Overview of GLOBAL FINANCE CRISIS and impact with market. Impacts of the US Financial Crisis on Indian Economy. FINANCE CRISIS, Subprime Mortgage Crisis, US Financial Markets, US Unemployment and Stock Market Returns, Treasury Rates and Inflation,
Naveen KumarDeputy Team Leader à Oracle Financial Software Services Limited (IPSL)
3. Country creditworthiness is now inter-shuffled
“Advanced” countries (Formerly) “Developing” countries
AAA Germany, UK Singapore, Hong Kong
AA+ US, France
AA Belgium Chile
AA- Japan China
A Malaysia, South Africa
A- Brazil, Thailand, Botswana
BBB+ Ireland, Italy, Spain
BBB- Iceland Colombia, India
BB+ Indonesia, Philippines
BB Portugal Costa Rica, Jordan
B Burkina Faso
S&P ratings, Feb.2012 updated 8/2012
4. Causes: How did we get into this mess?
Market Behaviour Cycle
5. Global Impacts of the Crisis
Investors will be very cautious to
Lack confidence in stock/bond
Consumer spending will slowdown
Lack of cash or unwilling to spend
World economy slip into recession
U.S. economy condition affected
GDP growth will be low
Economy slow down
May take long time to recover
Unemployment rate may be
Slow economy increase
Exports will decrease in China,
GDP growth heavily depends
7. • US Financial Markets
The United States has experienced 32 business cycles since 1854. While
the average duration of recessions has decreased, recent recessions have
been global and severe.
• 16 recessions averaging 22 months
• 6 recessions averaging 18 months
• 11 recessions averaging 11 months
Annual GDP Growth Since 1930
Annual GDP Growth Since 1930
8. With the steady decline of the manufacturing sector in the United States through outsourcing of
production to cheap labor areas abroad, 2.9 million well-paying manufacturing jobs have
disappeared in the period 2005-2008 alone. And that’s on top of a loss of more than 3 million jobs in
manufacturing from 1998 to 2003, with millions more lost in the entire postwar period.
11. US Unemployment and Stock Market Returns
US Unemployment Rates and the Dow Jones Industrial Average
Dow Jones Industrial Average
Dow Jones Industrial Average Unemployment Rate
12. Wall Street Instability
• 1987 -- Black Monday
• Blamed on program trading, this crash started in Hong Kong
and caused the Dow Jones Industrial Average to fall 22.61%.
• 1990-1992 -- Early 1990’s Recession
• Although the stock market quickly recovered from the 1987 crash,
Dow Jones Industrial Average 1985-Present
the Savings and Loan Crisis led to hundreds of bank failures and the RTC
• 1997 -- Asian Flu Crisis
• The Dow Jones Industrial Average fell 7.2% in one day amid concerns
about Asian economies and their impact on the United States
• 1998 -- Long Term Capital Management
• Used complex mathematical models to take advantage of fixed income
arbitrage opportunities. Fund grew bigger, confidence in risk models.
The Russian Financial Crisis led to a bailout of LTCM of $4.6 billion
• Late 1990s-Early 2000s -- Dot-com Bubble
Dow Jones Industrial Average 1985-Present
• A speculative bubble from about 1995-2000 in internet stocks which led to the rapid rise of equities in industrialized nations. Investors bet big on the
future earnings potential of internet firms with no track record. The NASDAQ Composite lost 78% of its value from peak to trough in the early 2000s.
• Early 2000s -- Corporate Scandals
• Enron, Tyco, Worldcom and many others lost billions as the result of failed corporate governance and fraud. Enron hid billions in debt from failed deals
and projects with accounting loopholes, special purpose entities and the help of its auditor, Arthur Andersen. Worldcom was involved in a similar
accounting scandal, as the recession in early 2000’s hurt their core business and led to fraudulent accounting methods.
•2007-2009 -- Financial Crisis
• The collapse of the US housing bubble caused the value of securities tied to US real estate to plummet. Resulted in the collapse of large financial
institutions, the bailout of banks by national governments and downturns in stock markets across the world.
•2011 -- Financial Crisis II?
• The US Treasury downgrade and solvency issues in Europe have resulted in fears of a global slowdown as developed economies struggle to grow despite
low interest rates and a plethora of government stimulus.
16. WHAT`S HAPPENING IN RECENT YEAR
In 2006/07, RBS paid $100 billion for ABN Amro.
