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Global Financial Crisis
Meaning of Global Financial Crisis The term financial crisis is applied broadly
to a variety of situations Usually, some financial institutions or assets
suddenly lose a large part of their value– Banking Panics (and recessions)– Stock market crashes– Bursting of financial bubblesAnd biggest organizations
How Did All This Happen? From 1820 to 1970, every decade U.S.
workers experienced a rising level of wagesIn the 1970s this came to an end; real wages
stopped rising and they have never resumed since
U.S. workers became more productive, but got paid the same; wages began to stagnate and decline
The gap between labor and capital grew bigger
Contd…The large corporations made huge profits and
had much money at their disposalThey bought other corporations (mergers and
acquisitions) and they put their money into banks
The banks loaned that money (with interest) to workers who didn’t have money to consume
This was done to raise their purchasing power because their wages weren’t enough to buy things
Then What ?Since employers no longer raised workers’
wages, the workers had to go into debt to surviveDebt went up and up and things got out of
controlThe banks continued to loan money through new
loans (secondary mortgages) at high interest rates, and this was a profit bonanza for the banks
As corporations increasingly began to invest abroad (outsourcing production and services), U.S. workers lost their jobs, and this led to greater unemployment and underemployment
Summing up Proximate causes
Sub-prime lendingOriginate and distribute modelFinancial engineering, derivativesCredit rating agenciesLax regulationLarge global imbalances
Fundamental causeExcessively accommodative monetary policy in
the US and other advanced economies (2002-04)
Timeline• Fed ignores pleas for investigating sub-prime
lending – 2001 to 2004• HSBC's Mortgage chief resigns after losses
hit $10.5 Billion – Feb. 2007• Bernanke says the housing sector "is a
concern, but at this point we don't see it as being a broad financial concern or a major factor in assessing the course of the economy." - Feb. 2007
Timeline• UBS shuts sub-prime lending unit and GMAC
announces huge mortgage related losses – May 2007
• Countrywide Financial (largest US mortgage lender) avoids bankruptcy by taking $11.5 Billion loan
• Freddie Mac posts $2 Billion Loss – Nov. 2007
2008Banks face losses of $900 Billion• Jobs lost across the board across many
industriesCollapse of major Wall Street firms begins
with Bear Stearns and continues thru to Leyman Brothers. Others?
Global liquidity issues know no boundariesOil and commodities go thru the roof and then
crater
Current scenario of USAGDP 2011- 1.8% 2012- 2.3% 2013- 2% (P) US housing market remained in depression From 6.5% of GDP To 1.9% of GDP President Obama declared Cut in Government
spending by $85 billion Cutback in defense spending by 13% Cutback in non defense programs by 9% Fall in durable goods orders by 5.8% The US government has created over 100,000 jobs
but still well below required 200,000
Cash flow and interestHigh oil prices are presenting a significant
headwind to US economyWhile the federal reserve continues to try to
stimulate it with durable near zero interest rates
Overall GDP growth , income , consumption all are in positive but are growing at below trend rates
President Obama recently presented his fiscal budget which would likely to increase deficit
The republicans encountered the budget to cut spending and reform entitlements
The payroll and bush tax cuts are set to expire just as reduction in jobless benefits
The debt ceiling may need to be lifted again the growth impulse contribution from
foreign trade was positive for a while in year 2011
While trade and current account balances risks remaining in strong under combination of US demands for imports and rising oil prices
Impact on the UKUnemployment increased by 164,000
between May and August 2008; almost a 10 % rise from 1.63 million
Most hard hit is London where number of jobless looking for jobs increased by 42 % in September 2008
Some estimates put 1.5 million additional unemployment generated by end-2010 leading to an unemployment rate of 10% from current 5.7 %.
