The Sub Prime Crisis - The Big Picture

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Information about The Sub Prime Crisis - The Big Picture

Published on January 27, 2009

Author: aSGuest11532


Slide 1: THE SUB-PRIME CRISIS : The Big Picture Slide 2: The Sub Prime Crisis : A Human Story How the cookie crumbled Role of different players Risk involved Implications & Remedies - US A Sub Prime Crisis & India : Analyst’s view Lessons to be learnt The Fall of the Giants AGENDA Slide 3: Dude, I need a home loan but the bank won’t gimme one? I dnt have good credit rating. What do I do???? No probs mate. I have a good rating and I can give you loan. American 1 American 2 The Sub – Prime Crisis : A Human Story Slide 4: My pleasure buddy? American 1 American 2 Slide 5: Llemme not wait for the principal and the interest on subprime loans to be repaid so that the loan to the bank can be repaid American 2 divides the home loans into a lot of small tranches and gives it out as home loans to lots of other Americans like the first American at a higher rate of interest than at what he borrowed from the bank American 2 So what does he do????.......................... Slide 6: Yyippee!!!!!!!!!! Yyippee!!!!!!!!!! Money Sell financial securities American 2 RSG Investment Bank of Wall Street …………..He goes ahead and securitises these loans. Securitisation essentially involves converting these home loans into financial securities, which promise to pay a certain rate of interest Financial securities are then sold to big institutional investors who are repaid by subprime borrowers through EMI Slide 7: Yyippee!!!!!!!!!! Yyippee!!!!!!!!!! Money American 2 First Bank of Bankland Loan repaid Slide 8: But here was the ‘Hitch’!!!!!!!!!!!!!! Slide 9: Subprime Home loans given as floating rate home loans Interest rate goes up Interest rate to be paid on floating rate home loans also go up EMI that need to be paid to service these loans also go up Higher EMIs hit hard the sub prime borrowers leading to repayment defaults FIs not paid back leading to piling of losses ultimately leading to ‘crisis’ Slide 10: My pleasure buddy? American 1 American 2 I am screwed!!!!!!!!!!! I am screwed!!!!!!!!!!! Slide 11: YWe are screwed as well!!!!!!!!!!!!! First Bank of Bankland RSG Investment Bank of Wall Street Slide 12: “How” of Sub Prime Positive forecast about rising home prices Bursting of the US housing bubble Housing prices starts to drop moderately in 2006-07 Securitization Value of the underlying mortgage assets declined Slide 13: 1890 1920 1940 1960 1980 2005 1998 Housing Prices Slide 14: The Housing Price Crash Slide 15: The new model of Mortgage Lending – How it went wrong? Slide 16: In a nutshell, Anytime something bad happens, it doesn't take long before blame starts to be assigned. In the instance of subprime mortgage woes, there is no single entity or individual to point the finger at. Instead, this mess is a collective creation of the world's central banks, homeowners, lenders, credit rating agencies and underwriters, and investors. Slide 17: Role of Different Players 1.Role of borrowers Easy credit, combined with the assumption that housing prices would continue to appreciate, also encouraged many subprime borrowers to borrow at higher than prime market rate. 2.Role of lenders It was the lenders who ultimately lent funds to people with poor credit and a high risk of default. 3.Role of Financial Institutions Ninja loans interest-only adjustable-rate mortgage (ARM) "payment option" loan Slide 18: 4. Role of securitization Due to securitization, loans with a high risk of default could be originated, packaged and the risk readily transferred to others. 5. Role of mortgage brokers & underwriters The Role of mortgage brokers& underwriters was also paramount in fuelling and exacerbating the crisis. 6. Role of government & regulators The regulators also failed to regulate the sub prime borrowing market and taking corrective measures at the right time. Slide 19: Credit rating agencies are now under scrutiny for giving investment-grade ratings to securitization transactions (CDOs and MBSs) based on subprime mortgage loans. 7. Role of credit rating agencies 8. Role of central banks Central banks are less concerned with avoiding asset bubbles. Central banks have generally chosen to react after such bubbles burst to minimize collateral impact on the economy, rather than trying to avoid the bubble itself. Slide 20: Risk Involved 1. Credit risk: The risk of default Innovations in securitization ; Risk transferred to third party investors In lieu of assuming credit risk, the third party investors receive a claim on the mortgage assets 2. Asset price risk: Risk involved with overvaluing or undervaluing of the asset With MBS revalued downwards, substantial losses were incurred Slide 21: 3.Liquidity risk: Ability of many companies to issue commercial paper as a means of short term funding has been significantly affected Interest rate charged to provide loans for commercial papers has increased substantially 4. Counterparty risk: With the decline in financial health of investment banks, the risk to their counterparties has also increased Slide 23: Implications for USA The widespread dispersion of credit risk and the unclear effect on financial institutions caused lenders to reduce lending activity or to make loans at higher interest rates. Similarly, the ability of corporations to