A

Presentation on
Sub prime lending crisis

Presented by-
Roll no 55 -Umang Dwivedi
56 - Varsa Lodha
57 - V.g Vengatesh
58 - Venkatesh Thatraju
59 - Vidha Shukla
60 - Yogesh Sirsat
Agenda-
• What is sub prime crisis?
• How did it spread?
• Sequence of crisis.
• The participants of the crisis.
• Housing bubble.
• Impact of sub prime crisis in USA
• Domino effect across the World.
• Domino effect in India.
• Conclusion-Is there light at the end of the tunnel?
Definition-
• The sub prime crisis is an ongoing real estate
crisis and financial crisis triggered by a dramatic
rise in mortgage delinquencies and foreclosures
in the United States, with major adverse
consequences for banks and financial markets
around the globe.
 How did it spread?
financial institutions CDO
Financial institutions

Lowest risk/
Highest rating

Medium Risk

SECURITISATION
Highest Risk/
Equity
proceeds Sale of loan
Sub prime lenders Investors
Sub-Prime Borrower
Buying Home
banks

Hedge Funds

Insurance & E Cos

Pension Funds
loan
Sequence of events
 The participants of the crisis

Lenders / Mortgage broker

originators

Borrowers Rating agencies

Fannie Mae and

Freddie Mac
Housing bubble-
 A silent storm brewed in international
financial markets with origins in the US
housing market, which witnessed an
unprecedented boom since 2001.

The boom was led by rising housing

prices, low interest rates & aggravated
by financial innovation viz. MBS, CDO
and CDS.
Housing prices in USA began to drop
in 2006. Rising interest rates & falling
housing prices led to rise in sub prime
mortgage delinquencies & resultant
foreclosure.
Result: The housing bubble burst in
Aug 2006
Impact of crisis in USA
 Initial impact was felt in March 2008, when
investment bank, Bear Stearns was acquired
by J.P. Morgan Chase, a commercial bank, for
US$1.2 billion.
 September 2008, witnessed major shakeouts
in the US financial sector. The drama began
with Lehman Brothers declaring bankruptcy on
15 September 2008, facing a refusal by the
federal government to bail it out.
 Washington Mutual is closed by the US
government in the largest failure of a US bank.
Its banking assets are sold to J.P. Morgan
Chase for US$1.9 billion.
 The problem with investment bank balance
sheets is that on the left side nothing is right
and on the right side nothing is left.
Contd…
 US Federal Reserve provided an emergency loan
of US$85 billion to insurance major, American
International Group (AIG), which will be repaid by
selling off assets of AIG

 Investment bank, Merrill Lynch was acquired by

Bank of America in September 2008 for $50
billion.

 US Federal Reserve granted approval to

investment banks, Goldman Sachs and Morgan
Stanley to convert themselves into commercial
banks.

 US Treasury Department confirmed that both

Fannie Mae and Freddie Mac, would be placed
into conservatorship with the government taking
over their management.
Contd…
 Wachovia Corp agrees to sell most of its assets
to Citigroup Inc in a deal brokered by regulators.
However, Wells Fargo, a commercial bank, drafted
an agreement to acquire assets of Wachovia for
US$15.1 billion.

 The deal forced Wachovia to backtrack from the

Citigroup deal worth US$2.2 billion which was
backed by the US Government.

 US Government releases a US$700 billion bailout

package for its financial industry.

 Washington Mutual is closed by the US

government in the largest failure of a US bank. Its
banking assets are sold to J.P. Morgan Chase for
US$1.9 billion
Domino Effect across the World
 Northern Rock Bank had difficulty finding finance to
keep the business going and was nationalised in
February 2008.

 loan lender in an all-share deal which values HBOS

at over £12 billion (US$22.3 billion)

 In September 2008, British bank Bradford & Bingley

was nationalised by the UK government, which will
take control of the bank's £50bn mortgages and
loans, while its savings operations and branches
are to be sold to Spain's Santander.

 The Dutch operations of Fortis, Europe's largest

victim of the credit crisis, have been nationalised in
a €16.8 billion (£13 billion) deal aimed to calm
investors in the troubled banking and insurance
group.
Contd…
 Germany struggled to rescue lender Hypo Real Estate (Mortgage
Giant), underlining the challenge facing European leaders, who
vowed to restore stability in a banking system hit by the worst crisis
since the 1930s.

 In October 2008, the Australian government announced that AU$4

billion was to be raised to fund non-bank lenders that are unable to
obtain funding to finance new loans. After industry feedback this
was increased to AU$8 billion.

 Japanese financial powerhouse, Nomura Holdings Inc. bought over

Lehman's franchise in Europe and Asia Pacific, including Japan and
Australia.

 Stock markets tanked - Crisis caused panic in the financial markets

and investors sold out and withdrew their money, resulting in sharp
drop in stock prices.
Contd…
 Many banks, mortgage lenders, real estate investment trusts & hedge
funds suffered significant losses

 Credit got tighter - banks became extremely careful parting with their
capital and decreased lending activities either to business houses, retail
customers and even to each other.

 Effect on jobs – Many employees lost their jobs, especially in the

financial sector.
Contd…
 The world market capitalization has fallen by 20% since March 2007
and by 31% since December 2007. Year to date, the Indian and
Chinese markets have been the worst performers amongst the
larger indices
Domino Effect in India
 FII investments increased in most of 2007 in a booming Indian
economy, as the Sensex was on its way to a historic peak of over
20,000 points.

 Since the inflow of dollars in the Indian economy increased, the dollar
exchange rate decreased.

 In 2008, however, due to the effect of the sub prime crisis, FIIs
liquidated their equity investments in a big way – leading to a crash in
the stock markets.

 Simultaneously international commodity prices, including oil prices, were

on a rise due increasing demand for these commodities.

 The combined effect resulted in an increase in the dollar exchange rate.

Is there light at the end of the
tunnel?
 There are factors that indicate that there may be more trouble left in
American equity markets viz. USA has a low private savings rate and a
negative household savings rate, in addition to a large current account
deficit and a currency that needs to depreciate further to reduce this gap.

 economy. It does not seem likely the trouble has ended just yet.

 However, Warren Buffet may have started to see some light and has
invested $5bn in the preference shares (attached with equity warrants) of
Goldman Sachs and $3bn in the preference shares of General Electric.

 Commodity prices (and hence inflation) are falling sharply and this will
bring relief to the world and make a stronger case for lower interest
rates. This also mitigates the impact of higher interest rates warranted by
rising fiscal deficits of the governments being created to bail out/
takeover financial institutions.
Contd…
 After an extended debate the US legislators have thought it fit, probably
even profitable, to create a bailout fund of US$700bn. This has been
widely endorsed by most while some still feel the amount to be grossly
inadequate.
 Central Banks around the world are putting up a concerted effort to
provide liquidity to the globe by extending lines and cutting rates. This
cannot but have a stemming effect.
 The world’s Wealth is estimated at US$150 trillion, a lot of which was
built in the last 3 years. Some of the current losses in stocks and wealth
is of course very painful but in the long term may prove to be just a bad
dream that led to some much needed reform and changes in global
leadership, a nightmare which looks like it shall last a while.
 Never before have housing, banks, hedge funds, insurance companies,
commodities and currencies got so badly intertwined. Untangling them
will take sometime. When done, this will create a new world order
Thank you