For this amount it could buy in 2008:
Citibank $22.5 billion
Morgan Stanley $10.5 billion
Goldman Sachs $21 billion
Merrill Lynch $12.3 billion
Deutsche Bank $13 billion
Barclays $12.7 billion
And still have $8 billion change......with which it would
be able to pick up GM, Ford, Chrysler and the Honda F1
19. September 14, 2008:
Merrill Lynch sold to Bank of
America amidst fears of a
liquidity crisis and Lehman
Brothers collapse September 15, 2008:
Sep-08 Sep-08 Sep-08 Sep-08 Sep-08 Oct-08
September 7, 2008:
Federal takeover of Fannie
Mae and Freddie Mac
Lehman Brothers files for
September 16, 2008:
Moody's and Standard and
Poor's downgrade ratings
on AIG's credit on concerns
over continuing losses to
sending the company into
fears of insolvency.
September 19, 2008:
Paulson financial rescue
plan unveiled after a volatile
week in stock and debt
September 17, 2008: The
US Federal Reserve loans
$85 billion to American
International Group (AIG)
to avoid bankruptcy.
September 25, 2008:
Washington Mutual was
seized by the Federal
Corporation, and its banking
assets were sold to JP
Morgan Chase for $1.9bn.
September 29, 2008: The
House rejected bail-out bill,
DJIA down 7%
October 3,2008: The
House pass the bail out bill
GLOBAL FINANCE CRISIS- "Red September"
22. Origins of the Crisis
• The periodic crises resulting from the
capitalist business cycle now unfolds at
the global level
• The current crisis of the world economy
is an outcome of the consolidation of
economic power that the globalization
of capital has secured for the
• This has led to a string of problems
associated with the financial, banking,
real estate, and productive sectors of
the economy that have triggered
the current economic crisis
26. Subprime Mortgage Crisis
• Sharp rise in home foreclosures in late 2006
• Only 9% in 1996, 13% in 1999, 20% in 2006
• $1.3 Trillion subprime mortgage as of March 2007
• The delinquency rate had risen to 21% by 2008
• Subprime Borrowers
• For poor credit history
• Limited income
• Subprime Lenders
• Greater risks
• High returns
Dissecting A Classic Financial Boom and Bust
New Century collapse;
Stimulus Euphoria Leveling Crash
Source: Inside Mortgage Finance
Subprime Mortgage Originations ($BN)
virtually zero credit
28. MBS: an industry which grew too fast...
MBS have developed
extremely fast in 8 years.
Risk has been spread-out
among Banks and Hedge-
Funds through “obligations
baskets” sold by SPV
working from off-shore
could induce a major
1998 2002 2004 2005 2006 2007
29. The development of Mortgage Based Securities
• Credit Default Swaps (CDS).
• Collateralized Debt Obligations (CDO).
• Collateralized Loan Obligations (CLO).
• “Selling” risk on financial markets: MBS are
actually a kind of insurance system for the
emitter and they are attractive bonds for buyers
till the default rate is low (usually 0.5%).
• But MBS have spread the risk throughout the
financial system and everybody can become an
insurance company if it buy a CDS or a CDO….
30. The Banking crisis
• Banks have been the main user of MBS (40% of
• Strong competition in a deregulated market has
made Subprime-ARM based CDS attractive to
boost Banks profit rates.
• The use of SPV and SPV-based Securities-baskets
by banks has decreased transparency.
• New accounting rules (“Mark to Market”) have
increased Banks and Insurance companies
vulnerability to financial market fluctuations.
39. Direct Impacts of the Crisis
Financial Institutions –
New Century Financial (USA)– Apr. 2,
American Home Mortgage (USA) – Aug.
Sentinel management Group (USA) –
Aug. 17, 2007
Ameriquest (USA) – Aug. 31, 2007
NetBank (USA) – Sept. 30, 2007
Terra Securities (Norway) – Nov. 28,
American Freedom Mortgage Inc. (USA)
– Jan. 30, 2007
40. Direct Impacts of the Crisis
Financial Institutions – Write-Downs
Citigroup (USA) - $24.1 bln
Merrill Lynch (USA) - $22.5 bln
UBS AG (Switzerland) - $16.7 bln
Morgan Stanley (USA) - $10.3
Credit Agricole (France) - $4.8 bln
HSBC (United Kingdom) - $3.4 bln
Bank of America (USA) - $5.28 bln
CIBC (Canada) – 3.2 bln
Deutsche Bank (Germany) - $3.1 bln
By 02/19/08 losses or write-downs > U.S. $150 bln
Be expected exceeding $200 - $400 bln. But ended up with $770 bln
41. Domestic Impacts of the Crisis
• Low GDP growth rate
• Business close out or lose money (banks, builders etc.)
• Weak financial market
• Low consumer spending
• Lose jobs
Other credit markets
• Credit card
• Car loan
43. Impacts on Indian Economy
Impact on stock market
The immediate impact of the US financial crisis has been felt when India’s stock
market started falling. On 10 October, Rs. 250,000 crores was wiped out on a single day
bourses of the India’s share market. The Sensex lost 1000 points on that day before
regaining 200 points, an intraday loss of 200 points. This huge withdrawal from the India’s
stock market was mainly by Foreign Institutional Investors (FIIs), and participatory-notes.
