RECESSIORECESSIONN

““This is not the end of the worldThis is not the end of the world

The only thing that will bring on the end of the The only thing that will bring on the end of the world world

will be the end of world “ will be the end of world “

Factors that push an economy Factors that push an economy in to recessionin to recession

Credit crunch : Credit crunch : Shortage of financeShortage of finance Falling house prices : Falling house prices : related to shortage of related to shortage of

mortgages and credit crunch. mortgages and credit crunch. Cost push inflation squeezing incomes and Cost push inflation squeezing incomes and

reducing disposable income.reducing disposable income. Collapse in confidence of finance sector Collapse in confidence of finance sector

causing lower confidence amongst real causing lower confidence amongst real economy.economy.

Financial factorsFinancial factorsofof

RecessionRecession

Subprime LendingSubprime LendingWhat are subprime loans?What are subprime loans? A type of loan that is offered at a rate above A type of loan that is offered at a rate above

prime to individuals who do not qualify for prime prime to individuals who do not qualify for prime rate loans. Quite often, subprime borrowers are rate loans. Quite often, subprime borrowers are often turned away from traditional often turned away from traditional lenders because of their low credit ratings or lenders because of their low credit ratings or other factors that suggest that they have a other factors that suggest that they have a reasonable chance of defaulting on the debt reasonable chance of defaulting on the debt repayment .repayment .

Increased rate of subprime lendingIncreased rate of subprime lending

It all started in It all started in U.S………………….U.S………………….

In US, a boom in the housing sector was In US, a boom in the housing sector was driving the economy to a new level.  A driving the economy to a new level.  A combination of low interest rates and large combination of low interest rates and large inflows of foreign funds helped to create inflows of foreign funds helped to create easy credit conditions where it became easy credit conditions where it became quite easy for people to take home loans. quite easy for people to take home loans. As more and more people took home As more and more people took home loans, the demands for property increased loans, the demands for property increased and fueled the home prices further. As and fueled the home prices further. As there was enough money to lend to there was enough money to lend to potential borrowers, the loan agencies potential borrowers, the loan agencies started to widen their loan disbursement started to widen their loan disbursement reach and relaxed the loan conditions.reach and relaxed the loan conditions.

Contd…………..Contd…………..

As a result, many people with low As a result, many people with low income & bad credit history or those income & bad credit history or those who come under the NINJA (No who come under the NINJA (No Income, No Job, No Assets) category Income, No Job, No Assets) category were given housing loans in were given housing loans in disregard to all principles of financial disregard to all principles of financial prudence. prudence.

Bubble that Bubble that burst………burst………

Bubble that Bubble that burst………burst………

As the saying goes, “No boom lasts forever”, the As the saying goes, “No boom lasts forever”, the housing bubble was to burst eventually. housing bubble was to burst eventually. Overbuilding of houses during the boom period Overbuilding of houses during the boom period finally led to a surplus inventory of homes, causing finally led to a surplus inventory of homes, causing home prices to decline beginning from the summer home prices to decline beginning from the summer of 2006. Once housing prices started depreciating of 2006. Once housing prices started depreciating in many parts of the U.S., refinancing became in many parts of the U.S., refinancing became more difficult. Home owners, who were expecting more difficult. Home owners, who were expecting to get a refinance on the basis of increased home to get a refinance on the basis of increased home prices, found themselves unable to re-finance and prices, found themselves unable to re-finance and began to default on loans as their loans reset to began to default on loans as their loans reset to higher interest rates and payment amounts.higher interest rates and payment amounts.

Cond………..Cond………..Now you must be wondering how this Now you must be wondering how this

housing boom and its subsequent housing boom and its subsequent decline is related to current decline is related to current economic depression? After all it economic depression? After all it appears to be a local problem of appears to be a local problem of America.America.

What complicated the What complicated the matter?…matter?…

The interest rate charged on subprime loans was The interest rate charged on subprime loans was about 2% higher than the interest on prime about 2% higher than the interest on prime loans ; lenders were confidant that they would loans ; lenders were confidant that they would get a handsome return on their investment. In get a handsome return on their investment. In case a sub-prime borrower continued to pay his case a sub-prime borrower continued to pay his loans installment, the lender would get higher loans installment, the lender would get higher interest on the loans. And in case a sub-prime interest on the loans. And in case a sub-prime borrower could not pay his loan and defaulted, borrower could not pay his loan and defaulted, the lender would have the option to sell his home the lender would have the option to sell his home (on a high market price) and recovered his loan (on a high market price) and recovered his loan amount. In both the situations the Sub-prime amount. In both the situations the Sub-prime loans were excellent investment options as long loans were excellent investment options as long as the housing market was booming. Just at this as the housing market was booming. Just at this point, the things started complicating. point, the things started complicating.

