1 Sub-prime is a financial term that denotes financial institutions providing credit to borrowersdeemed sub-prime (sometimes referred as under-banked). Sub-prime borrowers have aheightened perceived risk of default, those with a recorded bankruptcy or those with limiteddebt experience. Sub-prime lending means extending credit to people who would otherwisenot have access to the credit market

Robert J. Shiller, The Subprime Solution, Princeton: Princeton University Press, 2008,

2 Securitisation is a structured finance process, which involves pooling and repackaging ofcash flow producing financial assets into securities that are then sold to investors. Securitisationmeans turning something into a security. For example, taking the debt from a number ofmortgages and combining them to make a financial product which can then be traded. Bankswho buy these securities receive income when the original home-buyers make their mortgagepayments.

(iii) Excessive Leverage1The final problem came from excessive leverage. Investors boughtmortgage-backed securities by borrowing. Some Wall Street Banks hadborrowed 40 times more than they were worth.17 In 1975, the SecuritiesExchange Commission (SEC) established a net capital rule that required theinvestment banks who traded securities for customers as well as their ownaccount, to limit their leverage to 12 times. However, in 2004 the Securitiesand Exchange Commission (SEC) allowed the five largest investment banks– Merrill Lynch, Bear Stearns, Lehman Brothers, Goldman Sachs and MorganStanley – to more than double the leverage they were allowed to keep ontheir balance sheets, i.e. to lower their capital adequacy requirements.The Basel-II framework evolved by the Bank of International Settlements(BIS) in 2006 sets a CRAR of 9 per cent for adoption by banking regulatorsglobally. However, at the end of the year 2007, the Federal National MortgageAssociation (Fannie Mae) and the Federal Home Loan Mortgage Corporation(Freddie Mac) had an effective leverage of an astounding 65 times and79 times, respectively. And the leverage ratio for the big five investmentbanks at 2007 year end was 27.8 times for Merrill Lynch, 30.7 times for LehmanBros., 32.8 times for Bear Stearns, 32.6 times for Morgan Stanley and26.2 times for Goldman Sachs. These investment banks had become thereference point of excessive leverage.

This was far too risky. The system went into reverse gear after themiddle of 2007. US housing prices fell at their fastest rate in 75 years.Sub-prime borrowers started missing their payment schedules. The banksand investment firms that had bought billion of dollars worth of securitiesbased on mortgages were in trouble. They were caught in a vicious circle ofcredit derivative losses, accounting losses, rating downgrades, leveragecontraction, asset illiquidity and super distress sale of assets at belowfundamental prices causing another cascading and mounting cycle of losses,further downgrades and acute credit contraction. Initially started as a liquidityproblem, it soon precipitated into a solvency problem, making them search forcapital that was not readily available. Bear Stearns was sold to the commercialbank J.P. Morgan Chase in mid-March 2008; Lehman Bros filed for bankruptcyin mid-September 2008; Merrill Lynch was sold to another commercial bank,Bank of America and finally Morgan Stanley and Goldman Sachs signed a letterof intent with US Federal Reserve on September 22, 2008 to convert themselves into bank holding companies. The year 2008 will go as the worst year in the history of modern finance wherein the sun of powerful and iconic Wall Streetinvestment banks set in.

1Leverage means borrowing money to supplement existing funds for investment in such a waythat the potential positive or negative outcome is magnified and/or enhanced. It generallyrefers to using borrowed funds, or debt, so as to attempt to increase the returns to equity.

(iv) Misleading judgements of the Credit-Rating Organisations-

The role of the Credit-Rating Organisations (CROs) in creating anartificial sense of security through complex procedure of grading hadcontributed to the financial mess. The giants of credit rating agencies likeStandard and Poor (S&P), Moody’s, Fitch had dominated the global ratingsmarket for a long time. They were the agencies which had been deemed bythe US capital markets regulator Securities and Exchange Commission (SEC)as Nationally Recognized Statistical Rating Organisations (NRSRO). AsNRSROs, these CROs had a quasi regulatory role and were required todisclose their methodologies. But, these credit rating agencies used poorlytested statistical models and issued positive judgments about the underlyingloans. No safeguards were put in place for assembling an appropriateinformation system to deal with the delinquencies and defaults that mighteventually arise.

(v) Mismatch between Financial Innovation and Regulation

It is not surprising that governments everywhere seek to regulate financialinstitutions to avoid crisis and to make sure a country’s financial systemefficiently promotes economic growth and opportunity. Striking a balancebetween freedom and restraint is imperative. Financial innovation inevitablyexacerbates risks, while a tightly regulated financial system hampers growth.When regulation is either too aggressive or too lax, it damages the veryinstitutions it is meant to protect.

(vi) Failure of Global Corporate GovernanceOne of the reasons for current crisis in the advanced industrial countriesrelated to the failures in corporate governance that led to non-transparentincentive schemes that encouraged bad accounting practices. There isinadequate representation and in some cases no representation of emergingmarkets and less developed countries in the governance of the internationaleconomic institutions and standard setting bodies, like the Basle Committeeon Banking Regulation. The international economic organization such asIMF has been wedded to particular economic perspectives that paid little attention to the inherent risks in the policies pursued by the developedcountries.

