The Bubble That Burst -Usa

8/6/2019 The Bubble That Burst -Usa

http://slidepdf.com/reader/full/the-bubble-that-burst-usa 1/28



An Anecdote ³ When your neighbor loses his job , it

is economic slow down .

When you lose your job , it is arecession.

But, when an economist loses his

job, it becomes a depression .



The Great Depression of 1929

Bank failures

Men in threadbare clothes

Shoe stuffed with newspaper to plugholes in the sole

Unemployment

Poverty



The theor y of a free mar ket The economic system of US A believes

the less gover nment intervention ; thebetter

The mantra is that mar kets know best!!



Flash back ± US A , The Super Power

Growth in the financial sector

Profits in millions

Shareholders and senior executives atan enviable position

A strong nation, world superpower



The Asian financial crisis of

1997 Arose due to the de- linking of the baht

from the dollar

The crisis spread to South ± East Asia,Russia , Latin America and finallyto US A .

This led to the failure of the hedgefund , LTCM



The Crisis of September, 2008

Fall of Bear Stear ns and take over by

JP Morgan

Nationalizing of two failing mortgagere-financing institutions ,Freddie Macand Fannie Mae

Lehman Brothers filed for bankruptcyand sold part of its shares to Barclay¶s



September 2008

Merrill Lynch filed for bankruptcy andwas taken over by Bank of America

Gover nment bailed out AIG , the giantinsurance company as it involved thetrust of a large number of people

Long standing companies are re-

defining themselves by tr ying to merge.



Where did it all begin ??

Problem with sub prime mortgages

Mortgaged backed securities landed in

trouble This spread to asset±backed

commercial paper and auction ± rate

securities The problem spread like a virus and

started swallowing whole firms



The no of defaulters began to rise There was a feeling that the home prices

would increase

Rather , the prices fell sharply and themar kets crashed The parties blamed each other ± The borrower contended that he did not

understand the complicated mortgageprocess

The lenders vehemently denied about theignorance of the borrower



The Saviour The Federal Reserve has stepped in to

save the firms, to help the financial

mar kets as they were linked across theworld .

Bad financial practices created the

bubble that led to the origin of the newcrisis of 2008.



The lessons not lear nt

The US gover nment failed to understandthat the system of taking deposits andissuing mortgages has failed .

In the late1980¶s and early 1990¶s they hadto use 100 billion dollars of tax payer ¶smoney to rescue the financial mar kets.

The financial institutions were dabbling insecurities and derivatives that ver y fewpeople understood



The accounting systems were µshady¶as it allowed the firms to keep some

items off their balance sheets . Rating agencies were µdodgy¶ as they

were accepting the ratings that thebundlers gave them without verif yingthem independently.



The debate continued« The gover nment in US convinced the nation

that the social security in the countr y shouldbe privatized

In the year 1999 , they went ahead andgave up all the safeguards that the Glass-Steagall Act had put together lear ninglessons from the Depression of 1929 toseparate investment banks and commercialbanks .



Soon the bankers realized thoughquite late that they had over-borrowedand they had no reserves to fall backon

Growing credit losses anddelinquencies have caused the banks

to tighten credit standards The businessmen found that it was

becoming difficult to get loans



The bail out plan ± Is it the

right move ?? The moral hazard ± The gover nment µs

support in such a situation will remove

limitations on future risk takings It will look like a free -for -all and make

the risk look like child¶s play

The philosophical role ± Raise questions about the functioning

of a free enterprise



The Priority ±The Question of Moral Hazard

or Preservation of the Society

and the System



The decisive force What if the gover nment always comes

to the rescue when the chips are down

What does it matter if one puts thesystem over the edge ---

So long as ¶ UNCLE S AM µ will take

care Could any individual pass up those

kind of opportunities???



Then what next ? The conflict of interests can be

avoided by refusing to bail out the risk

± takers Let the financial miscreants squirm in

their own juice «.

This can provide satisfaction to themoralists

But , is life so simple ??



The Bail Out The bail out costs $700 billion

It contemplates the creation of aspecial entity

It will acquire all the distressed assets

It will recover the costs when theassets are finally sold out atappropriate occasions



The Ripple Effect on the Indian

Economy



Bail Out and the Indian Economy

The Impact Low liquidity in the US will reduce the

capital inflow in India

Reduce access to foreign credit sourcefor the corporates¶

As capital inflow dries up , whether FDI

or F

II , the rupee will drop as dollar supply decreases



The Impact

Import will become costlier and the burden

on the gover nment to maintain subsidies will

increase Tight liquidity position in the Indian mar ket

may require the RBI to ease the constraintson CRR

Decline in the crude oil price does notmitigate the situation as the price that theconsumer pays has not shown any change



Should reforms be eased in India ??

Should the RBI ease up on financialreforms ?

Should further liberalization of FDI norms be considered for the insurer ?



The well placed regulator y system in India

NP A¶s a t an appropriately low level

Commercial banks with distinctcharacteristics

The regulation laid by the RBI reposesfaith and confidence

This is necessar y for social andfinancial inclusion in the countr yside



Message to take away

Mar kets have a tendency to µfall¶ since timeschange and behavior changes too

When the mar kets show signs of weakness ,gover nments must be ready to intervene

A wise gover nment must have the disciplineto leave the mar kets alone when they are

wor king fine and vice versa . Innovation for the sake of innovation should

definitely be avoided



Names to remember in the USCrisis

Alan Greenspan ± Head of the US centralbank form 1987-2006

Henr y Paulson-Current Secretar y of the USTreasur y ( the head of Goldman Sachs for many years )

Mr Warren Buffet head of Ber kshire

Hathway, who said ,´I told you so long ago ³The war ning about the slide of the dollar and serious consequences for the economy

The Bubble That Burst -Usa

Documents

Transcript of The Bubble That Burst -Usa