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Nikit Shah
September 25, 2008: Washington Mutual was seized by the Federal Deposit Insurance Corporation, and its banking assets were sold to JP Morgan Chase for $1.9bn.
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September 17, 2008: The US Federal Reserve loans $85 billion to American International Group (AIG) to avoid bankruptcy.
September 29, 2008: The House rejected bail-out bill, DJIA down 7%
September 16, 2008: Moody's and Standard and Poor's downgrade ratings on AIG's credit on concerns over continuing losses to mortgage-backed securities, sending the company into fears of insolvency.
The mayhem caused by sub-prime primarily in U.S. then the rest of the world in 2008 is named as Subprime Crisis. This crisis brought the world to the doorstep of financial doom. It started in U.S. and spread within few days to the rest of the world. It was related to American housing loan. The housing loans provided to people with low income and less creditworthiness which was the negative part of this loan structure.
The main reason for the financial crisis were sub-prime loans. Sub-prime or mortgage loans are the loans provided to people with less creditworthiness or low income. The loans were given so as to have their dream of their own house fulfilled as everyone couldnt afford one. The lending institutions took loan from bank dividing these into small portions providing loans to people with above criteria at higher interest rates. They had two advantages: firstly they hedged their bets, secondly they securitized these loans which paid them a fixed rate of interest.
Main Investors
The main investors which took interest in investing in this sub-prime or mortgage loans were the leading investment banks, lending and financial institutions like Lehman brothers and Morgan Stanley. Other culprit were lenders, central banks and financial institutions which provided loans. The list also includes credit rating agencies, underwriters of CDOs and mortgage and asset backed securities. Lastly the blame goes to hedge fund industry. Overall it was a mix up fault of investors and participants.
Figure: 1 Note: The data presented herein are believed to be reliable but have not been independently verified. Any such information may be incomplete or condensed.
Figure: 1 Image courtesy Hammond Associates. The data presented herein are believed to be reliable but have not been independently verified. Any such information may be incomplete or condensed.
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Increase in banking rates To control inflation they cut their lending and policy rates. FII pulled out their huge amount of money leaving investor with bear market and stock fall. Backing of FDI US has 17.08% of FDI in India in almost every sector whereas in banking sector they have 49% of FDI. When US lost their income they pulled out money. Exports to India from US reduced which included various metals also which affected many sectors. Panicking environment Investors lost their faith and hope in market.
It all started in 2007, US GDP has shown negative growth rate starting from start of Sep 2008 till date.
ECONOMY United States v/s Indian GDP Per Capita (Purchasing Power Parity)
Housing Structure
US Vehicle Sales
US sub-prime crisis started hitting Indian market like Banks, Financial services, Real Estate, Infrastructure, Information Technology, Auto. Banks in India India largest private sector bank ICICI Bank was the 1st bank to announce a loss of Rs 10.56 billion. Public sector Banks like Punjab National Bank, Bank of India, State Bank of India, Bank of Baroda were the major Bank of India were having an exposure to the instruments issued by Lehman Brothers and Merrill Lynch. Punjab National Bank reported total exposure of $5 million, expected loss of $2 million. Bank of India reported total exposure of $11 million, expected loss of $5 million. State Bank of India reported total exposure of $5 million, expected loss of $3.5 million. Bank of Baroda reported total exposure of $10 million, expected loss of $6 million. Banking sector have to face tight liquidity condition a part form mark-to-market losses.
The Banks are expected slow and stable growth due to limited impact from exposures, the profitability may see lower growth on account of rising cost of funds and lower credit growth. Tight liquidity continuous, may impact bond portfolio of the banks. Banks need to avoid high NPA and low Capital Adequacy Ratio.
Financial services
Broking firms have been seeing low volumes with investors pooling hands to invest in stock market.
This effect on revenue streams of insurance companies and AMCs, that would have limited impact based on their bound portfolios. Financial institutions need to avoid less diversified business for some time.
Global banks and Brokerage firm, an estimated amount $512 billion in Sub-prime losses. Where largest hits taken by, Citigroup $55.1 bn and Merrill Lynch $ 52.2 bn.
