The global financial and economic crisis of 2008/2009

Assignment 1

Question No Allotment=22

The global financial and economic crisis of 2008/2009?

The global financial crisis of 2008–2009 is an ongoing major financial crisis. It became prominently visible in September 2008 with the failure, merger, or conservatorship of several large United States-based financial firms. The underlying causes leading to the crisis had been reported in business journals for many months before September, with commentary about the financial stability of leading U.S. and European investment banks, insurance firms and mortgage banks consequent to the subprime mortgage crisis. Beginning with failures of large financial institutions in the United States, it rapidly evolved into a global credit crisis, deflation and sharp reductions in shipping resulting in a number of European bank failures and declines in various stock indexes, and large reductions in the market value of equities (stock) and commodities worldwide. The credit crisis was exacerbated by Section 128 of the Emergency Economic Stabilization Act of 2008 which allowed the Federal Reserve System (Fed) to pay interest on excess reserve requirement balances held on deposit from banks, removing the longstanding incentive for banks to extend credit instead of hoard cash on deposit with the Fed. The crisis led to a liquidity problem and the de-leveraging of financial institutions especially in the United States and Europe, which further accelerated the liquidity crisis, and a decrease in international shipping and commerce. World political leaders and national ministers of finance and central bank directors have coordinated their efforts to reduce fears but the crisis is ongoing and continues to change, evolving at the close of October into a currency crisis with investors transferring vast capital resources into stronger currencies such as the yen, the dollar and the Swiss franc, leading many emergent economies to seek aid from the International Monetary Fund. The crisis was triggered by the subprime mortgage crisis and is an acute phase of the financial crisis of 2007–2009.

ROOT OF TURMOIL

Ø The current financial turmoil is rooted to the sub prime crisis.

Ø During boom years, mortgage brokers lured by big commissions talked buyers with

Poor credit into accepting housing mortgages without any down payment

Ø US housing market started feeling pain of high interest rates ,which rose from 1% to

5.35% during 04-06.

Ø In 2006 those that could least afford to purchase homes -- so called subprime

Borrowers --started to default in the U.S., prices having run well out of their range of

Affordability.

Ø The serious sub prime mortgage crisis began in June of 2007 when two Bear

Stearns hedge funds collapsed.

Ø Federal Reserve Bank and European Central Bank dumped $100-billion in

Liquidity into the system that calmed the market down for a short period.

LEHMAN BROTHERS

Ø Lehman Brothers was started in 1847 as commodities-trading/brokerage firm

Ø Lehman Brothers were a major player in the market for sub prime and prime mortgages.

Ø On June 9, 2008, Lehman announced a second-quarter loss of $2.8 billion

Ø Lehman Bros able to survive the great depression of 1929

Ø Not able to survive the current financial turmoil

Ø Bear Stearns was bought by JP Morgan Chase at a bargain basement price under the threat of bankruptcy.

Lehman and Bear Stearns had a number of similarities.

Ø Both had relatively small balance sheets, they were heavily dependent on the mortgage market, and they relied heavily on the “repo” or repurchase market, most often used as a short-term financing tool.

Ø Northern Rock, an aggressive British mortgage lender was forced to be bailed out by The Bank of England, which subsequently nationalized it altogether.

Ø Meanwhile U.S. housing prices continued to decline. The result was massive losses in the mortgage-related derivative assets held by large global banks

Ø These instruments are called derivatives because their value is derived from the value in underlying assets like mortgages.

Ø Merrill Lynch filed for bankruptcy shortly after Lehman Brothers, and, it cut a deal with the Bank of America for $50b, far below its value, before the effects could become more devastating.

Ø AIG (American International Group), the world’s largest insurance company was pushed to the edge of Bankruptcy, but was bailed out by The Federal Reserve.

EFFECT ON INDIA

IT Companies which have nearly half of their revenues coming from banking and financial services segments closely monitor the financial crisis.

Banks:

Ø Lehman Brothers and Merrill Lynch had invested substantially in the stocks of Indian banks.

Ø ICICI bank is the worst hit as of now.

Ø ICICI Bank is expected to lose approximately $80 million (Rs 375 cr), invested in Lehman’s bonds.

Ø A telecommunication giant has lost foreign exchange of nearly $100 million.

Real estate:

Ø Lehman had given Rs 740 crore to Unitech Ltd.

Ø Lehman had also signed a MoU with Peninsula Land Ltd to fund projects worth Rs 576 crore.

Ø Another organization affected is DLF Assets in which it had invested $200 million.

COMPARISON WITH GREAT

DEPRESSION OF 1929-31

Ø Crisis set in 1929 and lasted until 1941.

Ø Regarded as the worst economic slump in USA, Europe, and other industrialized nations.

Ø It started with the collapse of the NYSE.

Ø 11,000 of the 25,000 banks in the US went under.

Ø Production dropped and unemployment rose.

Ø It was caused by unreal expectations and lack of systemic controls.

BAILOUT PACKAGE

Ø The US government proposed to create a $700-billion rescue fund for the American financial sector.

Ø The fund will be used to buy back bad debt from ailing US banks and other financial institutions

Ø The White House gave a package of over $700 bn -a lifeline to sinking equity markets around the world.

Ø New rescue plan to revive the credit markets and restore market liquidity.

Ø Will ease pressure on the balance sheets of banks and other financial institutions.

Ø Bill allows Govt to inject fresh capital into financial institutions and get ownership shares in return.

Ø US, European, UK & Chinese Central Banks Cut Rates To Ease Liquidity.

Ø The move increases the US public debt to $10.25 trillion.

The National Debt Clock shown near Times Square. The clock has run out of digits to record the growing figure. The dollar sign has been switched to a figure — the ‘1' in $10 trillion

Ø In India, finance minister P Chidambaram assures that PSU banks had virtually no exposure to Lehman Brothers.

Ø But the credit crunch globally will impact credit availability in the Indian market.

Ø Sensex plunged by almost 1,000 points in a single day.

Ø Sensex has dropped below 10,000.

Ø RBI announced a 1.5 % point cut in the cash reserve ratio(CRR).

Ø This would infuse Rs 60,000 crore in the banking system.

Ø RBI also released around Rs 8,000 crore through unwinding of Market Stabilisation Scheme (MSS).

CONCLUSION

Ø The crisis has raised questions about adequate regulation.

Ø Lack of regulation identified as the trigger for the financial crisis in the United States.

Ø We will just have to wait and watch to see how much damage does this “credit crisis” cause!

Submitted To: - Prof. Gurdeepak Singh

Submitted by: - Parvesh Goyal (MBA Sem 1 C)