final touch spc

8/9/2019 Final Touch Spc

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Presentationywhat is a recession

y Causes

y Past recessionyWhat is sub prime crisis

y Causes

y Impacts

y Solutions


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So what is a recession????y A recession is a decline in a country's gross domestic

product (GDP) growth for two or more consecutivequarters of a year. A recession is also preceded by several

quarters of slowing down.

What causes it?y A recession normally takes place when consumers lose

confidence in the growth of the economy and spend less.

y This leads to a decreased demand for goods and services,which in turn leads to a decrease in production, lay-offsand a sharp rise in unemployment.

y Investors spend less as they fear stocks values will fall andthus stock markets fall on negative sentiment.


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Past recessionsy The US economy has suffered 10 recessions since the

end of World War II.

y The Great Depression in the United was an economicslowdown, from 1930 to 1939.

y 1930s. Industries that suffered the most includedagriculture, mining, and logging.

y Production declined sharply, as did profits andemployment. Unemployment jumped from 14.3 percent in 1937 to 19.0 per cent in 1938.


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Past recessionsy The US saw a recession during 1982-83 due to a tight

monetary policy

y This was followed by Black Monday in October 1987,when a stock market collapse saw the Dow JonesIndustrial Average plunge by 22.6 per cent affectingthe lives of millions of Americans.

y

The early 1990s saw a collapse of junk bonds and afinancial crisis.


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Past recessionsy The US saw one of its biggest recessions in 2001, ending ten

years of growth, the longest expansion on record.

y

From March to November 2001, employment dropped byalmost 1.7 million. In the 1990-91 recession, the GDP fell 1.5per cent from its peak in the second quarter of 1990. The2001 recession saw a 0.6 per cent decline from the peak inthe fourth quarter of 2000.

y The dot-com burst hit the US economy and manydeveloping countries as well. The economy also sufferedafter the 9/11 attacks. In 2001, investors' wealth dwindled astechnology stock prices crashed.


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Impact of a US recession on India

y Indian companies have major outsourcing deals from theUS. India's exports to the US have also grown substantiallyover the years

y Between January 2001 and December 2002

y the Dow Jones Industrial Average went down by 22.7 percent, while the Sensex fell by 14.6 per cent. If the fall fromthe record highs reached is taken, the DJIA was down 30

per cent in December 2002 from the highs it hit in January2000. In contrast, the Sensex was down 45 per cent

y The whole of Asia would be hit by a recession as it dependson the US economy.


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What is Subprime Crisis???y The term subprime refers to the credit status of the

borrower (being less than ideal), not the interest rate

on the loan itself. sub prime is any loan that does notmeet prime guidelines

y Subprime lending, also called B-paper, near-prime, orsecond chance lending, is the practice of making loansto borrowers who do not qualify for the best marketinterest rates because of their deficient credit history.

yA subprime loan is offered at a rate higher than A-paper loans due to the increased risk.


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Who opt subprime lending?y These individuals may have had job loss, previous debt or

marital problems, or unexpected medical issues, usuallythese events were unforeseen and cause a major setback in

finances. As a result, late payments, charge-offs,repossessions and even foreclosures may result.

y Due to these previous credit problems, these individualsmay also be precluded from obtaining any type of loan foran automobile.

y From a servicing standpoint, these loans have highercollection defaults and experience higher repossessionsand charge offs. Lenders use the higher interest rate tooffset these anticipated higher costs.


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What about lending rates?y ARM:Adjustable-rate mortgages (or ARMs) that give them a lower initial interest

rate. But with potential annual adjustments of 2% or more per year, these loans canend up charging much more.

y So a $500,000 loan at a 4% interest rate for 30 years equates to a payment of about$2,400 a month. But the same loan at 10% for 27 years (after the adjustable periodends) equates to a payment of $4,470.

y A 6-percentage-point increase in the rate caused slightly more than an 85%increase in the payment.The 2/28 ARM : This is an adjustable rate mortgage on which the rate is fixed for 2

years, and then reset to equal the value of a rate index at that time, plus a marginy

For example, the rate is 8% for 2 years but the index is currently 4% and the marginis 6%. If the index remains at 4% after 2 years, the loan rate will jump to 10%.

y Home borrowers with poor credit scores take a 2/28 at a high rate and plan torebuild their credit during the 2-year period. Their plan is to refinance at a betterrate at that time.


