduced to compensate

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poorer households for VAT increases. Combining these measures would support the recovery, enhance efficiency and protect the weakest without harming consolidation.

To meet the UK's ambitious climate change targets and continue to reduce CO2 emissions, the survey recommends higher and more consistent carbon prices and more predictable conditions for renewable energy providers.

The Organization for Economic Co-operation and Development is an international economic organization of 34 countries founded in 1961 to stimulate economic progress and world trade. It is a forum of countries committed to democracy and the market economy, providing a platform to compare policy experiences, seek answers to common problems, identify good practices, and co-ordinate domestic and international policies of its members.

American culture of living on credit system


Following a period of economic boom, a financial bubbleglobal in scopehas now burst. A collapse of the US sub-prime mortgage market and the reversal of the housing boom in other industrialized economies have had a ripple effect around the world. Furthermore, other weaknesses in the global financial system have surfaced. Some financial products and instruments have become so complex and twisted, that as things start to unravel, trust in the whole system started to fail.

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The subprime crisis came about in large part because of financial instruments such as securitization where banks would pool their various loans into sellable assets, thus offloading risky loans onto others. (For banks, millions can be made in money-earning loans, but they are tied up for decades. So they were turned into securities. The security buyer gets regular payments from all those mortgages; the banker off loads the risk. Securitization was seen as perhaps the greatest financial innovation in the 20th century.) Starting in Wall Street, others followed quickly. With soaring profits, all wanted in, even if it went beyond their area of expertise. For example, Banks borrowed even more money to lend out so they could create more securitization. Some banks didnt need to rely on savers as much then, as long as they could borrow from other banks and sell those loans on as securities; bad loans would be the problem of whoever bought the securities. Some investment banks like Lehman Brothers got into mortgages, buying them in order to securitize them and then sell them on. Some banks loaned even more to have an excuse to securitize those loans. Running out of whom to loan to, banks turned to the poor; the subprime, the riskier loans. Rising house prices led lenders to think it wasnt too risky; bad loans meant repossessing high-valued property. Subprime and self-certified loans (sometimes dubbed liars loans) became popular, especially in the US.

Some banks evens started to buy securities from others. Collateralized Debt Obligations, or CDOs, (even more complex forms of securitization) spread the risk but were very complicated and often hid the bad loans. While things were good, no-one wanted bad news.

The immediate cause or trigger of the crisis was the bursting of the United States housing bubble which peaked in approximately 20052006. Already-rising default rates on "subprime" and adjustable rate mortgages (ARM) began to increase quickly thereafter. As banks began to give out more loans to potential home owners, housing prices began to rise. In the optimistic terms, banks would encourage home owners to take on considerably high loans in the belief they would be able to pay them back more quickly, overlooking the interest rates. Once the interest rates began to rise in mid-2007, housing prices dropped significantly. In many states like California, refinancing became increasingly difficult. As a result, the number of foreclosed homes also began to rise.

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Share in GDP of U.S. financial sector since 1860

Steadily decreasing interest rates backed by the U.S Federal Reserve from 1982 onward and large inflows of foreign funds created easy credit conditions for a number of years prior to the crisis, fueling a housing construction boom and encouraging debt-financed consumption. The combination of easy credit and money inflow contributed to the United States housing bubble. 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 number of financial agreements called mortgagebacked securities (MBS) and collateralized debt obligations (CDO), which derived their value from mortgage payments and housing prices, greatly increased. Such financial innovation enabled institutions and investors around the world to invest in the U.S. housing market. As housing prices declined, major global financial institutions that had borrowed and invested heavily in subprime MBS reported significant losses. Falling prices also resulted in homes worth less than the mortgage loan, providing a financial incentive to enter foreclosure. The ongoing foreclosure epidemic that began in late 2006 in the U.S. continues to drain wealth from consumers and erodes the financial strength of banking institutions. Defaults and losses on other loan types also increased significantly as the crisis expanded from the housing market to other parts of the economy. Total losses are estimated in the trillions of U.S. dollars globally.

