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Agenda
Subprime
•Traditional Model Vs Subprime Model
•Players in the Game
Bubble
•Housing Bubble
Why it burst?
Global Crisis
Impact
Events
Bailouts
What Next?
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Subprime
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Traditional Model Vs Subprime
Model
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Players in the GAME
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Players
Player 1: Fed
-- Fed kept the interest rate low during much of 1990s
and particularly 2001-2005 (low oil prices, and low
inflation prompted the policy), fueling the market
-- During the 2001-2005, FFR was in the 1% to 3%
range, and mostly in the 1% range
-- Fed encouraged more risky ARM lending
(Greenspan)
Player 2: Mortgage Salespersons
-- Worked on commission based on the number of
arms successfully twisted
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Contd..
Player 3: Primary Lenders
-- No incentives for judicious lending
Banks no longer needed to hold on to the mortgage,
as use of mortgage-backed securities made risk
taking more appealing
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Contd..
Player 5: Credit rating Agencies and Analysts
-- Lack of market for many of these securities, so
models were used to price them
-- Inflated ratings, mostly in A range (similar to T-Bills)
-- Conflict of Interest: Investment bankers’ analysts
were rating investment bankers’ clients (scandal)
-- For example, 3 months prior to its demise, AIG was
rated strong buy (8 analysts), buy(3), hold (10))!!!
Player 6: Home Buyers (Taking Excessive Risk)
-- Home buyers were enjoying the ride
-- New ones were joining the ride, even if unqualified
-- Home ownership up from 60% in 1990s to 70%
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Bubble
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Historic Bubbles
Dutch Tulip Mania (1630s)
South Sea Bubble (1710s)
British Railway Bubble (1840s)
US Railway Bubble (1880s)
Roaring Twenties (1920s)
Multi Bubble (1960s)
Internet Bubble (1990s)
Housing Bubble (2000s)
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Structure of a Bubble
Displacement (diffusion of new technology starts)
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Population Dynamics in the Course of
a Bubble
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Housing Bubble
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Why housing bubble
burst????
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Process of Securitization
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Recap: Causes
Boom and bust in the housing market
Securitization practices
Speculation
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Contd..
Inaccurate credit ratings
Government policies
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How did this turn into a crisis ?
Step 1 - The housing boom in the US started fading out in 2007
Step 5 - These borrowers were no longer able/willing to pay high price for a house
that was declining in value
Step 6 – Security/Guarantee being the house being bought , this increased the
supply of houses for sale while lowering the demand, thereby lowering prices
even further and setting off a vicious cycle
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Ripple Effect-Suck Everything
The housing bubble
Banks go belly-up
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Impact
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Banks Writedown($ billion) Actions
Citigroup 55.1 Bailout by Fed Reserve($326 billion)
HSBC 27.4
15000
10000
5000 17th Jan' 2008
25th Nov' 2008
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Indices
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List of events
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Date Events
16th September Reserve Primary Fund “breaks the buck” U.S. government seizes
control of AIG in $85B bailout
18th September Treasury Secretary Paulson announces bailout plan
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Date Events
25th September Washington Mutual is seized by FDIC; assets sold to JPMorgan for
$1.9B
900
800
700
600
500
Expon. (Series1)
400
300
200
100
0
savings and loan crisis(1986- Banking crisis(1990-99) Banking Crisis(98-99) Subprime crisis(2007-present)
95)
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IMF raises the loss amount to
1.4 trillion dollars
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Country wise Action
United kingdom
Has lined up a $850-billion rescue plan, May nationalise Royal Bank of Scotland
Will recapitalise banks by up to $88 billion. Abbey, Barclays, HSBC, Llyods, Standard
Chartered, HBOS and Nationwide Building Society can draw from an aggregate of $44
billion to boost their Tier 1 capital
The government will guarantee $439 billion worth of short-and-medium term debt
Alarm: The total liabilities of Barclays of £1,300 billion (leverage ratio of over 60),
surpass Britain's GDP
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Contd..
Belgium
The government took partial control of the struggling Fortis Bank
Alarm: Fortis Bank's liabilities are several times larger than the GDP of Belgium
(leverage ratio of 33)
Iceland
The government has nationalised three of Iceland's biggest banks
Germany
Has organised a credit lifeline of euros 35 billion for blue-chip commercial real estate
lender Hypo Real Estate Holding
Alarm: The total liabilities of Deutsche Bank (leveraging ratio of over 50) amount to
2,000-billion euro, which is more than 80 per cent of the GDP of Germany
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Contd..
Singapore
Eased monetary policy for the first time since 2003 after sinking into its first
recession in six years, hit by the meltdown in financial markets
The government revised its 2008 growth forecast to around 3 per cent from an
earlier estimate of 4 to 5
Italy
UniCredit Bank has announced plans to raise its capital ratio by spinning of
property assets
Ireland
Has guaranteed all bank deposits
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Contd..
Spain
Will spend 50 billion Euros ($68 billion) to buy bank assets, almost a third of the
proposed 2009 central government budget
Japan
Yamato Life Insurance failed with $2.7 billion in debt
Alarm: Real estate companies are folding up, forcing regional banks to
raise reserves against bad loans
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Bailout Ben
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Rationale for the Bailout
Stabilise the Economy
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Now What???
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Liquidity Crunch
The reduced availability of liquidity
Interest rate premiums
U.S.: Banks not lending to each other
ROW: London Interbank Offered Rate (Libor)
Libor is used to set rates on the $360
trillion of financial products worldwide.
Three month Libor set an all time high last
week at 5.34%.
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Overview of Credit Exposures and Estimated Losses
(September 2008; billions of US dollars)
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Is Depression Imminent:
During the Great Depression
Combined GDP of 7 largest economies dropped by
20%
during 1929-1932
There were no deposit insurance, so people withdrew
money from banks and many banks failed
Fed increased interest rate (!!) and reduced liquidity
U.S. imposed heavy tariffs and other countries
reciprocated lowering world trade by 70%