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How the subprime crisis started?

y The subprime lending is 9% in 1996 but in 2004 it is 21%.

y Between 1997 and 2006, American home prices increased

by 124%.Easy credit combined with the assumption thathousing prices would continue to appreciate alsoencouraged many subprime borrowers to obtain ARM theycould not afford after the initial incentive period. Withhousing prices now depreciating moderatel in many parts

of the U.Sy Beginning in late 2006, the U.S. subprime mortgage

industry entered what many observers have begun to referto as a meltdown


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How the subprime crisis started?

y A steep rise in the rate of subprime mortgage foreclosures hascaused more than 100 subprime mortgage lenders to fail or filefor bankruptcy

y

New Century Financial Corporation, previously the USAs secondbiggest subprime lender. The failure of these companies hascaused prices in the $6.5 trillion mortgage backed securities

y However, the crisis has had far-reaching consequences across theworld.

y UK housing market will in fact be largely unaffected by the US

subprime crisis, and have classed it as a localized phenomenony September 2007 Northern Rock, the UKs fifth largest mortgageprovider, had to seek emergency funding from the Bank ofEngland, the UKs central bank as a result of problems ininternational credit markets attributed to the sub-prime lendingcrisis.


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What are the Causes for sub prime

crises???y Boom and bust in the housing markety Low interest rates and large inflows of foreign funds created easy

credit conditions for a number of years prior to the crisis

Between 1997 and 2006, the price of the typical American houseincreased by 124%

Household debt grew from $705 billion at yearend 1974, 60% to$14.5 trillion in midyear 2008, 134% of disposable personalincome.

U.S. home mortgage debt relative to GDP increased from anaverage of 46% during the 1990's to 73% during 2008, reaching$10.5 trillion

which caused U.S. housing prices to peak and begin declining in mid-2006.


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crises???

y September 2008, average U.S. housing prices had declined by over 20% fromtheir mid-2006 peak

y This major and unexpected decline in house prices means that many borrowers

have zero or negative equityin their homes, meaning their homes were worthless than their mortgagesAs of March 2008, an estimated 8.8 million borrowersto 12 million by November 2008

y Increasing foreclosure rates . nearly four million existing homes were for sale,of which almost 2.9 million were vacant.[This overhang of unsold homeslowered house prices.

y

Speculationy During 2006, 22% of homes purchased (1.65 million units) were for investmentpurposes, with an additional 14% (1.07 million units) purchased as vacationhomes. In other words, a record level of nearly 40% of homes purchases werenot intended as primary residences.


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crises???y High-risk mortgage loans and lending/borrowing practices

y Lenders offered more and more loans to higher-risk borrowersSubprime mortgages amounted to $35 billion (5% of total

originations) in 1994,to $600 billion (20%) in 2006y difference between subprime and prime mortgage interest rates

(the "subprime markup") declined significantly between 2001and 2007.

y The total amount of mortgage-backed securities American

homeowners, consumers, and corporations owed roughly $25trillion during 2008. The securitization markets started to closedown in the spring of 2007 and nearly shut-down in the fall of2008. More than a third of the private credit markets thusbecame unavailable as a source of funds.


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crises???yInaccurate credit ratingsy conflicts of interest between rating agencies and issuers of structured securitiesy $1.9 trillion in mortgage backed securities. Financial institutions felt they had to lower

the value of their MBSyGovernment policies:y Increasing home ownership has been the goal of several presidents

including Roosevelt, Reagan, Clinton and G.W.Bush. In 1982, Congresspassed the Alternative Mortgage Transactions Parity Act (AMTPA),which allowed non-federally chartered housing creditors to write

adjustable-rate mortgages. Among the new mortgage loan typescreated and gaining in popularity in the early 1980s were adjustable-rate, option adjustable-rate, balloon-payment and interest-onlymortgages Approximately 80% of subprime mortgages are adjustable-rate mortgages.


