Financial Crisis

• A.B.C.of The Global Financial Crisis 2008

BY SUMEET BASSI

Faces of the CRISIS

Global Financial Crisis Dictionary 2008

The financial crisis. How did this all happen?? Let’s start with the Borrowers, from their point of view…

Things were going swell with the US economy.

With low interest rates people can borrow money easily (it’s cheap to pay it back)

When people borrow money, that puts lots of money in the system, lots of ‘liquidity’

There was a general shift. The banks feel OK offering lots of people a loan….even those that may not normally qualify. These are called Sub prime borrowers.

Banks offer more loans, with lots of different terms. Adjustable rates, interest only for a while, etc.

The buyers were encouraged by mortgage lenders, the terms were doable, at least until the rates adjusted, and overall, people were confident.

When House values go up, my house increases in value. I will be able to renegotiate my loan for a better rate from someone else..

The economy is still growing! The buyer isn’t worried about their mortgage.

Interest rates were historically low.

SUMEET BASSI

So what happened?

So things were good. The economy was growing fast, and then 2 things happened.

The Fed decided it was time to raise interest rates. They wanted to prevent inflation, which happens as a result of lots of money in the system. So it went from 1% to 5.2% over a period of time.

And…overall the number of people (or the demand) for houses went down.

So less people bought houses,.

With less people buying houses, the price of homes fell.

People who had these loans out and thought they would be able to refinance their home, when the value of their home went up, were stuck paying a much larger payment than they agreed on. And subsequently…couldn’t make their payment.

So lots of people defaulted,. When the borrower doesn’t make payments …someone still has to come up with the money. .

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These loans were no longer with the banks that had made them. Instead they were held by investors around the world.

And because these banks can’t borrow, they are left needing money, and wanting to sell their securities..* But…no one really wants to buy these..

Here’s where it gets sticky. Remember the bank.s…:

In this case, the fear that drives the word “crisis” is that no one will lend money (bank to bank, or otherwise). People are afraid of the default risk…and it simply becomes ridiculously expensive to borrow money.

…And we have a credit crisis.

Hence the necessity to give banks money…or Bail them out with money.

Bankers didn’t count on this perfect storm, everyone defaulting at the same time. There were big models of risk…none of which predicted this.

It became harder for banks for borrow. The impact wasn’t just the mortgage market. It trickled into the corporate market and overall drove down the appetitive for investment.SO….the price of borrowing went up and the value of debt goes down. What this means is that Banks had to write down their assets. How much? People were unsure.

When people don’t know, they don’t trust. And when you don’t trust someone, you’re not going to want to lend them money. This is called a liquidity crisis..

Imagine if you had a gold necklace that you thought was worth mega money., and you bet it in a game of poker. You lose. Then, the next day, you find out the necklace is worth a lot less. Yikes! You still owe that person money, but now can’t sell the gold necklace to get the money. The banks had a lot of gold necklaces they couldn’t sell, and needed money

*Securities.. are any form of ownership that can be easily traded on a secondary market…bonds, stocks, mutual funds. SUMEET BASSI

United States housing bubble

WHAT ARE INVESTMENT BANK ?

• An investment bank is a financial institution that raises capital, trades in securities and manages corporate mergers and acquisitions. Investment banks profit from companies and governments by raising money through issuing and selling securities in capital markets

MAJOR INVESTMENT BANKERS ?

• Goldman Sachs • Morgan Stanley• Deutsche Bank• HSBC• JPMorgan Chase• Merrill Lynch • Lehman Brothers

SUBPRIME LOAN

• Definition• A loan offered to an individual who does not

qualify for a loan at the prime rate due to their credit history. If a lender thinks that there is an above-average risk involved in giving a loan to a certain individual, they will sometimes offer them a subprime loan, which has an interest rate higher than the prime rate. The subprime rate offered by the lender can vary from institution to institution

SUBPRIME LOSSE

Background and timeline of events

• Mortgage market• Boom and bust in the housing market • Speculation • High-risk mortgage loans• Inaccurate credit ratings • Government policies • Boom and collapse of the shadow banking

system

• Bank become insolvent

LEHMAN: became the largest corporate bankruptcy in

United States history.

• THE MERGER: Merrill Lynch CEO John Thain (L) and Bank of America CEO Kenneth Lewis (R) speak to reporters at a press conference on Sept. 15, 2008 to announce Bank of America's acquisition of struggling Merrill Lynch.

AIG: Former AIG CEO Edward Liddy testifies before the U.S. House Financial Services Committee in March 2009 as protesters

decry the federal government's bailout of the troubled insurer

DOW DROPS 778 POINTS: A trader reacts as the Dow

Jones Industrial Average sank 777.68 points

THE TREASURY CHIEF: Former Treasury Sec. Henry Paulson spoke to the media at the White House in Washington on Sept. 15, 2008

regarding the financial crisis

BANKS

Washington Mutual Barclays Capital

Citigroup Lehman Brothers

Merrill Lynch UBS

Sub prime losses by Big Banks

Stakes Taken by Federal Government in 9 Large US Banks

$25

$25

$15

$10

$10

$10

$3

$2

$25

0 5 10 15 20 25 30

Citigroup

JP Morgan Chase

Wells Fargo*

Bank of America

Merrill Lynch

Goldman Sachs

Morgan Stanley

Bank of NY Mellon

State Street

• On September 15, 2008, Lehman Brotrhers became the largest bankruptcy in US history, its collapse paralysing the global financial system. Take a look at the timeline of the crisis:

Sept 15, 2008: Lehman Bros files for bankruptcy. Merrill Lynch, also stung by the credit crunch, agrees to be taken over by Bank of America for $50 bn.

Sept 16, 2008: Fed announces an $85-bn rescue package for AIG, USङs biggest insurance co, to save it from bankruptcy, in return for an 80% stake in the firm.

Sept 17, 2008: Lloyds announces takeover of Britain's biggest mortgage lender HBOS in a 12-bn pound deal creating a banking giant holding close to one-third of the UK's savings and mortgage.

• Sept 20, 2008: Bush asks Congress for $700 billion to bail out firms burdened with bad mortgage debt. Barclays buys the core pf Lehman’s US business.

Sept 21, 2008: Goldman Sachs and Morgan Stanely are granted approval to become bank holding company regulated by the Fed, effectively killing off the investment banking model.

Sept 22, 2008: Japan’s Nomura Holdings buys the Asian operations of Lehman. Later acquires European ops as well.

Sept 25, 2008: In the largest bank failure yet in the US, mortgage lender Washington Mutual, which had assets valued at $307 bn, is closed down and sold to JPMorgan Chase

• Nov 23, 2008: US announces $20-bn rescue plan for Citi after its shares plunge by over 60% in a week.

Nov 25, 2008: US Fed announces it will inject another $800 bn into economy to stabilise financial system.

Nov 26,2008: European Commission unveils a recovery plan worth euro 200 bn to save millions of jobs.

Bailouts and failures of financial firms

Insurers

Saved by government funding

Confidence in Market

Investors

Mistakes1. Wrong belief of housing prices always going up

2. FED overlooked warnings

3. Past data reference illusion

4. High leveraging

5. Miscalculated ratings fooled investors

6. Appetite beyond capacity

7. Slicing and dicing spread the risk but did not eliminate it