Subprime lending
Intense competition between mortgage lenders for revenue and market share, and the limited supply of creditworthy borrowers, caused mortgage lenders to relax underwriting standards and originate riskier mortgages to less creditworthy borrowers. Prior to 2003, when the mortgage securitization market was dominated by regulated and relatively conservative Government Sponsored Enterprises, GSEs policed mortgage originators and maintained relatively high underwriting standards. However, as market power shifted from securitizers to originators and as intense competition from private securitizers undermined GSE power, mortgage standards declined

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and risky loans proliferated. The worst loans were originated in 2004-2007, the years of the most intense competition between securitizers and the lowest market share for the GSEs.

U.S. subprime lending expanded dramatically 2004-2006

The term subprime refers to the credit quality of particular borrowers, who have weakened credit histories and a greater risk of loan default than prime borrowers. The value of U.S. subprime mortgages was estimated at $1.3 trillion as of March 2007, with over 7.5 million first-lien subprime mortgages outstanding. As well as easy credit conditions, there is evidence that competitive pressures contributed to an increase in the amount of subprime lending during the years preceding the crisis. Major U.S. investment banks and government sponsored enterprises like Fannie Mae played an important role in the expansion of lending, with GSEs eventually relaxing their standards to try to catch up with the private banks. Subprime mortgages remained below 10% of all mortgage originations until 2004, when they spiked to nearly 20% and remained there through the 2005-2006 peak of the United States housing bubble. A 2000 United States Department of the Treasury study of lending trends for 305 cities from 1993 to 1998 showed that $467 billion of mortgage lending was made by Community Reinvestment Act (CRA)-covered lenders into low and mid-level income (LMI) borrowers and neighborhoods, representing 10% of all US mortgage lending during the period. The majority of these were prime loans. Sub-prime loans made by CRA-covered institutions constituted a 3% market share of LMI loans in 1998. Nevertheless, only 25% of all sub-prime lending occurred at CRA-covered institutions, and a full 50% of sub-prime loans originated at institutions exempt from CRA. As of March 2011 the FDIC has had to pay out $9 billion to cover losses on bad loans at 165 failed financial institutions.

Easy credit conditions


Lower interest rates encourage borrowing. From 2000 to 2003, the Federal Reserve lowered the federal funds rate target from 6.5% to 1.0%.This was done to soften the effects of the collapse

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of the dot-com bubble and of the September 2001 terrorist attacks, and to combat the perceived risk of deflation.

U.S. current account deficit.

Additional downward pressure on interest rates was created by the USA's high and rising current account deficit, which peaked along with the housing bubble in 2006. Federal Reserve Chairman Ben Bernanke explained how trade deficits required the U.S. to borrow money from abroad, which bid up bond prices and lowered interest rates. Bernanke explained that between 1996 and 2004, the USA current account deficit increased by $650 billion, from 1.5% to 5.8% of GDP. Financing these deficits required the USA to borrow large sums from abroad, much of it from countries running trade surpluses, mainly the emerging economies in Asia and oil-exporting nations. The balance of payments identity requires that a country (such as the USA) running a current account deficit also have a capital account (investment) surplus of the same amount. Hence large and growing amounts of foreign funds (capital) flowed into the USA to finance its imports. This created demand for various types of financial assets, raising the prices of those assets while lowering interest rates. Foreign investors had these funds to lend, either because they had very high personal savings rates (as high as 40% in China), or because of high oil prices. Bernanke referred to this as a "saving glut." A "flood" of funds (capital or liquidity) reached the USA financial markets. Foreign governments supplied funds by purchasing USA Treasury bonds and thus avoided much of the direct impact of the crisis. USA households, on the other hand, used funds borrowed from foreigners to finance consumption or to bid up the prices of housing and financial assets. Financial institutions invested foreign funds in mortgage-backed securities. The Fed then raised the Fed funds rate significantly between July 2004 and July 2006.This contributed to an increase in 1-year and 5-yearadjustable-rate mortgage (ARM) rates, making ARM interest rate resets more expensive for homeowners. This may have also contributed to the deflating of the housing bubble, as asset prices generally move inversely to interest rates and it became

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riskier to speculate in housing. USA housing and financial assets dramatically declined in value after the housing bubble burst. By September 2008, average U.S. housing prices had declined by over 20% from their mid-2006 peak. As prices declined, borrowers with adjustable-rate mortgages could not refinance to avoid the higher payments associated with rising interest rates and began to default. During 2007, lenders began foreclosure proceedings on nearly 1.3 million properties, a 79% increase over 2006. This increased to 2.3 million in 2008, an 81% increase vs. 2007. By August 2008, 9.2% of all U.S. mortgages outstanding were either delinquent or in foreclosure. By September 2009, this had risen to 14.4%.