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crises???y Policies of central banks:A contributing factor to the rise in house

prices was the Federal Reserve's lowering of interest rates early in the decade.From 2000 to 2003, the Federal Reserve lowered the federal funds rate targetfrom 6.5% to 1.0%

y This contributed to an increase in 1-year and 5-year ARM rates, making ARMinterest rate resets more expensive for homeowners

y Financial institution debt levels and incentivesy Manyfinancial institutions, investment banks in

particular, issued large amounts of debt during 20042007, A 2004 U.S. Securities and Exchange Commission(SEC) decision related to the net capital rule allowedUSA investment banks to issue substantially more debt,

which was then used to purchase MBS


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crises???y Credit defaults swaps: (CDS) are financial instruments used as

a hedge and protection for debtholders, in particular MBS investors,from the risk of default. Hence the question is which side of the CDSwill have to pay and will it be able to do so. When investment bankLehman Brotherswent bankrupt in September 2008

y Investment in U.S. by foreigners of their proceeds from America'snet importsBetween 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 fromcountries running trade surpluses, mainly the emerging economies inAsia and oil-exporting nations.


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Impact in the U.S.y By early November 2008, a broad U.S. stock index, the S&P 500,

was down 45 percent from its 2007 high.y Housing prices had dropped 20% from their 2006 peak, with

futures markets signaling a 30-35% potential drop.y Total home equity in the United States, which was valued at $13trillion at its peak in 2006, had dropped to $8.8 trillion by mid-2008 and was still falling in late 2008.

y Total retirement assets, Americans' second-largest householdasset, dropped by 22 percent, from $10.3 trillion in 2006 to $8trillion in mid-2008.

y During the same period, savings and investment assets (apartfrom retirement savings) lost $1.2 trillion and pension assets lost$1.3 trillion. Taken together, these losses total a staggering $8.3trillion


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Impact in the Worldy The crisis began to affect the financial sector in February

2007, when HSBC, the world's largest (2008) bank, wrotedown its holdings of subprime-related MBS by $10.5billion, the first major subprime related loss to be reported.

y During 2007, at least 100 mortgage companies either shutdown, suspended operations or were sold

y In all of 2007, insured depository institutions earned

approximately $100 billion, down 31% from a record profitof $145 billion in 2006. Profits declined from $35.6 billion in2007 Q1 to $19.3 billion in 2008 Q1, a decline of 46%.


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Bank loses


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y As of August 2008, financial firms around the globe havewritten down their holdings of subprime related securitiesby US$501 billion.[

y The IMF estimates that financial institutions around theglobe will eventually have to write off $1.5 trillion of theirholdings of subprime MBSs. About $750 billion in suchlosses had been recognized as of November 2008

y As a result of the financial crisis in 2008, twenty five U.S.banks became insolvent and were taken over by the FDIC

y .[As of August 14, 2009, an additional 77 banks becameinsolvent.


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BOND MARKET COLLAPSE


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Third-World economiesy However, some economists state that Third-World

economies, such as the Brazilian and Chinese ones,

will not suffer as much as those from more developedcountries


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What about solution?

y Loan modification, pumping money into market mayslow down the crisis.

yEstablish rescue funds for borrowers facing short-termproblems caused by illness, layoffs or other one-timeevents.

y Establish a bond fund to pay for switching borrowers

out of unaffordable ARMs.y Refinance loans for victims of predatory lending. This

would involve working with Fannie Mae, the quasi-governmental corporation.


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STEPS TAKEN BY US GOVTy Federal Reserve and central banksy In December 2008, the Fed further lowered the federal

funds rate target to a range of 0-0.25% (25 basis points)

y In November 2008, the Fed announced a $600 billionprogram to purchase the MBS of the GSE, to help lowermortgage rates

y On 17 February 2009, U.S. President Barack Obama signedtheAmerican Recovery and Reinvestment Act of 2009, an$800 billion stimulus package with a broad spectrum ofspending and tax cuts.

y Bank solvency and capital replenishmenty Bailouts and failures of financial firmsy HomeownersAffordability and Stability Plan


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VENKI.

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