Presented By:

Kaushambi Ghosh

Manish Madhukar

Mohit Almal

Pankaj Agarwal

Agenda

�Subprime•Traditional Model Vs Subprime Model

•Players in the Game

�Bubble•Housing Bubble

�Why it burst?

�Global Crisis

�Impact�Events

�Indian story

�Bailouts

�What Next?

Subprime

Traditional Model Vs Subprime

Model

Players in the GAME

Players

Player 1: Fed-- Fed kept the interest rate low during much of 1990s

and particularly 2001-2005 (low oil prices, and lowinflation prompted the policy), fueling the market

-- During the 2001-2005, FFR was in the 1% to 3% range, and mostly in the 1% range

-- Fed encouraged more risky ARM lending (Greenspan)

Player 2: Mortgage Salespersons-- Worked on commission based on the number of

arms successfully twisted

Contd..

Player 3: Primary Lenders-- No incentives for judicious lending

Banks no longer needed to hold on to the mortgage,as use of mortgage-backed securities made risktaking more appealing

-- Use of ARMs with low teaser rates (below marketrates for a while, followed by much higher ratestied to index, LIBOR + some %). Teaser rates are popular when long-term interest rates are at historical lows (like much of this period), as they help lenders benefit from ARMs as rates rise

-- Net Effect: Many loans were made to NINJA’s (people with No Income, No Jobs or Assets).

Contd..

Player 4: Other Financial Institutions

-- Freddie Mac and Fannie Mae issued many

Mortgage Backed Securities

-- Other financial institutions that traded in

these as well as derivatives based on real

estate assets. Many of these were global

institutions

Contd..

Player 5: Credit rating Agencies and Analysts-- Lack of market for many of these securities, so

models were used to price them-- Inflated ratings, mostly in A range (similar to T-Bills)-- Conflict of Interest: Investment bankers’ analysts

were rating investment bankers’ clients (scandal)-- For example, 3 months prior to its demise, AIG was

rated strong buy (8 analysts), buy(3), hold (10))!!!

Player 6: Home Buyers (Taking Excessive Risk)-- Home buyers were enjoying the ride-- New ones were joining the ride, even if unqualified-- Home ownership up from 60% in 1990s to 70%

Bubble

Historic Bubbles

�Dutch Tulip Mania (1630s)

�South Sea Bubble (1710s)

�British Railway Bubble (1840s)

�US Railway Bubble (1880s)

�Roaring Twenties (1920s)

�Multi Bubble (1960s)

�Internet Bubble (1990s)

�Housing Bubble (2000s)

Structure of a Bubble

� Displacement (diffusion of new technology starts)

� Take off (stock prices show abnormal increase)

� Exuberance (stock prices grow at very high rate)

� Critical Stage (stock price growth slows down)

� Crash (stock prices start tumbling)

Population Dynamics in the Course of

a Bubble

Housing Bubble

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Why housing bubble

burst????

Process of Securitization

Recap: Causes

�Boom and bust in the housing market

�High-risk mortgage loans and lending practices

�Securitization practices

�Speculation

Contd..

�Inaccurate credit ratings

�Government policies

�Policies of central banks

�Financial institution debt levels and incentives

�Credit default swaps

How bubble burst led to

crisis???

How did this turn into a crisis ?

Step 1 - The housing boom in the US started fading out in 2007

Step 2 - Boom had led to massive increase in supply of housing

Step 3 - Thus House prices started falling

Step 4 - This increased the default rate among sub-prime borrowers

Step 5 - These borrowers were no longer able/willing to pay high price for a house

that was declining in value

Step 6 – Security/Guarantee being the house being bought , this increased the

supply of houses for sale while lowering the demand, thereby lowering prices

even further and setting off a vicious cycle

Ripple Effect-Suck Everything

The housing bubble

Defaults & write

A hole in the bubble

Banks go belly-up

Banks get sucked in

How it Unfolded???

Impact

Banks Writedown($ billion) Actions

Citigroup 55.1 Bailout by Fed Reserve($326 billion)

Merrill Lynch 51.8 Taken over by Bank of America

UBS 44.2 $5.3 billion Swiss government bailout

HSBC 27.4

Wachovia 22.5 Wells Fargo

Bank of America 21.2

Royal Bank of Scotland 14.9

Morgan Stanley 14.4 bank holding companies

JP Morgan chase 14.3

Lehman Brothers 8.2 Files for Bankruptcy

AIG 18.5 bailed out by Federal reserve

Crashing Stock Indices

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Indices

17th Jan' 2008

25th Nov' 2008

List of events

Date Events

8th September Fannie Mae/Freddie Mac placed into conservatorship by U.S.