High-risk mortgage loans and lending/borrowing practices

A mortgage brokerage in the US advertising subprime mortgages in July 2008.

In the years before the crisis, the behavior of lenders changed dramatically. Lenders offered more and more loans to higher-risk borrowers, including undocumented immigrants. Lending standards particularly deteriorated in 2004 to 2007, as the GSEs market share declined and private securitizes accounted for more than half of mortgage securitizations. Subprime mortgages amounted to $35 billion (5% of total originations) in 1994, 9% in 1996, $160 billion (13%) in 1999, and $600 billion (20%) in 2006. A study by the Federal Reserve found that the average difference between subprime and prime mortgage interest rates (the "subprime markup") declined significantly between 2001 and 2007. The combination of declining risk premiums and credit standards is common to boom and bust credit cycles. In addition to considering higher-risk borrowers, lenders had offered increasingly risky loan options and borrowing incentives. In 2005, the median down payment for first-time home buyers was 2%, with 43% of those buyers making no down payment whatsoever. By comparison, China has down payment requirements that exceed 20%, with higher amounts for non-primary residences. The mortgage qualification guidelines began to change. At first, the stated income, verified assets (SIVA) loans came out. Proof of income was no longer needed. Borrowers just needed to "state" it and show that they had money in the bank. Then, the no income, verified assets (NIVA) loans came out. The lender no longer required proof of employment. Borrowers just needed to show proof of

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money in their bank accounts. The qualification guidelines kept getting looser in order to produce more mortgages and more securities. This led to the creation of NINA. NINA is an abbreviation of No Income No Assets (sometimes referred to as Ninja loans). Basically, NINA loans are official loan products and let you borrow money without having to prove or even state any owned assets. All that was required for a mortgage was a credit score. Another example is the interest-only adjustable-rate mortgage (ARM), which allows the homeowner to pay just the interest (not principal) during an initial period. Still another is a "payment option" loan, in which the homeowner can pay a variable amount, but any interest not paid is added to the principal. Nearly one in 10 mortgage borrowers in 2005 and 2006 took out these option ARM loans, which meant they could choose to make payments so low that their mortgage balances rose every month. An estimated one-third of ARMs originated between 2004 and 2006 had "teaser" rates below 4%, which then increased significantly after some initial period, as much as doubling the monthly payment. The proportion of subprime ARM loans made to people with credit scores high enough to qualify for conventional mortgages with better terms increased from 41% in 2000 to 61% by 2006. However, there are many factors other than credit score that affect lending. In addition, mortgage brokers in some cases received incentives from lenders to offer subprime ARM's even to those with credit ratings that merited a conforming (i.e., non-subprime) loan. Mortgage underwriting standards declined precipitously during the boom period. The use of automated loan approvals allowed loans to be made without appropriate review and documentation. In 2007, 40% of all subprime loans resulted from automated underwriting. The chairman of the Mortgage Bankers Association claimed that mortgage brokers, while profiting from the home loan boom, did not do enough to examine whether borrowers could repay. Mortgage fraud by lenders and borrowers increased enormously. The problem was that even though housing prices were going through the roof, people weren't making any more money. From 2000 to 2007, the median household income stayed flat. And so the more prices rose, the more tenuous the whole thing became. No matter how lax lending standards got, no matter how many exotic mortgage products were created to shoehorn people into homes they couldn't possibly afford, no matter what the mortgage machine tried, the people just couldn't swing it. By late 2006, the average home cost nearly four times what the average family made. Historically it was between two and three times. And mortgage lenders noticed something that they'd almost never seen before. People would close on a house, sign all the mortgage papers, and then default on their very first payment. No loss of a job, no medical emergency, they were underwater before they even started. And although no one could really hear it that was probably the moment when one of the biggest speculative bubbles in American history popped.

Andrew Ross Sorkin is The New York Times chief mergers and acquisitions reporter and a columnist. He wrote book Too Big to Fail in which he described how Wall Street and Washington Fought to Save the Financial System.

