Financial crisis 2008

Created by: RANJITH KUMAR.C

Let’s start with Basics

CAN ANY ONE KNOWS WHAT IS THE PROFIT OF SBI FOR THE FINANCIAL YEAR 2007-08 ?

ITS EXACTLY AMOUNTS TO 67.29

BILLION (RS)

WHAT IS THE SOURCE THROUGH

WHICH THE BANKS GET THESE MUCH

OF PROFITS?

Bank Operation

Take money as deposits on which they pay interests

Lend it to borrowers who use if for investment or consumption

Borrow money from other banks (inter bank market)

Make profit on the difference between interest paid and received

Banks collects deposits from the depositors @ 8-10% and gives to the

Borrowers @14-18%.

Source: The Economist: Making Sense of Modern Economy

Investment Banks

Help firms raise money in the capital markets (equity and bonds market)

Advise firms whether to finance themselves with debt or equity

Underwrite such issues by agreeing often with other banks in syndicate, to

buy any unsold securities

Paid a commission for this service @

0.5% -2%

Advice on mergers and acquisitions

(most lucrative work- not during

sub-prime crisis though!!)

Source: The Economist: Making Sense of Modern Economy

Insurance companies

Oldest type of institutional investor

From protection to savings + protection

Law of large numbers – risk can be managed by pooling individual

exposures in large portfolios

Catch1- law works if risk are not correlated

Catch2- losses in any 1 year may differ hugely from the long run trend

Mortgage Broker

Mainly found in developed economies like US, Western Europe

Professionals who are paid a fee to bring together lenders and borrowers

Sells mortgage loans on behalf of businesses (ex. Banks)

Tasks undertaken: Marketing to attract clients

Assessment of the borrowers circumstances (Mortgage fact find forms interview).

This may include assessment of credit history (normally obtained via a credit report)

and affordability (verified by income documentation)

Assessing the market to find a mortgage product that fits the clients needs

(Mortgage presentation/recommendations)

Applying for a lenders agreement in principle (pre-approval)

Gathering all needed documents (paystubs / payslips, bank statements, etc.),

Completing a lender application form

Explaining the legal disclosures

Submitting all material to the lender

Source: Wikipedia

Sub-prime mortgage – What’s that?

Home loans made to borrowers with poor credit ratings — a group

generally defined by FICO scores below 620 on a scale that ranges

from 300 to 850

 FICO - a number that is based on a statistical analysis of a person's

credit report, and is used to represent the creditworthiness of that

person.

(FICO is the acronym for Fair Isaac Corporation, a publicly-traded corporation (under the symbol

"FIC") that created the best-known and most widely used credit score model in the US.)

Creditworthiness—the likelihood that the person will pay his or her

debts. Calculated by credit reporting agencies.

Ex. Equifax, Experian, and TransUnion in US

Source: Wikipedia

Details : Private Sub-prime mortgage process

1. Brokers identify borrowers

2. Originator and broker identify a loan for borrower after looking at his credit rating

3. Formal application for loan by borrower

4. Originator transfers the loan to the subsidiary of an investment banking firm ( Seller)

5. Seller(Investment bank) collects a pool of loans and call it as SPE/SIV/SPV. Off balance sheet instrument

6. SPV can be a corporation, partnership or limited liability company. Most often a Trust. It has nothing else except mortgage loans

7. Underwriter purchases all the securities (derivative income streams) 8. In designing SPV and its tranches underwriter works with credit rating agencies

9. Underwriter then sells the securities to the investors10. High rated tranches might be guaranteed by a 3rd party insurance company11. Seller also arranges to sell the rights to service the loan pool to a company or sometimes Originator takes these rights

12. MERS – document custodian. Company to keep track of mountains of paper work on loans in the pool. At National level. Source : Subprime Mortgage Market Turmoil , testimony by Christopher L. Peterson

Good days turn bad. Crisis at the door (mid 2006 onwards):

Through financial innovations loans issued to borrowers at minimal rate,

adjusted rate. By mid 2006 time to pay bigger amounts comes

Household income did not increase in same proportion as house prices

Subprime mortgage owners start defaulting

Rating agencies revise ratings of MBS/CDO as expected number of

defaults turn out higher. Many ratings are lowered

Bewildered investors lost faith in ratings, many stop buying MBS/CDO

altogether

Alarm bell at SIV/SPVs

Banks find themselves in non-comfortable position , stop making loans

Housing prices plummet owing to increase in foreclosure, delinquency

and stoppage of loans

How Sub prime became Global Financial Crisis?

Lets look into it from start again:

 Industry data suggest that between 2000 and

2006, nominal global issuance of credit

instruments (MBS/CDO) rose twelve fold, to

$3,000bn a year from $250bn

Became intense from 2004, partly because

investors were searching for ways to boost returns

after a long period in which central banks had kept

interest rates low.

“slicing and dicing” was fuelling a credit bubble,

leading to artificially low borrowing costs, spiraling

leverage and a collapse in lending standards

Source: Financial Times , http://www.ft.com/cms/s/0/a09f751e-6187-11dd-af94-000077b07658,dwp_uuid=698e638e-e39a-11dc-8799-0000779fd2ac.html

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How could problems with sub prime mortgages, being such a small sector of global financial markets, provoke such dislocation?

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Sept. 25 failure of Washington

Mutual was bar far the largest in

US history. Sold to JP Morgan Chase by govt. for $1.9B

plus WaMu’s loans and deposits

Resurgent bank failures (13 in 2008 as of Oct. 12)

are symptomatic of weakness in the financial system. FDIC says many

more may failFailure of Indy Mac was the 4th largest in

history

Top 10 Largest Bank Failures

Sub prime losses by Big Banks

Worldwide :US$ 586.2 billion and still counting

Source: Financial Times

Stakes Taken by Federal Government in 9 Large US Banks

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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

•Feds announced a total $125B stake in 9 large banks on Oct. 14.

•Another $125B will be infused in regional and local banks

•Sum comes from $700B in Troubled Asset Relief Program in the Emergency Economic Stabilization Act of 2008

Investments devalued across the Globe

Source: BBC News, http://news.bbc.co.uk/2/hi/talking_point/7644574.stm

Sub prime impact across globe

Source: Financial Times

Impact of Financial crisis-felt across the globe

Source: Reuters, http://www.reuters.com/news/globalcoverage/creditcrisis

Distribution of $700 Billion in Funds Under Emergency Economic Stabilization Act of 2008

9 Large Banks*, 125 , 18%

Regional & Local Banks, 125 , 18%

Troubled Asset Purchases, 450 ,

64%

Shifting Emphasis

•Original EESA allocated all $700B to Troubled Asset Relief Program

•View was that TARP would take too long and that liquidity/credit crisis required direct infusion of capital in banks by feds

It is the right time to buy a house in U.S rather than buying a house in Hyderabad.

Thank ”u”