Global financial crisis

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