obtain funds through the issuance of commercial paper was affected. This aspect of the crisis is consistent with a credit crunch. The subprime crisis also places downward pressure on economic growth, because fewer or more expensive loans decrease investment by businesses and consumer spending, which drive the economy. A separate but related dynamic is the downturn in the housing market, where a surplus inventory of homes has resulted in a significant decline in new home construction and housing prices in many areas. Slide 24: Cushion for the Crisis US: 2nd Oct : The Senate passed the $700 billion bailout package by a wide margin 74-25 to help financial institutions 8th Oct : Federal reserve orders emergency rate cut to I.5 % 15th Oct : US to pump in $250 billion to rescue banking system UK : 13th Oct, A $ 691 billion package is on the cards to improve liquidity in the banking system Germany : 13th Oct, Working out a plan to purchase equity in financial institutions worth up 100 billion euro Slide 25: Subprime & India - Analyst’s View 1. Anil Singhvi - Managing Director, Ican Investments Advisers Ltd. “If the US, which has a 25 per cent share of global GDP, slows down, it will definitely have an impact on the Indian economy.” 2. The SEBI Chairman, Mr M. Damodaran “He will be a bold man who assumes that stock prices are a resultant of one single factor. At the end of the day the price of a stock is determined by the demand and supply of that stock … A fall in the indices cannot be linked to one factor, especially if it is external … It would be an oversimplification if the fall in the stock market in India is linked only to the sub-prime mortgage crisis in the US.” Slide 26: 3. Finance Minister P Chidambaram, March 18 “When crisis (has) moved from the subprime mortgage market to the housing market, and now the housing market to the credit market, there is impact upon India. There is impact in terms of credit flows and financial flows. But at the moment, I believe that impact is second-order impact and a moderate impact,” 4. PM, Dr. Manmohan Singh ,21st October “The financial crisis is likely to have an indirect impact on the Indian economy. We must be prepared for a temporary slowdown in the Indian economy.” Slide 27: 5. Kamal Nath, Commerce Minister “What need s to be done is to inject cash into the system” 6. Montek Singh Ahluwalia, Dy Chairman , Planning Commission “A rate cut is something that the RBI should certainly consider ” 7. C Rangarajan, Rajya Saba Member “The exposure of Indian banks to toxic assets is minimal ” 8. K V Kamath, CEO, ICICI Bank “I am very confident that normalcy will return soon” Slide 28: Slowdown in jobs Increase in loan rates Correction in real estate prices Slowdown in FDI More inflation Speed breaker ahead Rollercoaster ride Implications for India Slide 29: CRR cut by 250 basis points from 9% to 6.5%; expected to add Rs 1.25 lakh crore liquidity in the economy Repo rate cut by 100 basis points to 8% Commercial banks ready to cut home loan rates by Diwali by 50 basis points GOI plans to allow 100% FDI in single-brand retail;current cap 51% What is the Indian government doing? Contd… Slide 30: FII investment in corporate debt doubled to $6 billion Early release of farm debt waiver subsidy Interest ceiling on FCNR and NRE deposits raised Bank’s overseas borrowing limit doubled Govt to infuse capital into banks with CAR below 12% Banks allowed to pledge another 50 bps of their SLR to lend to mutual funds Contd… Slide 31: Cover of the 20 October 2007 issue of The Economist showing an image related to a Credit crunch caused by the subprime mortgage crisis. Cover of the 05 April 2008 issue of The Economist showing an image related to fixing the Credit crunch caused by the subprime mortgage crisis. Slide 32: Lessons to be learnt for India The financial sector should adopt better standards to evaluate the credit worthiness of potential borrowers. It should collate and analyse consumer data based on the latest international norms before dishing out loans. Investors should carefully evaluate the future before taking new loans for asset purchases. As a globally integrated economy, international events will leave its mark on our economy whether we like it or not. It is important that we remain abreast of what’s happening in the global markets and base our consumption and investment decisions on a judicious extrapolation of the impact of these global events on the Indian economy. Slide 33: The Fall of the Giants Bear Stearns sold to JP Morgan Chase in Mar’08 for $236.2 million or $2 per share Effective nationalization on Sept’08 of mortgage giants Fannie Mae and Freddie Mac Merrill Lynch sold out to Bank of America on 15 Sept’08 for about $50 bn Iconic I – Banks Goldman Sachs & Morgan turn themselves into old –fashioned retail banks Contd… Slide 34: Contd… Lehman Brothers, the 158 year old U.S.A’s 4th largest Investment Bank files for bankruptcy Fed arranges to lend $85 bn to AIG, American International Group, U.S.A’s biggest national insurer in exchange for 79.9% equity stake Morgan Stanley steps up its merger talks with Wachovia Barclay’s Capital, U.K agrees to acquire Lehman’s North American Investment Banking operations Japanese Bank, Nomura, agrees to buy a large chunk of Lehman’s operations in Europe and BPO operations in India Slide 35: THANK YOU -BY RITURAJ (A9043)

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