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Why the U.S. government let Lehman Brothers fail in 2008, but not American International Group (AIG). How the bailout process proceeded, starting with AIG. How U.S. financial officials convinced bankers to take bailout cash.

In Too Big To Fail, Sorkin takes you inside the terrifying days just prior to the failure of Lehman, an event that proved to be the tripwire of global financial upheaval. From there, you are immediately inside the bailout of AIG, followed by the near collapse of Morgan Stanley, Goldman Sachs and perhaps General Electric. As if we didn't know before, we get confirmation that the world of high finance is full of grey areas. Hank Paulson had a brother working at Lehman Brothers in Chicago, former president George W. Bush's brother Jeb was an adviser to Lehman's private equity division, and a cousin of the president, George Walker IV, was on Lehman's executive committee. Had Paulson found a way to bail out Lehman Brothers with the help of government money, these connections would likely have raised serious questions of conflicts of interest. Was he hamstrung? We may never know. Lehmann CEO Fuld's long-time No. 2 Joe Gregory, would helicopter to work each day Then there was John Thain, the Merrill Lynch/Bank of America executive, in a Washington meeting that saw the banks forced to take government money. Sorkin reveals that the first question out of Thain's mouth was how taking taxpayer cash would affect compensation policies at the banks. So much for concern about Main Street.

Aside from the inside dope on high-stakes meetings and negotiations, the book's strength lies in the details about the people involved.

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We learn that Paulson, with the hundreds of millions of dollars he made as CEO of Goldman Sachs prior to joining Treasury, lived a frugal life for a big shot. He and his wife were housed in a mere 1,200-square-foot apartment in New York City when he ran the storied investment bank. We later find out that this dedicated birder, a Prius driver, also owns an enormous tract of land in the southern United States, but as a conservationist. Lehman, on the other hand, was run by obnoxious big spenders. CEO Dick Fuld's long-time No. 2, Joe Gregory, would helicopter to work each day. Repeat: helicopter to work. Gregory, according to Sorkin, was also an SOB, making zero allowances for a fellow executive who had a daughter with cystic fibrosis, essentially ruining the man's career. As a reader, you cheer when Gregory is forced out after being Fuld's junkyard dog for 30 years. Reading about the recklessness at Lehman prior to the crisis, one can easily conclude that it deserved to fail, notwithstanding the harrowing consequences for the world's financial markets. Mind you, one might also conclude the markets deserved what they got. Henry Paulson and Timothy Geithner had a dim view of Christopher Cox, the chairman of the Securities and Exchange Commission, the market regulator. Cox is described as useless. At the risk of splitting hairs, it sometimes shows that this was a rush job. There are typos and even the odd inaccuracy. The book describes $500-billion worth of toxic mortgages bundled up and sold by Merrill Lynch. By my own back-of-the-napkin calculation, that's probably impossible. The whole sub-prime fiasco has cost the U.S. government just (just!) over $1-trillion so far. Merrill was not responsible for half of it.

Don't let these minor flaws take away from what is truly a bowl-them-over book. It has movie written all over it. When I interviewed Sorkin recently and asked if it's headed to the big screen, he said, stay tuned. He did allow that Robert DeNiro might be good in one of the leading roles.

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Key players: Treasury secretary Henry Paulson (Former chairman and CEO Goldman Sachs), Richard Fuld chairman CEO Lehman brothers, Warren buffett worlds richest man. What Caused The Fall Of Lehman Brothers In 2008? Larry (known as Lawrence McDonald in the USA) participated in the financial services discussion in the 2010 European Business Summit in Brussels. Their debate included brief conversations relating to financial education for the population, the difficulty of finding work in Wall Street and investment banks, the amount of leverage in the financial system and much more. As we all know, the failure and fall of Lehman Brothers in 2008 and the financial crisis more broadly, was caused by many different problems in the banking world. These reasons include sub-prime mortgages, an interconnected world of derivative contracts, poor understanding of the risks being taken and much more. Many of these issues played out in Lehman Brothers and are described in Larry's book, A Colossal Failure of Common Sense . In our interview, we discuss a number of the broader issues. EBS is really about European government policy making, so we had to discuss some of the more related topics of regulators and regulations, wages and bonuses. As interesting as this interview was, Larry was even more interesting off camera before and after (apologies for not catching more of it). He has some strong views on the increase in prop trading by the big investment banks, the impact this had on their business models and their relationships with clients. We also discussed at some length the role of pension funds and why their insistence to company boards of directors that they use limited amounts of borrowing (broadly a very sensible idea) opens them up to the more predatory private equity funds and their mountains of aggressively used borrowed money. This leads to a central issue for Larry in the current financial world - that many of the new products and financial 'developments' have created ways to simply transfer wealth en masse from stockholder and pension fund investor to financiers. In short, if you have an interest in finance or a desire to understand more about the workings of the world, he is a very interesting man! To my slight shame at the time, I have the book on my shelf but have yet to start reading it. However, after our conversations, I find it difficult to believe that it can be anything other than a revelation of facts about the mismanagement of global and corporate finance.