Impact on India’s trade
The trade deficit is reaching at alarming proportions. Because of worker’s
remittances. NRI deposits, FII investment and so on, the current deficit is at around $10
billion. But if the remittances dry up and FII takes flight, then we may head for another
1991 crisis like situation.
Impact on India’s export
With the US and several European countries slipping under the full blown recession, Indian
exports have run into difficult times, since October. Manufacturing sectors like leather,
textile, gems and jewellery have been hit hard because of the slump in the demand in the
US and Europe. Indian exports fell by 9.9 per cent in November 2008, when the impact of
declining consumer demand in the US and other major global market, with negative
growth for the second month, running and widening monthly trade deficit over $10
44. Impact on India’s handloom sector, jewelry export and tourism
Again reduction in demand in the OECD countries affected the Indian gems and
jewellery industry, handloom and tourism sectors. Around 50,000 artisans employed in
jewellery industry have lost their jobs as a result of the global economic meltdown.
Further, the crisis had affected the Rs. 3000 crores handloom industry and volume of
handloom exports dropped by 4.6 per cent in 2007-08, creating widespread
unemployment in this sector (Chandran, 2008).
Exchange rate depreciation
With the outflow of FIIs, India’s rupee depreciated approximately by 20 per cent
against US dollar and stood at Rs. 49 per dollar at some point, creating panic among the
The overall Indian IT-BPO revenue aggregate is expected to grow by over 33 per
cent and reach $64 billion by the end of current fiscal year (FY200). Over the same
period, direct employment to reach nearly 2 million, an increase of about 375000
professionals over the previous year. IT sectors derives about 75 percent of their
revenues from US and IT-ITES (Information Technology Enabled Services) contributes
about 5.5 percent towards India’s total export. So the meltdown in the US will definitely
impact IT sector. Further, if Fortune 500 companies slash their IT budgets, Indian firms
could adversely be affected.
45. FII and FDI
The contagious financial meltdown eroded a
large chunk of money from the Indian stock market,
which will definitely impact the Indian corporate
sector. Due to global recession, FIIs made withdrawal
of $5.5 billion, whereas the inflow of foreign direct
investment (FDI) doubled from $7.5biilion in 2007-08
to $19.3 billion in 2008 (April-September).
From the above argument it can be noted
down that the ‘Financial or Subprime Crisis’ was the
shear consequences of ‘greed’ and to make ‘too
much profit’ on the part of Wall Street Firms and
Investment Banks. This crisis also shows the failure
of capitalist market economy. Though the Indian
economy would be able to withstand the crisis
without any major difficulty, but the crisis is still
causing mayhem all over the world.
A financial crisis can come as a result of institutions or assets being overvalued, and can be exacerbated by investor behaviour. A rapid string of sell offs can further result in lower asset prices or more savings withdrawals. If left unchecked, the crisis can cause the economy to go into a recession or depression.
There are many types of financial crises:
Currency crisis when a fixed exchange rate regime collapses or a currency goes into a free fall
Balance of Payments (BoP) or external debt crisis
Sovereign debt crisis
Corporate debt crisis
Household debt crisis
Broad financial crisis that combines many elements of the above crises.
Sectoral financial balances (The sectoral balances are a sectoral analysis framework for macroeconomic analysis of national economies developed by British economist Wynne Godley.) in U.S. economy 1990–2012. By definition, the three balances must net to zero. Since 2009, the U.S. capital surplus and private sector surplus have driven a government budget deficit.
Let’s begin with review what happened during the past months.
We knew that:
March 16, 2008: Bear Stearns gets acquired for $2 a share by JPMorgan Chase in a fire sale avoiding bankruptcy. The deal is backed by Federal Reserve providing up to $30B to cover possible Bear Stearns losses.
After that event, market and investors stayed calm with believe that the crisis was in the end.
But, suddenly, things got worst and turn up-side-down, and we recognized that we’re just in the end of the beginning of the more serious crisis. That was “Red September”.
Looking at the economy in 10-year increments starting from 1948 (when declines from wartime spending had ended), averaging GDP’s annual growth percentage shows the following:
In finance, swap spread is a popular way to indicate the credit spreads in a market. It is defined as the spread paid by the fixed-rate payer of an interest rate swap over the rate of the on the run treasury with the same maturity as the swap. For example, if the fixed-rate of a 5-year fixed-for-float LIBOR swap is 7.26% and the 5-year Treasury is yielding at 6.43%, the swap spread is 7.26% - 6.43% = 83 bps.