Introduction Now a days everybody talks about,Economic Crisis,
Slowdown, US Economy Meltdown, Jobs Cut, Industrial Loss. We all
know that market have Slumped. People talks about at least 24 month
of Recession, jobs losses. Companies are closing, Sales are not
picking up Suddenly cash has Evaporated from the Market.
Profitability is severely hit. Do you Know why suddenly Indian
Market get affected by US Economy slowdown? What was the Reason for
GLOWBLE RECESSION ? What is Subprime Mortgage Crisis ?
Slide 3
Causes The crisis, which has its roots in the closing years of
the 20th century, became apparent in 2007 and has exposed pervasive
weaknesses in financial industry regulation and the global
financial system. The subprime mortgage crisis is an ongoing
financial crisis triggered by a dramatic rise in mortgage
delinquencies and foreclosures in the United State, with major
adverse consequences for banks and financial markets around the
globe. Many USA mortgages issued in recent years are subprime,
meaning that little or no down payment was made, and that they were
issued to households with low incomes and assets, and with troubled
credit histories. When USA house prices began to decline in
2006-07, mortgage delinquencies soared, and security backed with
subprime securities backed with subprime mortgages, widely held by
financial firms, lost most of their value. The result has been a
large decline in the capital of many banks and USA government
sponsored enterprises, tightening credit around the world.
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Subprime Mortgage Crisis On a national level, housing prices
peaked in early 2005, began declining in 2006 and may not yet have
hit bottom. Increased foreclosure rates in 20062007 by U.S.
homeowners led to a crisis in August 2008 for the subprime. 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
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Background: Subprime Lending Proponents v. Opponents
Proponents: Subprime lending extends credit to individuals who
would otherwise be shut out of the credit market thereby depriving
them of the ability to own their homes, cars etc. Opponents:
Subprime lending encourages predatory lending and attracts
borrowers who lack the resources to repay, thereby leading to
default, seizure of collateral and foreclosure by the lender.
Slide 6
Typical Subprime Borrower Profile Lower Credit Score FICO score
of 620 or below FICO score is a measure of past credit history
Higher Loan-to-Value ratio Compares the value of the loan to market
value of the property Indicator of borrower leverage Higher Income
Ratio Compares monthly loan payments to monthly income Indicator of
income adequacy Lower Documentation Standards Verification of
income is less rigorous
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New Model of Mortgage Lending
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Who are the Key Participants? 1. Home Buyer 2. Mortgage Brokers
3. Sub Prime Lenders 4. Big Banks 5. Securitization, Manufacturers
of CDOs 6. Rating Companies 7. Securities and CDOs 8.
Investors
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How does it all Work ? Sub Prime Loan Lending to borrowers with
a weak, substandard or incomplete credit history Subprime loans are
also called B-paper because they are offered at interest rates that
are higher than that of A-paper or Prime credit risk. Subprime
loans include the financing of homes, cars, credit cards etc.
However, most of the recent attention from the media has been on
subprime home mortgages.
Slide 10
Modification of Community Investment Act, 1995 The Move
encourage to Subprime Loan to Poorer Section to Society having poor
Credit Rating. Loan were bearing High Risk thus High Rate of
Interest. The value of Sub prime Mortgage Loan stood $ 1.3 trillion
as on March 2007. Low Interest Rate during the period of 2000 and
2004. Cheap funds triggered an increase in housing demand which in
turn led to a rise in housing prices.
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The Housing Boom Between 1997 and 2006 home prices in the US
increased by 124%. This led to huge increase in construction
activity. Banks offered NINJA Loans i.e. No income, No Jobs, Assets
Loans, where no down payment is required to be made. Easy payment
teaser loans(wherein the first few installments' are deceptively
low and then increase drastically as per the prevalent interest
rates). Cheap and easy loans coupled with rising housing prices
propelled an increase in home demand both for residential as well
as speculative purposes. Rising home prices also prompted home
owners to obtain second mortgages against the increased value for
consumer spending thereby leading to a large increase in household
debt. Thus a large proportion of consumer spending was out of
borrowed funds instead of from genuine income of customers.
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The Housing Bust Over Building in the Housing Sector, led to
rise in interest rates, surplus inventory in housing markets.
Housing price begins to falls as a results of such inventory
surplus and thus demand declined. By May 2008, housing prices had
declined by more than 18% from their peak in Q2 2006. Consumers
found it difficult to refinance their mortgages. By March 2008, the
values of the homes were lower than the value of the mortgages
which provided the consumers an incentive to foreclose their loans
and walk away without their homes. During 2007, nearly 1.3 million
homes were subject to foreclosure activity, up 79% from 2006.