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The immediate impact of the nearly one trillion dollar bailout of the U.S. financial sector by the Treasury Department is, hopefully, an end to short-selling speculation and a return to greater stability. The latter will find expression in banks being willing to lend to one another again, after a period of about a year when requests for loans were treated as toxic. This will be positive for the economy in the short run and will get businesses and consumers back into a spending frame of mind as credit becomes more available and worthless mortgages are purged from the system. The United States, having never been through such a massive government bailout before, may well have to face up to some harsher long-term realities. Here is what would seem to be the most likely scenario. The U.S. government will be anxious to reduce its debt load of about ten trillion dollars as quickly as possible. It will be hard to resist having higher prices take care of part of the problem. This means a likely pickup in inflation caused by printing more money. More inflation means higher interest rates. More inflation also means a worsening of the trade deficit. This may lead to additional downward pressure on the value of the U.S. dollar. The huge trade deficit already in place has required China and Japan to keep buying treasury bills at interest rates that are unappealingly low. The greenback versus the Euro is likely to suffer further indignity. Higher inflation, a falling dollar and rising interest rates are a terrible trinity. Recession will be hard to avoid. Policy makers might well be advised to ask what measures an international agency such as the World Bank or International Monetary Fund would require of a delinquent nation when its finances go into arrears

http://www.reedconstructiondata.com/alex-carrick/post/consequences-of-the-us-financialsector-bailout-the-bigger-picture/ Impact of EU bailout on the U.S:


Facing a long-awaited and rapidly building financial contagion, the European Union (EU) announced a massive 750 billion ($956 billion) self-bailout on May 9. This comes on the heels of a previously announced smaller bailout for Greece, Europes weakest link financially. The immediate effects of the big package were to provide some stability to the euro, suspend the contagion, and give European leaders time to devise and implement more fundamental changes to their fiscal policies, economic policies, and the very structure of the European economic system. What the EU bailout did not do was address the underlying causes of the debt crisis. The basic conditions that led to the present state remain. Greece remains a basket case fiscally, politically, and economicallywith what an International Monetary Fund (IMF) assessment diplomatically referred to as deep-rooted vulnerabilities. Many European nations are running unsustainable budget deficits that debt markets are increasingly reluctant to finance. Even Germany may be at risk due to enormous and as yet unbooked losses from its state-owned Landesbanken. And above all, the reality of Europes bankrupting social welfare programs is no longer a matter for future reflection and discussion but is now immediately apparent and demanding of immediate correction. As Czech President Vclav Klaus explains, The European soziale Markwirtshaft is an unproductive variant of a welfare state, of state paternalism, of leisure society, of high taxes and low motivation to work. In many respects, the United States is in an enviably stronger position. While the recent recession was painful, the fundamentals of relatively free markets, relatively low taxes, and a strong and enduring entrepreneurial spirit suggest the economy will return to robust growth despite all the policy bric-a-bracs Washington throws at it. Yet some deeply biting fiscal thorns intrude into this rosy backdrop. The U.S. is running a massive budget deficit of its own due to an unprecedented surge of spending.