Government

14th September Bank of America agrees to purchase Merrill Lynch for $35B

15th September Lehman Brothers declares bankruptcy

16th September Reserve Primary Fund “breaks the buck” U.S. government seizes

control of AIG in $85B bailout

18th September Treasury Secretary Paulson announces bailout plan

19th September Governments worldwide announce short selling restrictions

Treasury establishes Temporary Guarantee Program for money

market funds

21st September Fed allows investment banks Goldman Sachs and Morgan Stanley to

become bank holding companies

23rd September Warren Buffett announces $5B investment in Goldman Sachs

Date Events

25th September Washington Mutual is seized by FDIC; assets sold to JPMorgan for

$1.9B

29th September Citigroup agrees to acquire Wachovia with FDIC guarantee; a

private transaction with Wells Fargo is later announced

First bailout bill is rejected by U.S. House of Representatives

3rd October - Congress passes TARP legislation

FDIC temporarily increases deposit insurance to $250,000

7th October Fed announces Commercial Paper Funding Facility (CPFF)

8th October Coordinated rate cut by central banks around the globe

13th October Mitsubishi UFJ finalizes $9B equity investment in Morgan

Stanley

14th October Mitsubishi UFJ finalizes $9B equity investment in Morgan

Stanley

Treasury announces TARP Capital Purchase Program

21st October Fed announces Money Market Investor Funding Facility

(MMIFF)

Loss in crisis

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savings and loan crisis(1986-

95)

Banking crisis(1990-99) Banking Crisis(98-99) Subprime crisis(2007-present)

Expon. (Series1)

IMF raises the estimated loss

amount to 1.4 trillion dollars

Country wise ActionUnited kingdom�Has lined up a $850-billion rescue plan, May nationalise Royal Bank of Scotland

�Will recapitalise banks by up to $88 billion. Abbey, Barclays, HSBC, Llyods, Standard Chartered, HBOS and Nationwide Building Society can draw from an aggregate of $44 billion to boost their Tier 1 capital

�Bank of England will infuse liquidity of $351 billion through loans

�The government will guarantee $439 billion worth of short-and-medium term debt

�Britain has seized control of mortgage lender Bradford & Bingley

�Earlier this year nationalised Northern Rock

�Alarm: The total liabilities of Barclays of £1,300 billion (leverage ratio of over 60), surpass Britain's GDP

Contd..

Belgium�The government took partial control of the struggling Fortis Bank

�France, Belgium and Luxembourg stumped up $93 billion to recapitalise Dexia, a French-Belgian lender that ran up huge losses in its US operations

Alarm: Fortis Bank's liabilities are several times larger than the GDP of Belgium (leverage ratio of 33)

Iceland�The government has nationalised three of Iceland's biggest banks

�Accounts in these banks stand frozen

Contd..

United states�May pick up ownership in failing US banks (Morgan Stanley is reported to be one)

�Fed ready to lend directly to stressed companies

Germany

�Has guaranteed all bank deposits

�Has organised a credit lifeline of euros 35 billion for blue-chip commercial real estate lender Hypo Real Estate Holding

�Alarm: The total liabilities of Deutsche Bank (leveraging ratio of over 50) amount to 2,000-billion euro, which is more than 80 per cent of the GDP of Germany

Contd..

Singapore

� Eased monetary policy for the first time since 2003 after sinking into its first

recession in six years, hit by the meltdown in financial markets

� The government revised its 2008 growth forecast to around 3 per cent from an

earlier estimate of 4 to 5

Italy

� UniCredit Bank has announced plans to raise its capital ratio by spinning of

property assets

Ireland

� Has guaranteed all bank deposits

Contd..