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Thus, as can be concluded from above, while the real estate
market boomed, lenders as well as borrowers, both made merry;
lenders by issuing easy loans to non deserving customers and
borrowers by availing these loans to fulfill the great American
dream owing a home. But these dreams crashed once interest rates
shot up and housing prices began deflating. But the buck did not
stop at the financial institutions who issued high risk sub prime
mortgage loans, instead of waiting for the principal and interest
to be repaid on these loans over a period of time, the banks went
ahead and securitized these mortgage loans. The Housing Bust
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Process Of Securitization Model Of Securitization MORTGAGE
BROKER LENDER BORROWER Step 1- Borrower obtains a Loan from Lender
with the help of Mortgage Broker. SERVICER ISSUER TRUSTEE
UNDERWRITER RATING AGENCIES CREDIT ENHANCEMENT PROVIDER Step 4- The
Servicer collect Monthly Payments from the Borrower and remits the
same to the Issuer. The Trustee and the servicer manage the
delinquent loans according to the Pooling And service Agreement.
INVESTOR Loans Cash Loan Loans Proceeds Monthly Payments Securities
Cash Monthly Payments Step 2- Lender Sells the Loans to Issuer an
Borrower Begins Monthly Payments to Servicer. Step 3- The Issuer
sells the Securities to the investor, Underwriter assist in sale,
credit Rating Agencies Rate the Securities, Credit Enhancement may
be provided.
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Securitization allowed a large number of high risk loans to be
transferred to special purpose vehicles from the balance sheets of
lending institutions through products such as MBOs and CDOs. It
also enabled the financial institutions to bundle off its mortgage
loans through securitized products to investors and generate
immediate cash. Securitization of loans also freed cash to allow
financial institutions to make more loans. This further fuelled the
boom in the Housing Market. Inaccurate credit risk measurement
practices resulted in risky sub prime loans being clubbed with
prime loans within the same securitized products. High credit
ratings on securitized products encouraged the flow of investor
funds into these securities. Moreover, in the booming housing
market, there was a false sense of security, that even if the
borrowers defaulted on their payments, the value of the house would
be more than enough to cover the outstanding loan amounts. Role of
Securitization in Current Financial Crisis
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Liquidity Crisis As defaults in the loans grew beyond
expectations, the investors sought sell their positions. The
institutions holding these packages of loans had to sell some of
their assets to meet cash demands from their investors. However,
there wasnt anyone to buy these securities, except as very low
prices (pennies on the dollar). This started the liquidity crisis.
It expanded when the same intuitions then sold their more solid
assets to help meet the cash demand from their investors. This
included stocks with solid fundamentals, causing the stock markets
to fall. As a result rates for new loans rose in price to better
reflect the realities of the market. New borrowers were faced with
rates that were substantially higher than just a few weeks ago.
Even well qualified borrowers encountered difficulties borrowing
money as the lending institutions over reacted to the credit
problems. This is how we experienced the latest liquidity crisis
which has caused much of the increase in volatility we have been
seeing the stock markets. Chapter XIV Regulatory responses to the
sub prime crisis.
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Causes of the Crisis The Housing Downturn Reduction in Interest
Rates Excess supply of home inventory Sub Prime Loan Sales volume
of new homes dropped Reduced market prices Increasing foreclosure
rates Borrowers Difficulties in re-financing Begin to default on
loans Walk away from properties Fraudulent misrepresentations
Slide 18
Causes of the Crisis Financial Institutions Attraction from
high returns Offered high-risk loan and incentives Believes that
will pass on the risk to others Securitization Mortgage backed
securities Risk readily transferred to other investors From 54% in
2001 to 75% in 2006
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Causes of the Crisis Government and Regulators Community
Reinvestment Act, encourages the development of the subprime
debacle Glass-Steagall Act contributes to the subprime crisis (FDIC
back up) Central banks Less concerned with avoiding asset bubbles
React after bubbles burst to minimize the impact No determination
on monetary policy Institutions risk more because of Feds
rescue
Slide 20
Domestic Impacts of the Crisis Home Owners Housing prices down
10.4% in Dec. 07 vs. year-ago Sales of new homes dropped by 26.4%
in 07 vs. 06 By Jan. 2008, the inventory of unsold new homes stood
at 9.8 months, the highest level since 1981. Two million families
will be evicted from their homes Minorities Disproportionate level
of foreclosures in minority 46% Hispanics, 55% blacks got higher
cost loans
Slide 21
Direct Impacts of the Crisis Financial Institutions Bankruptcy
New Century Financial (USA) Apr. 2, 2007 American Home Mortgage
(USA) Aug. 6, 2007 Sentinel management Group (USA) Aug. 17, 2007
Ameriquest (USA) Aug. 31, 2007 NetBank (USA) Sept. 30, 2007 Terra
Securities (Norway) Nov. 28, 2007 American Freedom Mortgage Inc.
