Global Financial Crisis

Adeel Ahmed FA07-MB-0005

Introduction

The financial crisis of 2007–2010 has been called by leading economists the worst financial crisis since the Great Depression of the 1930s. It contributed to the failure of key businesses, declines in consumer wealth estimated in the trillions of U.S. dollars, substantial financial commitments incurred by governments, and a significant decline in economic activity. Many causes have been proposed, with varying weight assigned by experts. Both market-based and regulatory solutions have been implemented or are under consideration, while significant risks remain for the world economy over the 2010–2011 periods

Key Terminologies

Sub-prime: The term sub-prime refers to the credit quality of particular borrowers, who have weakened credit histories and a greater risk of loan default than prime borrowers. Mortgage: A loan to finance the purchase of real estate, usually with specified payment periods and interest rates. The borrower (mortgagor) gives the lender (mortgagee) alien on the property as collateral for the loan.

How Crisis Started in US

On September 11 the Federal Reserve lowered the interest rate to 1% in order to stimulate the economy. Banks can borrow funds only @ 1%.

How Crisis Started in US (Cont’d)
 This

cheap credit causes banks to go crazy with leverage. is borrowing money to amplify the outcome of a deal.

 Leverage

How Crisis Started in US (Cont’d)
 This

gives wall streets (e.g. banks) an idea.

 They

can connect investors with the home owners through mortgages.

How Crisis Started in US (Cont’d)
A

family wants a house so they save a down payment and contact mortgage broker.  The mortgage broker connects the family to a lender who gives them a mortgage.

Global Crisis
 Now

(Cont’d)

family buys a house and become homeowner. This is great for them because house prices have been rising forever.

How Crisis Started in US (Cont’d)
One day, lender gets a call from investment bank who wants to buy mortgage. Lender sells it to him for a very nice fee.

How Crisis Started in US (Cont’d)
 Investment

bank then borrows millions of dollars and buys thousands more mortgages and puts them into a nice little box.

How Crisis Started in US (Cont’d)

Mortgages in the box are divided into three slices safe, okay and risky. This box is called Collateralized Debt Obligation (CDO). This means every month he gets the payment from the homeowners against the mortgages in the box.

How Crisis Started in US (Cont’d)
To make the top slice safer, bank charges a small fee – Credit Default Swap. Banker sells Safe slice to investors, Okay to other banks and Risky to risk takers.

How Crisis Started in US (Cont’d)
 He

then repays his loans

 Investors

found a good return on their investment, much better than that on T-Bills.

How Crisis Started in US (Cont’d)
 Investment

banker calls the mortgage lender for more mortgages, he calls the agent but he finds no homeowners.  Investment banker then got an idea.

How Crisis Started in US (Cont’d)
 He

started giving subprime mortgages. scenario seems to be making them all rich.

 This

How Crisis Started in US (Cont’d)

How Crisis Started in US (Cont’d)

How Crisis Started in US (Cont’d)

Causes of Crisis
          

Growth of the housing bubble Easy Credit Conditions Sub-prime lending Predatory lending Deregulation Over-leveraging Financial innovation and complexity Incorrect pricing of risk Boom and collapse of the shadow banking system Commodity bubble Role of economic forecasting

Crisis Impacts on US
 Impact

on Financial institution  Wealth Effect  GDP downed at annual rate of 6%  Unemployment rate increased to 10.20%

How rest of the world affected
 Most

countries hold their foreign exchange reserves in dollars.  Global equity markets are closely interlinked.

The End

Thank You