An sudden collapse of world leading financial houses, the Indian real estate players who were already facing a problem like RBI increased the interest rates to contain inflation. RBI put the restriction on Indian banks to finance real estate companies in the country. lack of funds due economic slowdown. correction in stock prices, would find it difficult to raise a funds.
Among the US financial houses - Lehman Brothers was very bullish on Indian Reality Sector and had an investment in excess of US $700 million (Maximum amongst peers). Lehmans PE investments in India: Hyderabad IT park project of peninsula. Unitechs Mumbai Pune Expressway. Hotel project of Future Capital. Realty companies having direct exposure of brothers faced selling pressure. Amt (US $ Mn) 12.5 175 200 Year 2008 2008 2007
INDUSTRY INFRASTRUCTURE
Infrastructure companies were adversely impact, specially their financial positions was disturbed which were in growth stage. Companies who raised money through IPO many have gone in for QIP issues with the financial majors across the world. Growth declined from 5.2% June, 07 to 3.4% June, 08.
Information Technology
Subprime crisis had limited impact on IT companies, growth will happen but at 22 23 % it will be lower than in the last two three years. IT - enabled services (ITES) such as (BPO) comprising voice and data processes had an impact on their businesses. Impact on revenue for two-three quarters from financial sector clients, conservative spending from clients on new projects and delay expansion.
IT companies with USA clients and Banking Financial Services and Insurance (BFSI) as biggest revenue earners, yet in sub-prime crisis still these companies are the safest bet. Companies having significant non USA focus eg: Educomp having 13% outside India revenue. This company is in safest bet. IT companies are focused on profitability and growth and have continues revenue visibility. However this growth are for long term at least for 2 3 years.
Automobiles
Credit crunch event from US to India, auto sales were impact due to tougher credit availability, higher interest rates and higher fuel prices. Two wheelers had decent growth in last 2 months, over all 2% drop in tow wheelers sales, more due to low base effect. Exports of top-line auto companies might not have significant impact, as the percentage contribution of sales form export is less form Indian auto. Over all auto industries sales fell 4% as compared to last years growth of 13.5%.
Impact on USA
Dow Jones Industrial Average hit a record high, closing above 14,000 for the first time. By August 15, the Dow had dropped below 13,000 and the S&P 500 had crossed into negative territory year-to-date. Similar drops occurred in virtually every market in the world, with Brazil and Korea being hard-hit. Large daily drops became common, with, for example, the KOSPI dropping about 7% in one day, although largest daily drop by the S&P 500 in the U.S. was in February, a result of the subprime crisis.
The world market capitalization had 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
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
FOREX - Introduction
Falling exchange rate directly impacts the real trade flows and foreign currency capital flows and its expectations The RBI uses interest rate measure to control the exchange rate, in times of extreme volatility in the exchange rate
India
52.5 50.5 48.5 46.5 44.5 42.5 40.5 38.5
1998- 199999 00 200001 2001- 200202 03 200304 42.08 39.97 43.28 42.01 45.61 47.53 48.27 45.83 44.84 44.13 50
USA
CONCLUDING REMARKS
Indeed, the worst of recession may be over but the U.S. economy is far from a sustainable recovery. In fact, most of the improvement in consumption and housing market has been coming from the government pumping money in the economy. For example, consumers this quarter have benefited from the cash-for-clunkers plan and extended jobless benefits aimed at stimulating spending, which accounts for 70 percent of the economy. Also, government stimulus efforts and low interest rates have made homes more affordable to first-time buyers, spurring increases in sales in July. But will the US economic recovery be sustainable when the effect of stimulus package fades? Probably not. After all, we cant forget the fiscal stimulus comes with a massive fiscal deficit. So the government needs to find money to finance the gap and it may need to sell more government bonds to pay for interest of bonds sold in the past to bailout major financial instructions which are now making billions of dollars in profits. Moreover, the Obama administration may need to increase taxes or not extend previous administration tax cuts engendering available income and consumer spending.