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Higher spending is causing the federal government to rapidly build public debt to Grecian levels, all on the way to a rapidly approaching calamity with an unsustainable federal social welfare state modeled on the European tradition. Failure to reverse the U.S. course on spending and soonradically exposes the United States to the same financial and economic problems now facing Europe. The difference is only a matter of time. The correct course is to reverse course on spending to bring deficits back to sustainable levels. Most immediately, the European mega bailout has produced a moment of relative calm. As uncertainties built in Europe, a large and growing uncertainty premium was building in financial markets. This was readily apparent in European equity and bond markets and in the sinking value of the euro. It was also apparent in sliding U.S. equity markets. It was less apparent in U.S. bond markets, as worries about Europe led to the predicted surge of flight-to-quality capital flows into the U.S. from abroad, driving down bond rates. The European bailout has allowed much of this uncertainty premium to dissipate for the moment and so global markets found a more normal footing. Near-term stabilization in Europe also means the European recovery should continue for a period, which means in turn that U.S. exports to Europe should follow their normal course, though there will

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be negative effects on the net trade deficit with Europe from a stronger dollar vis--vis the euro. In contrast, if the European contagion had swept the continent, or if it does yet, the European recovery would falter and the U.S. net trade deficit with Europe would balloon. So for the U.S., score two bullets dodged. Most important by far, however, is the big story. The U.S. has been episodically following the European model of massive government spending built around a high-tax social welfare statethe very system President Klaus warns aboutbut fortunately the U.S. has until recently lagged Europe by some decades. Under President Obama, the United States has been in a big rush to catch up through enormous increases in entitlement and non-entitlement spending, pushing spending from the normal levels of about 20 percent of GDP to 26 percent and higher. We have now seen first in Greecebut inexorably also in the United Kingdom and then even eventually in Germany and Francethe collapse of the European model. As The Washington Post presciently observed, the conditions attached to any bailout loans mean that European governments will rewrite a post-World War II social contract that has been generous to workers and retirees but has become increasingly unaffordable for an aging population. The essential problem with the European model is that the underlying grand bargain is not a static one. The grand bargain is an exchange of high economic growth and robust individual freedom for expectations of greater economic stability and security provided by an ever-more omnipresent government. Over time, the consequence of a dismissive attitude toward the forces necessary for economic growth is ever-less growth. Over time, the consequence of a more permissive attitude toward governmental beneficence is more and more government while the taxation necessary to support that level of government falls increasingly short

Two solutions:
Long-run federal spending is wildly unsustainable, as almost everyone from right to left agrees. Under President Obama, this long-run problem has been married to an almost equally unsustainable short-run problem of deficit spending. Thus, to watch developments in Europe today is to peer through a clear window into Americas own future. As the nation runs deficits in the Grecian mode and its own public debt soars toward 100 percent of its economy, a future crisis becomes as predictable as the sunriseand just as widely predicted. The issue is a simple one. Federal receipts will soon return to normal, but they will be inadequate to reduce budget deficits to sustainable levels because federal spending has exploded. One solution is to raise taxes massively, adopting the European high-tax social welfare model and accept permanently lower wages and incomes before and after tax. The other is to return spending to historical levels and enjoy both more freedom and a stronger economy. The right solution is to choose freedom.

http://www.heritage.org/research/reports/2010/06/what-the-eu-bailout-means-for-the-us

Socio cultural Impact:


A visit to Western Europe in early March provided some slightly different -- if unsettling -- insights into global economic arrangements and their socio-cultural co-ordinates. As the crisis unfolds, people everywhere are questioning current economic institutions and processes, and naturally

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enough their fears, insecurities and concerns also affect their visions for the future. The fundamental issues relate to income and resource distribution (don't they always?) but in this time of global crisis, the expression of these issues can become sharper and even more openly divisive in spirit.