Contd………………..Contd……………….. As the home prices started declining in the US, sub-As the home prices started declining in the US, sub-

prime borrowers found themselves in a messy prime borrowers found themselves in a messy situation. Their house prices were decreasing and situation. Their house prices were decreasing and the loan interest on these houses was soaring. As the loan interest on these houses was soaring. As they could not manage a second mortgage on their they could not manage a second mortgage on their home, it became very difficult for them to pay the home, it became very difficult for them to pay the higher interest rate. As a result many of them opted higher interest rate. As a result many of them opted to default on their home loans and vacated the to default on their home loans and vacated the house. However, as the home prices were falling house. However, as the home prices were falling rapidly, the lending companies, which were hoping rapidly, the lending companies, which were hoping to sell them and recover the loan amount, found to sell them and recover the loan amount, found them in a situation where loan amount exceeded the them in a situation where loan amount exceeded the total cost of the house. Eventually, there remained total cost of the house. Eventually, there remained no option but to write off losses on these loans.no option but to write off losses on these loans.

Mayhem in the Mayhem in the banks….banks….

Mayhem in the Mayhem in the banks….banks….

The effects of these losses were huge. The effects of these losses were huge. Global banks and brokerages have had to Global banks and brokerages have had to write off an estimated $512 billion in write off an estimated $512 billion in subprime losses so far, with the largest hits subprime losses so far, with the largest hits taken by Citigroup ($55.1 billion) and Merrill taken by Citigroup ($55.1 billion) and Merrill Lynch ($52.2 billion). A little over half of Lynch ($52.2 billion). A little over half of these losses, or $260 billion, have been these losses, or $260 billion, have been suffered by US-based firms, $227 billion by suffered by US-based firms, $227 billion by European firms and a relatively modest $24 European firms and a relatively modest $24 billion by Asian ones.billion by Asian ones.

Subprime LosersSubprime Losers

Investment Investment banksbanks - many - many large investment large investment firms have seen firms have seen their stock prices their stock prices plummet as a plummet as a result of the result of the subprime bust.subprime bust.

What is worse is the fact that the What is worse is the fact that the losses suffered by banks in the losses suffered by banks in the subprime mess have directly affected subprime mess have directly affected their money market the world over.their money market the world over.

Now what is a money Now what is a money market?market?

Money Market is actually an inter-bank market Money Market is actually an inter-bank market where banks borrow and lend money among where banks borrow and lend money among themselves to meet short-term need for funds. themselves to meet short-term need for funds. Banks usually never hold the exact amount of cash Banks usually never hold the exact amount of cash that they need to disburse as credit. The ‘inter-that they need to disburse as credit. The ‘inter-bank’ market performs this critical role of bringing bank’ market performs this critical role of bringing cash-surplus and cash-deficit banks together and cash-surplus and cash-deficit banks together and lubricates the process of credit delivery to lubricates the process of credit delivery to companies (for working capital and capacity companies (for working capital and capacity creation) and consumers (for buying cars, white creation) and consumers (for buying cars, white goods etc). As the housing loan crisis intensified, goods etc). As the housing loan crisis intensified, banks grew increasingly suspicious about each banks grew increasingly suspicious about each other’s solvency and ability to honour other’s solvency and ability to honour commitments. The inter-bank market shrank as a commitments. The inter-bank market shrank as a result and this began to hurt the flow of funds to result and this began to hurt the flow of funds to the ‘real’ economy. the ‘real’ economy.

How it has affected India?How it has affected India?

In the age of globalization, no In the age of globalization, no country can remains isolated from country can remains isolated from the fluctuations of world economy. the fluctuations of world economy. Heavy losses suffered by major Heavy losses suffered by major International Banks is going to affect International Banks is going to affect all countries of the world as these all countries of the world as these financial institutes have their financial institutes have their investment interest in almost all investment interest in almost all countries.countries.

As of now India is facing heat on As of now India is facing heat on three grounds…………….three grounds…………….

(1) Our Share Markets are falling (1) Our Share Markets are falling everydayeveryday

(2) Rupee is weakening against (2) Rupee is weakening against dollars dollars

(3) Our banks are facing severe (3) Our banks are facing severe crash crunch resulting in shortage of crash crunch resulting in shortage of liquidity in the market.liquidity in the market.

CONCLUSIONCONCLUSION

Greed of Greed of some…woes some…woes of billionsof billions

If you think about this with a cool mind, you If you think about this with a cool mind, you will find that the underlying cause of this will find that the underlying cause of this depression is the greed of those who failed depression is the greed of those who failed to anticipate the consequence of their to anticipate the consequence of their actions. On a more ideological front, it is actions. On a more ideological front, it is high time to have a rethink on the very idea high time to have a rethink on the very idea of free markets and capitalism. I think the of free markets and capitalism. I think the time has come to evolve a capitalism where time has come to evolve a capitalism where everything works under a broad regulatory everything works under a broad regulatory framework and we do not see a repeat of framework and we do not see a repeat of this condition where greed of some people this condition where greed of some people can affect the lives of billions.can affect the lives of billions.

““For every problem under the For every problem under the sun sun

There is a solution or is There is a solution or is nonenone

If there is one, try to find itIf there is one, try to find it

If there is none , never If there is none , never mind it”.mind it”.

THANKYOUTHANKYOU