(USA) Jan. 30, 2007
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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
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Domestic Impacts of the Crisis Economy Condition Recession
Severe Liquidity and Credit Crunch Low GDP growth rate Business
close out or lose money (banks, builders etc.) Weak financial
market Low consumer spending Investors have lost trillions of
dollars Lose jobs Decrease in consumer wealth Decline in
consumption led to decline in demand which in turn has affected the
manufacturing and services industry.
Slide 24
Global Impacts of the Crisis Investors will be very cautious to
act Lack confidence in stock/bound market Consumer spending will
slowdown Lack of cash or unwilling to spend World economy may slip
into recession U.S. economy condition will affect global economy
GDP growth will be low Lose businesses Lose jobs Economy slow
down
Slide 25
Global Impacts of the Crisis Financial market May take long
time to recover Unemployment rate may be high Slow economy increase
unemployment rate Exports will decrease in China, Korea, Taiwan GDP
growth heavily depends on export
Slide 26
Regulatory Responses 1. Economic Stimulus Act of 2008: enacted
February 13, 2008 an Act of Congress providing for several kinds of
economic stimuli intended to boost the United States economy in
2008 and to avert or ameliorate a recession. The law provides for
tax rebates to low- and middle-income U.S. taxpayers, tax
incentives to stimulate business investment, and an increase in the
limits imposed on mortgages eligible for purchase by
government-sponsored enterprises (e.g., Fannie Mae and Freddie
Mac). The total cost of this bill was projected at $152 billion for
2008 2. Housing and Economic Recovery Act of 2008 Enacted on July
30,2008 Lends money to mortgage bankers to help them refinance the
mortgages of owner- occupants at risk of foreclosure. The lender
reduces the amount of the mortgage (typically taking a significant
loss), in exchange for sharing in any future appreciation in the
selling price of the house via the Federal Housing Administration.
The refinancing must have fixed payments for a term of 30 years;
Requires that lenders disclose more information about the products
they offer and the deals they close; Helps local governments buy
and renovate foreclosed properties
Slide 27
Regulatory Responses 3. Emergency Economic Stabilization Act of
2008 commonly referred to as a bailout of the U.S. financial
system, is a law authorizing the United States Secretary of the
Treasury to spend up to US$700 billion to purchase distressed
assets, especially mortgage-backed securities, and make capital
injections into banks The bailed-out banks are mostly U.S. or
foreign banks, though the Federal Reserve extended help to American
Express, whose bank-holding application it recently approved. The
Act was proposed by Treasury Secretary Henry Paulson during the
global financial crisis of 2008. The bill, HR1424 was passed by the
House on October 3, 2008 and signed into law.
Slide 28
Impact of Financial Crisis on India Stock market steep fall.
Liquidity crunch and weak rupee. Decline in exports and increase in
trade deficits. Increase in job losses and unemployment rate.
Higher cost of borrowing and General slowdown in the industry. Real
Estate Market Crush. Lay off, Retrenchment, Closing down of Plants.
capital markets drying up. Commodity Price increase.
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Lesson From Crisis Key Lessons for Governments Importance of
sound information on what is happening on the ground as the crisis
unfolds. Short-term responses to a crisis cannot ignore longer term
implications for development in all its dimensions. The
macroeconomic stabilization response must be consistent with
restoring them growth process Financial sector policies need to
balance concerns about the fragility of the banking system with the
needs for sound longer-term financial institutions. The social
policy response must provide rapid income support to those in most
need, giving highest on the poorest amongst those affected, while
preserving the key physical and human assets of poor people and
their communities. Address the tradeoffs between rapid crisis
response and longer-term development goals
Slide 30
Key lessons for industries Diversify Globally Local foray
Tighten Recruitment and Retention Processes Address the Skills
Shortage Improve Productivity Innovate- do things differently
Slide 31
Key lessons for Individuals Know your debt Borrow sensibly Dont
over-leverage Every investment has risk Everything is interlinked
Diversify for retirement planning Development of Human Capital Save
during good times For investing in share markets Have a long-term
horizon One should know when to invest. Size Matters, at least in
Equities
Slide 32
Crisis Survival Guide Increase your savings rate Allocate to
fixed income Dont panic Look for alternate income sources Go for
insurance Manage your portfolio Dont worry what goes down will
always go up Markets will rebound these tips will prepare you to be
a winner