Two features of some current public responses in these societies are especially relevant in this context. The first is the barely concealed animosity towards China and India (inevitably clubbed together, despite all the huge differences) as perceived beneficiaries of globalisation and voracious consumers of global resources. The second is the general inability to conceive of a way out of the current global economic crisis in any way other than simply replicating the past, even though those past trends clearly cannot be sustained. European attitudes towards Asia have long been characterized by varying combinations of fear and fascination, respect and revulsion, competition and colonialism -- as studies of Orientalism have made only too evident. But the current public perceptions are somewhat different: fed by sensationalizing media that cannot waste time or space on complexities, they move in pendulum swings from seeing populous Asia as the breeding ground for poverty and terrorism to believing that aggressive exporting based on underpriced labor is causing more than two billion people to lead "middle class lives" that draw unsustainably on the world's resources. Of course, sheer ignorance explains a lot. Among the general public in Europe, and even in the more informed sections, there is almost no realization of how globalization has adversely affected livelihoods and employment of the majority of the population in the developing world including in fast-growing Asian countries. The agrarian crisis is largely seen to be history, supposedly vanquished by the rising prices of agricultural goods in world trade between 2002 and mid-2008, even though farmers' incomes continue to stagnate and cultivation is still barely viable in large parts of the developing world. Because of the volumes of manufacturing exports from Asia, there is still widespread perception of shift of manufacturing jobs from North to South -- even though manufacturing employment has declined in the developing world as a whole, has barely increased in most countries of Asia and has actually declined since 1997 in what is generally accepted to be the workshop of the world, China. A member of the audience at a public debate in London asked whether China and India, newly enriched by exploiting the globalization process, would therefore use the current crisis as opportunity to ride through the global economic tsunami that threatens to engulf everyone else and emerge stronger than the US and Europe. A distinguished-looking and apparently eminent elderly gentleman at a large conference in Berlin was even sharper: "China and India", he claimed, "benefited from the Asian economic crisis in 1997-98 at the cost of their neighbors, and now they will benefit from the global crisis". Another participant from the floor expressed it slightly differently: "These countries are not poor, they are full of billionaires and have four out of ten of the world's richest people, and yet they come blaming us for the crisis and demanding assistance from us". These are obviously not politically correct positions, nor are they necessarily even the majority view, since they were opposed by other participants in each of these events. Yet the sheer honesty of their expression is useful, since it provides some idea of what must be a widespread underlying perception. And the concerns do not relate only to potential shifts in geopolitical or economic power. Even among more progressive people in Europe, there is a palpable fear (sometimes unspoken and sometimes expressed only in

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subtle and qualified arguments) that growing consumption of such a large part of the world's population will put an unbearable strain on global resources and therefore cannot really be supported. There is certainly some degree of truth in this -- there is no question that current "Northern" standards of life cannot be sustained if they were made accessible to everyone on this planet. This means that future economic growth in the developing world has to involve more equitable and sensible patterns of consumption and production. But that hardly deals with the basic problem. Even if the elite and middle class of the developing world, and particularly China and India, just stopped increasing their consumption, simply bringing the vast majority of the developing world's population to anything resembling a minimally acceptable standard of living will involve extensive use of global resources. It will necessarily imply more natural resource use and more carbon emissions. So the stark reality is that the developed world must, on the whole, consume less of the world's resources and reduce its contribution to global warming absolutely. This in turn has effects on income as well. It is not immediately clear why rich countries with falling populations necessarily need to increase their GDP, and why they should not focus instead on internal redistribution and changing lifestyles, which could in fact improve the quality of life of every citizen. The current crisis is an excellent -- even unique -- opportunity to bring about such shifts in socially created aspirations and material wants, and to reorganize economic life in the developed world to be less rapacious and more sustainable. But sadly, this message is not being heard at least among the major policy makers in the core capitalist countries. In the United States, even the relatively environment-friendly Obama administration simply talks about promoting "cleaner, greener technologies" rather than altering absurd and wasteful consumption patterns. For example, it is still basing its transport strategy on excessive reliance on private automobile use rather than more extensive and efficient public transport. In Europe, too, the focus is on reviving and increasing the old (outdated?) patterns of consumption. Silvio Berlusconi in Italy has just pleaded with his people not to change their lifestyles because of this crisis, because this would reduce economic activity immediately! The implication is that wasteful and excessive consumption is socially desirable because that is the only way to preserve employment. Globally, too, policy makers are displaying the same startling lack of imagination. The focus is on the US and all eyes are on the Obama recovery package, since direct or indirect dependence on exports to the US is so great for most countries that this is seen as the only way for all economies to recover. Yet the US simply cannot continue to be the engine of world growth, given its huge external debt and current deficit, nor is it desirable that it should do so. This creates an inevitable and urgent need for other economies to redirect their trade and investment, at least at the margin. And associated with that, it also creates an opportunity for other countries to think about generating different, more sustainable and possibly more desirable, consumption patterns. Why is it that so few people, especially those in a position to influence economic policies today, are raising these rather obvious questions? What we do not seem to realize is that

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unless we sort out these basic issues, we will not only be marching with lemming-like intensity and desperation to the sea, but we will also be squabbling, fighting and even killing each other for the privilege of getting there first.