Spain�Will spend 50 billion Euros ($68 billion) to buy bank assets, almost a third of the proposed 2009 central government budget

Japan�Yamato Life Insurance failed with $2.7 billion in debt

�The government may revive a bank-rescue law of the 1990s banking crisis

�Tokyo may set up a $100-billion fund to prop up smaller lenders

�Alarm: Real estate companies are folding up, forcing regional banks to raise reserves against bad loans

Indian Story

Impact of Subprime Crisis in India

No direct impact:

Structured finance undeveloped

No deleveraging

On the contrary India and China were seen as saviors of a ‘decoupling’ global economy

Result:

Capital influx, currency appreciation, stock market boom

Impact on India-Second Round

The second round effect of Sub Prime + spike in oil prices was devastating for Asian countries, including India

But for the macroeconomic cushion of low external debt

Ratio and fiscal deficits and comfortable reserves this had

the ingredients of a classic currency crisis

The Devastation

�Oil shock – worsening current account balance�India’s merchandise trade deficit in April-July 2008 increased by 50%

�BRIC may split – prospects of Brazil/Russia brightened& that of India/China darkened

�Sharp increase in inflation – food & oil the culprits�Governments could no longer fully insulate consumers from increase in retail oil prices

�Spike in food prices through biofuels link

�Higher weightage of food and oil in the consumption basket of developing world

�July 2008- CPI at 9.41% and WPI at 12%+

�Increase in fiscal deficit�Government absorbed part of the increase in oil and food prices – lower savings

�EAC’s estimate of off balance sheet deficit on account of rising food and oil prices – 4.5% of GDP

�Threat of credit downgrade

�Decline in Capital flows�Sharp decline in stock market capitalization and bearish markets

�Rupee under pressure – feeds inflation

�Decline in Growth [EAC’s estimate for 2007-08 : 7.7%] �Rising interest rates hurt consumption and investment

�Rise in fiscal deficit and decline in corporate profits result in fall in savings

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Emerging economies adversely

impacted by demand destruction in

‘global consumer of the last resort’:

US major trading partner for India

(15% of exports), Brazil and China

(20% of exports)

Can India and China rescue the world?

Emerging markets have borne the brunt of the second round impact and are themselves

bearish

Lessons of the sub prime crisis for India

�You cannot decouple from the world’s biggest economy in a fast integrating world

�Sophisticated structured finance products canbecome ‘weapons of mass destruction’

�Moral hazard and financial sector liberalization

�RBI must rethink the concept of Universal Banking

�Focus on ‘Credit Discipline’ as a corrective to financial inclusion

�Reconsider basing monetary policy entirely on movements in consumer prices alone

Bailout Ben

Rationale for the Bailout

Stabilise the Economy

Improve Liquidity

Comprehensive Strategy

Immediate and Significant

Broad Impact

Investor Confidence

Impact on Economy and GDP

Second

Bailout of

$800 billion

announced

yesterday

by FED

When the music stops in terms of liquidity, things will When the music stops in terms of liquidity, things will When the music stops in terms of liquidity, things will When the music stops in terms of liquidity, things will

get complicated. But as long as the music is playing, get complicated. But as long as the music is playing, get complicated. But as long as the music is playing, get complicated. But as long as the music is playing,

you've got to get up and dance. We're still dancing. you've got to get up and dance. We're still dancing. you've got to get up and dance. We're still dancing. you've got to get up and dance. We're still dancing. ----

Chuck Prince, CitigroupChuck Prince, CitigroupChuck Prince, CitigroupChuck Prince, Citigroup

Now What???

Liquidity Crunch

The reduced availability of liquidity

Interest rate premiums

U.S.: Banks not lending to each other

ROW: London Interbank Offered Rate (Libor)

Libor is used to set rates on the $360

trillion of financial products worldwide.

Three month Libor set an all time high last

week at 5.34%.

Amount Outstanding Estimated Losses

Residential Credit:

Depository Institution Loans $2,889 $308

Non-Agency Securities $2,531 $523

GSE Exposures $4,807 $76

Subtotal $10,227 $907

Non Residential Credit:

Loans $7,670 $195

Non-Agency Securities $5,440 $475

Subtotal $13,110 $670

Total $23,337 $1,577

Overview of Credit Exposures and Estimated Losses(September 2008; billions of US dollars)

Estimated Costs of Banking Crisis

U.S.A. 2007-2010 $700 billion = 5.0 %

$1600 billion = 11.4 %

$3200 billion = 22.8 %

Country Period Estimated Cost as % of

GDP

United States 1980 2.5 %

Japan 1990 20.0 % est.

Norway 1987-89 4.0 %

Korea 1997 60.0 % p

Indonesia 1997 80.0 % p

Is Depression Imminent:

�During the Great Depression�Combined GDP of 7 largest economies dropped by

20%during 1929-1932

�There were no deposit insurance, so people withdrew money from banks and many banks failed

�Fed increased interest rate (!!) and reduced liquidity

� U.S. imposed heavy tariffs and other countries reciprocated lowering world trade by 70%

The situation is much different as a lot is learned from experiences of the Great Depression