RESULTS

Layoffs & Job Cuts

Financial institution lossBanks Loss Banks LossAmerica Out of AmericaUBS AG $37.7 bln Deutsche Bank $11.2 bln

Citigroup $39.1 bln Mizuho Financial Group $5.5 bln

Merrill Lynch $29.1 bln Crédit Agricole $4.8 bln Morgan Stanley $11.5 bln HSBC $17.2 bln Freddie Mac $4.3 bln Royal Bank of Scotland $15.2 bln Bank of America $7.95 bln Credit Suisse $9.0 bln JP Morgan Chase $5.5 bln Swiss Re $2.04 bln

Lehman Brothers $3.93 bln LBBW $1.1 bln

CIBC $3.2 bln Société Générale $3.0 bln Bear Stearns $2.6 bln BNP Paribas $0.870 bln Washington Mutual $2.4 bln Barclays Capital $3.1 bln

Goldman Sachs $1.5 bln BayernLB $6.7 bln

American International Group $11.1 bln Commerzbank $1.1 bln

Reducing dividend payouts to increase liquidity and further

Selling record amounts of bonds and preferred stock to obtain cash in the short-run

Banks harden loans policy.

Restrict loans conditions.

Stopping subprime loans

Improve supervision

What did Bank do?

Slowing GDPIn the past 5 years, the economy has grown at an average rate of 8-9 percent.Services which contribute more than half of GDP have grown fastest along withmanufacturing which has also done well. But this impressive run of GDP ended in the firstquarter of 2008 and is gradually reduced as the economy was slowing.

The most immediate effect of that crisis on India has beenan outflow of foreign institutional investment from the equitymarket. Foreign Institutional Investment (FIIs), which needto retrench assets in order to cover losses in their homecountries and were seeking havens of safety in an uncertainenvironment, have become major sellers in Indian markets.As FIIs pull out their money from the stock market, the largecorporate no doubt have affected, the worst affected waslikely to be the exports and small and marginal enterprisesthat contribute significantly to employment generation

Reduction in Import ExportGlobal recession affects the import export business severely. In New Delhi area,nearly 125 companies survey report shows that in Aug 08 to Oct 08 1792 cr. Exportorders lost which resulting 65000 people lost their employment. This can be elaboratedby the following table.

INDIAN STOCK MARKET

. Reduction in EmploymentEmployment is worst affected during any fiscal crisis, so is true with the current

global meltdown. This recession has adversely affected the service industry of India

mainly the BPO,KPO,IT companies etc. According to a sample survey by the commerce

ministry, 109,513 people lost their jobs between Aug 08 and Oct 08 in export related

companies in several sectors primarily textiles, leather, engineering, gems and jewellery,

handicraft and food processing.

TaxationThe economic slowdown has severely dented the Center's tax collection withindirect taxes bearing the brunt. The tax-GDP rate registered a steady increase from8.97 percent to 12.56 percent between 2000-01 and 2007-08. But this trend has beenreversed as the tax-GDP ratio has fallen to 10.95 percent during current fiscal yearmainly on account of reduction in customs and excise tax due to effect of economicslowdown.In comparison to the advanced market economies which are on the verge ofrecession, the rapidly globalizing emerging economies have been far more resilient anddynamic - India being one among them. In the post-reform period, India stands as aneconomy that is rapidly - modernizing, globalizing and growing. India is poised as a fastgrowing emerging market economy in the face of the current turmoil and pessimism. Theresilience shown by India comes from the strong macroeconomic fundamentals. Indiahas weathered the storms of the recent financial market crisis with great strength andstability. India flouts a robust GDP growth rate of almost 9.0 percent in the midst of allinternational economic mayhem. The household sector is coming to prominence withimpressive contribution in the national pool of savings. Rising investment levels and improvedproductivity are the engines driving growth. Indians have witnessed a doubling of averagereal per capita income growth during the tenth plan period.

HOW TO TACKLE RECESSION?

The following measures can be adopted to tackle the recession:

1. Tax cuts are generally the first step any government takes duringslump.2. Government should hike its spending to create more jobs andboost the manufacturing sectors in the country.3. Government should try to increase the export against the initialexport.4. The way out for builders is to reduce the unrealistic prices ofproperty to bring back the buyers into the market. And thusraise finances for the incomplete projects that they aredeveloping.5. The falling rupees against the dollar will bring a boost in theexport industry. Though the buyers in the west might becomescarce.

6. The oil prices decline will also have a positive impact on theimporters.India has adopted certain measures to combat recession. SinceOctober, 2008 The Reserve Bank of India has cut the repo rate andthe CRR by 350 and 400 basis points respectively. The reverse reporate has been cut by 200 basis points over the same period. This inturn has made credit cheaper and has increased the overall liquidity inthe system. Further, the PSU banks of the country have decreasedthe home loan rates. This is expected to induce more buyers andboost the real estate sector. In addition to this government hasproposed to cut service tax and excise duty on most goods.

Thank you