How much people are aware of the recent financial crisis


The role income inequality may have played in creating the financial crisis. For understanding the financial crisis, it might be that politics was much more of a driving force. Might actually have been that it was politics acting as sort of an autonomous force really shapes the state of finance and the financial industry in the United States. Especially over the last 25 years or so. Developments in the financial industry then pose both the financial crisis and also through related processes part of the inequality that we observe in the United States. I think there is a difference between what I'm going to call labor market inequality, which is what I think Rajan is talking about, and top inequality. By top inequality, I mean: How much do people in the very, very top of the income distribution earn relative to the rest of the population? The top 1%, or the top 0.1% of the U.S. population, the very highly paid CEOs; and the financial industry; there are also some in the entertainment industry and so on. That top 1 or .1 percent, it's a pretty diverse group of business executives, lawyers, surgeons, basketball players, entrepreneurs. Not many people in any of those, since we are talking about the very top. But some overrepresented in that tranche than it had been before. We'll talk about some work other economists have done that provides some evidence consistent with that. But the reason I'm drawing this distinction between labor inequality and top inequality is that there is fairly detailed work on what causes labor inequality, the difference between college graduates and high school dropouts, between people with MBAs and people with just a college degree. Or the 90th percentile relative to the 10th percentile. There is much less work about what's going on or causes of the explosion of inequality at the top of the distribution. A little bit. The superstar literature. But not empirical. Good reason for that, which is that the usual data sources that people use for long-term inequality trend, the Current Population Survey (CPS) or Census data, they are all top-coded [sp.?], which means they tell you accurately what's going on at the 90th percentile but not much more about that. There is a certain level above which your income is not revealed. Meaning: it's 100,000 or more, or a million or nor. But we don't see Bill Gates's income. For that reason, the labor literature hasn't spoken that much about those people. Recent research by Thomas Pickety and Emmanuel Saez use IRS data to look at some of the trends, but it doesn't have the same sort of richness as the CPS or Census data. Harder to know who these people are, what their level of education is, what industry they are working on. The more depressing one is that there was a political process that led to certain types of distortions in the financial industry. Those distortions then both laid the seeds of the financial crisis--because they encouraged the wrong type of risk-taking--and they also in the process made a lot of money for those people taking risks while those people hadn't turned south yet. Simple story; many people have sort of written about it. In your presentation you talked about the Political Science literature that correlates, giving contributions to politicians with policy outcomes that benefited, say, the housing industry.

Pakistan less affected by financial crisis: Raza


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Published: April 19, 2009

KARACHI - Governor State Bank of Pakistan (SBP) Syed Salim Raza has said that developing countries will have to stimulate their domestic economies, increase their capacity to consume surplus production in the wake of shrinking exports and achieving sustainable growth to effectively weather international financial crisis. Speaking as a chief guest at a lecture on Financial Meltdown and Global Economic Recession: Causes and Effects organized by Karachi Council on Foreign Relations, Economic Affairs and Law (KCFR) at a local hotel in Karachi on Saturday, Raza dwelt at length over the causes and effects of the ongoing crisis in the international financial markets. He said that in the wake of global financial meltdown, emerging markets have suffered a sharp fall in demand for their products, whether commodities or manufactured goods as major economies have contracted, and a sharp slowdown in private capital flows to the order of over $500b between 2007 and 2009 has taken place. He said Pakistan had not been adversely affected by the global financial crisis as the rest of the world. Nevertheless, one impact of the global financial meltdown is that private inflows of the order we witnessed until 2007 have dried up. The implication is that the role of multilateral inflows has become all the more important. And, the fact that our macroeconomic stabilization programme is on the right track will help these type of flows to materialize speedily, he said. Raza said that Pakistans economy is likely to grow between 4%-4.5percent in the next fiscal year. Responding to a query, he said the inflation is likely to be in single digit in the next fiscal year. He said that the federal government has successfully implemented macroeconomic stabilization programme and added we have been able to meet all the targets of the IMF. He also appreciated the role of IMF in the macroeconomic stabilization of Pakistan. The SBP Governor said the pledges of $5.28 billion made at the recently concluded Friends of Pakistan meeting in Tokyo show the confidence of international community over economic performance of the government.

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