THE SUB PRIME CRISIS - Revisited

•The 2008 Global

Financial Crisis
A brief Walk-through

• “ As sure as the spring will follow the winter, prosperity and economic growth will
follow recession.”
• - Bo Bennett

GROUP 6
1
The Lineup…
• Introduction & Early Triggers
1 • A brief Introduction and séries of évents Leading to the récession

• Impact on US & Global Economy

2 • The effect of crisis on the US Economy & other Economies globally

• Major Measures in retaliation

3 • The counter measures taken by countries in response to the crisis

• Conclusion
4 • Summary and conclusion – The Great Recession

2
 The Beginning…

• The “Prime” Story

• Increase in housing demand
Families with good repayment status – “Prime Families”
• Loan sanctioned to buy house- Papers with bank as
collateral
• Investment Banks
• Financial Modernization Act, IB, Commercial and Insurance play
• IB’s saw opportunity to deal with Mortgage papers
• Created ‘Collateral Debt Obligations’ by bundling the papers
• The rise in Demand of • Ratings were given by neutral third party credit rating agencies
CDOs
• Attractive returns raised the demand of CDOs
• Increased pressure on Brokers to get more loan
seekers
3
 • The “Sub prime” Story
• Pressure led to issuance of low-quality Loans
• Bundled sub prime & prime loans to play with ratings
• Insured the CDOs with prominent firms like American Int. Group
• The Building up • Gradually sub primes started defaulting

• Banks started acquiring default houses & selling

• Increased no. of defaults > Inc. sale of houses
• Increased supply through resale > Limited Demand

• High Supply – Low Demand

Fall of Housing Prices
• Teaser Loans : Loans with low down payment; Interest peaks after some time
• As prices fell & Interest peaked, people stopped repaying loans
• More defaults
4
 Economy Crash
• No Investment – Restricted • Lending Stopped- Credit
Spending- Unemployement Crunch

• Lehmann Brothers - • More Defaults-Fall of trust on

Bankruptcy CDOs

• Fall of Housing Prices – • Increased Housing Supply –

Loan>Price Limited Demand

5
 Impact on the US Economy
Employment Government Consumer Loss in
Response Spending Income

U.S. Unemployment
Rate rose to 9.5% in
June 2009 whereas it
Federal Government Average expenditure per Slower economic
was 5% in December
increased spending to consumer (household) growth
2007
mitigate the crisis declined after having
reached a peak point in As a result, income
Employers undertook
It aggravated an 2006 per U.S. household
mass layoffs
already existing fiscal declined
Construction and imbalance in U.S. People adopted
conservative approach in Loss in real estate
Manufacturing
consumption wealth of the nation
industries were hit
hardest by the crisis
 US Government Response
• The Fed lowered its key federal rate to provide additional liquidity to the financial
system
• The Fed expanded the range of collateral it would willing to accept in return for loans
and provided direct lines of credit to a broader variety of financial institutions
• Direct Aid to a number of prominent financial firms (Rescue of Fannie Mae and
Freddie Mac)
• Faced with the possibility of a systemic collapse of the financial system, the Treasury
proposed $700 billion plan that would involve the government’s purchase of impaired
assets from balance sheet
• Government offered direct purchase of commercial paper from highly rated issuers to
ensure short-term lending among corporations
Effect of Sub Prime Crisis On Global Economies
JAPAN
• Longer Term Impact
• Economy Pushed Into Severe Recession
• Exports Hit Due To Fall In Demand
• Got Overtaken by China in 2010

EUROPEAN UNION
• Very Closely Linked To The US Economy
• Some Used Forex To Inc. Liquidity & Bring Policy Changes
• Central & Eastern Countries Not So Lucky
• Faced High Unemployment Rates and –ve Economy Growth
• Many Small Countries Had To Ask IMF For Bailout Packages
Difference Between Countries Of E.U. – U.K. V/s Greece
 CHINA

• Declining FDI
• Net Exports Declined As Demand Fell From US & EU Countries
• World’s Largest Forex Reserves Used For
Countermeasures By Govt.
• Huge Domestic Market Acted As Cushion
• Budget Surplus In 2007, Maintained High Growth

EAST ASIA

• Asian Tigers managed well. Example – Malaysia.

• Adapted Swiftly To The Crisis
• Used Learnings From The 1997-1998 Asian Financial Crisis
• Implemented Capital Controls, ESPs To Improve Economy
• Increased Debt But Economy Recovered Faster
 RUSSIA

• Suffered On Two Fronts – GDP Shrinkage + Oil Prices Fell

• High Inflation Rates
• Economy Slipping Into Recession
• Forced Govt. To Take Countermeasures
• Forex Shrunk By 131 Billion US$
 MIDDLE EAST

• Falling Oil Prices Led To Higher Unemployment Rates

• Debt On Countries Like Jordan, Lebanon, Syria Swell.
• Crude Oil Averaged 47$ per Barrel Pushing Most OPEC Economies Into Slowdown
• Economies Recovered Using Reserves & When Oil Prices Bounced Back
Effect on Europe

EU

IRELAND
 GREECE

ICELAND
MEASURES TAKEN
 Crisis and Developing world-Asia
Facts and Figures
1. The stock markets of all
World countries were folded and
Asia also froze the trade between
countries.
Europe 2. Developing countries almost
lost 1 year worth wealth
USA Africa compared to developed
countries which lost 3 years
worth wealth.
Impact on ASIA
• Impact is major on ASEAN
countries and newly industrialized
economies
• Asian exports were down by at
least 30%, the emerging Asia stock
prices were fell by around 60%.
• Inter-Trade is affected very much
between the countries.
• Impact on India and China is
limited due to resilience of
domestic demand.
• The countries are also effected
because of the high cash outflows.
Crisis and Developing world-Asia
Growth rate of various economies during crisis
 Case of Malaysia
GDP
The GDP growth rate slowed down to
0.1% in the last quarter of 2008
Reduced by -6.2% in the 1st quarter of
2009.

Manufacturing Industry Growth affected

The decreasing exports had brought 26% shortfall in GDP from its 2020 vision
down electronics production by -4.1% in path
the 3rd qtr. of 2008 and -27.8% in the
4th qtr. of 2008

Negative Equity flow Took time for impact

Huge amount of cash outflows from the One of the fastest growing economy,
economy took time for the effect
African Economy and Crisis

Not deeply integrated with world economy like Asian countries

Depended on mostly on remittances and exports

Countries like Nigeria are dependent on oil exports were hit most.

Lost around 134 billion dollars during the crisis

How did countries come out of crisis?
How did Malaysia come out of Crisis?
ESP 1
1 1. Stimulus packages one is
ESP which was US$1.9
2 1.
billion or 1.04% of GDP
launched in November
2008.
2. ESP1 was for
infrastructure which is
mainly related to the
public amenities directed
at ensuring developing
the human capital.
ESP 2
The second (ESP 2) was
US$16.2 billion in March
2009.
2. ESP2 main aim was to
reduce unemployment
and increase the
opportunities and ease
the burden on the
economy.
Preventing the effects

One way is to isolate and other way is to diversify

Increase and diversify trade with many other countries

Making the institutions stronger by brining reforms like Basel III reforms
 Predictors
Policy Rates & Creation of Credits
Decline in short-term interest rates
Increased wholesale funding in the banking
sector rendering the financial system more
vulnerable
International Capital Flows
Capital inflow due to accumulation of
foreign reserves by Asian countries
Long-run interest rates govern the
capital market.

Co-movement of Equality & Debt

People use loans to support unsustainable levels

of consumption

More the inequality of income in a society,

higher the debt.
Thank You