Problems in Euro ZoneStarted in-Oct 2009 in GreeceIts immediate causes lie with the US crisis of
2007-09Greek GDP had its worst decline with -6.9%
in 2011The result in euro zone was sovereign debt
crisis PIIGS-
>Portugal ,Italy ,Ireland ,Greece ,SpainInterest rate surged on government bonds
In July 2011 European leaders agreed to cut rate of interest which Ireland was paying on its EU/IMF bailout loan from 6% to 3.5%
In Feb. 2012 ECB & IMF agreed to provide a second bailout package of €130 billion
Euro group on 9 June 2012 grants Spain a financial support package of up to €100 billion
Lower tax returns and higher budget deficitOn July 26 Ireland returns to financial market by
selling €5 billion in long-term government bonds
MeasuresAusterity measures like higher taxes and
lower expenses Bailout packages from ECB & IMF for
stabilizing their economies Paying less than 4% on new debt which is
incurringPrivate sector rescheduling and
restructuring
Other measuresGovernment responded swiftly and decisively to
save the systemCentral banks stepped in and provided liquidity
to the banking system to keep it functioningExpanded the money supplyGovernment provided bailout for major
financial institutions to avert their collapseGovernment also cut taxes and raised spending
to prevent economy from falling into recession
Impact on India• $16 Billion outflow from India in 2008• Inflation at 12%• $291 Billion – Indian FX reserves as of 03 Oct. • Indian Oil Corp costs to rise 70% to $45
Billion• Industrial growth plummets to 1.3% in August• Sensex down ~50% in 2008• Sensex up ~50% from 2004 Indian Rupee depreciated 1$=55
What not happened here• No subprime• No toxic derivatives• No bank losses threatening capital• No bank credit crunch• No mistrust between banks
Our Problems Reduction in Capital flowsPressure on BoPStock marketsMonetary and liquidity impactTemporary impact on MFs/NBFCs (Sept-Oct)Reduction in flow from non-banksPerceptions of credit crunch
Contd.
Impact on Developing NationsTrade And Trade Prices:Growth in China and India has increased
imports and pushed up the demand for copper, oil and other natural resources, which has led to greater exports and higher prices
Remittances:Remittances to developing countries will
decline. There will be fewer economic migrants coming to developed countries
Contd.
Foreign Direct Investment (FDI) And Equity Investment : while 2007 was a record year for FDI to developing countries
Commercial Lending:Banks under pressure in developed countries may not be able to lend as much as they have done in the past.
Summing upWeaker export revenueFurther pressures on current accounts and
balance of paymentLower investment and growth ratesLost employmentThere could also be social effectsLower growth translating into higher
poverty
Current Scenario Across the GlobeThe world is trying to recover from
aftermath of great recession with India and China leading
The world bank projects global GDP to expand between 3.3 and 3.7% in 2012
Developing economies are expected to grow between 6.7 and 6.2%
High income countries expected to grow at 2.4% and 3%
Measures taken by RBIExpanding rupee liquidity
Reduction in CRR (400 bps) & SLR (100 bps)Special Repo window under LAF for banks on-
lending to NBFCs, HFCs & MFSSpecial Refinance to banks without collateralUnwinding of MSS – buybackOMOs – pre-announced calendar
Cut in repo (425 bps) and reverse repo (275 bps) rates.
Existing instruments – enough flexibility
Contd.
Managing Forex liquidityNRE and FCNR(B) deposits: interest
rate ceilings raisedECB norms relaxedAllowing corporates to buy back
FCCBsRupee-dollar swap facility for banks
with overseas branchesEncouraging Flow of credit
Lessons From Crisis Avoid high volatility in monetary policy Appropriate response of monetary policy to
asset prices Manage capital flow volatility Look for signs of over leveraging Active dynamic financial regulation
Capital buffers, dynamic provisioning Look for regulatory arbitrage incentives/
possibilities
(Re)SourcesBusiness Week, What will the crisis mean for venture
capital?, Sarah Lacy, 09 Oct. 2008 http://bit.ly/3A43xXYahoo Finance Charts and Historical dataMeltdown 2008, TerranceDC, Oct. 2008,
http://bit.ly/4gRiwhSequoia Capital Presentation to Portfolio Companies -
http://bit.ly/16F8WKGoogleRBI WebsiteTeknatus Blog http://www.teknatus.com/blog/pjainwww.imf.com