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CRISIS ON THE STREET

Historical regularity

T.Ramaswamy

Returning Home

J
O
B
S

The Emerging landscape


BUBBLES, PANICS FROM THE PAST
Tulip-Bulb The South
Bubble of 1634 Sea Bubble:
A virus caused tulips to develop stripes. Tulips were in high demand and some sold
houses to buy them.

Half lb Witte Croonen 64 guilders to 1668 in Jan 1637 and back to 37 in 1642. Bulb
prices collapse and then Holland goes into a recession.

Many small investors were highly leveraged to buy tulip bulbs, and many loans were
defaulted on. The small investors ended up being hurt the most.
In 1711 The South Sea Company stock price soared. New companies went public and
enjoyed immediate stock inflation as the public poured in money.

“The South Seas Company” saw their stock rise from 55 to 1,000
and Directors sold all their stock. The stock plummeted.
The small investors ended up being hurt the
most.
Newton was one of the losers in the South Sea Bubble
“I have learned to predict the movement of celestial bodies but not the
movement of man in markets.”
OVERCONFIDENCE
MARKET CRASH OF 1929

Margin purchases

Buying on credit

Investment Pools

Build group Heavy Credit fueled speculation during


Trade stock amongst selves
the 1920s brought a chain reaction of
Release good rumors about the
farm foreclosures and bank failures
stock when agricultural prices fell
Start a stampede, then
Landget out in Miami for around $800,000 in 1923 could be sold
bought
Florida in 1924 for twice the price.
Next year, that land could be sold for $4,000,000. One third of the
Miami population became real estate agents and the bubble
collapsed.
The small investors ended up being hurt the most.
Japan's Burst Bubble BIS on crisis in Japan
$ 3 TRILLION IN Aggressive Financial
BAD DEBTS Institutions
Protracted Monetary easing
JAPAN'S ECONOMY
SUFFERED THE “LOST Policies causing rise in land
DECADE prices
Overconfidence and Euphoria
• Land prices double from
1987 to 1990 ALL A BUBBLE
– Total land Japanese land value is 3
• Nikkei 225 stock index
times greater than the US
– Doubles from 1983 to 1986
• Higher land prices lead to
– And from 1986 to 1989
higher stock prices
– 10,000 in 1983,
20,000 in 1986, 40,000 in1989

• High stock prices → equity


– Ginza district land is
finance boom
$300,000 per sq meter
– Funds from equity finance →
purchase of more stock and land
ZAITECH-Speculation
Bubble fueled by a Japanese
corporate invention, "zaitech," or
"Financial Engineering,“-
Speculation.
corporations raised funds on the
markets and recycled back into
further speculative market
activities again and again.

Land speculation important part of that


Investors would then rush bubble economy. Banks often accepted
to purchase their stock, property as collateral for loans.
driving prices and
earnings even higher Now, more than a decade later, average
and providing more funds for the Japanese land prices are still falling and
company's speculative actions. banks are only just pulling out of a land-
related bad-loans crisis.
A lot of similarities in the Dow 1929-32
Nasdaq 2000-02 & Japan 1980-90

1929-32: Total drop 77% Painful memories


Japan: Total drop 63% Plus land last a generation
2002: Drop off peak
S&P 500: 50%
NASDAQ: 80%

The Dow returned to pre-1929 levels in late 1954

Weekly chart of the Peaks along the X- Axis,


with Y- Axis representing Percentage change
World Output & Trade 1929 & Present Falls compared

Global activity forecast


-1.4 % 2009 & + 2.5 % 2010.
Advanced economies -3.8%
2009 + 0.6 % 2010

World industrial production World trade has stabilised, but


continues to track closely the 1930s these are still following paths far
fall, with no clear signs of ‘green below the ones they followed in
shoots’. the Great Depression.
Differences in the debt’s
composition from the 1930s to today

NIGHTMARES FROM
OVERLOADED DEBT
2002-2006: Total Credit
increased by $8T; Mortgage
debt increased 60% to $9.5T
and Subprime debt
increased by $2T when GDP
increased $2.8T

Household Sector Debt: 125% of


GDP

Household borrowing
(flow) peaked at 15%
of Disposal Income

For bottom half of income


distribution, debt doubled from
’92 to ’04, to almost 100% of
income

Debt Almost 350% of GDP


2.1T$
Japan’s “Bubble Economy crisis”
• ” a precursor to Subprime Crisis
– Debt-financed speculative bubble Japan Debt to GDP
GDP Ratios
Ratios
– Burst end-1989 300
200
130

– Two decades later, still in low level Government


Private
Private
Depression Aggregate Debt
– Government debt far higher, 120
150
private debt slightly lower… 200
• But economy still mired in 110
economic slump

Percent
100

100
100

50
90

$ 6.3T
800
1970
1970 1975
1975 1980
1980 1985
1985 1990
1990 1995
1995 2000
2000 2005
2005 2010
2010

• Can’t “pump prime” way out of debt crisis


that simply swaps public debt for private
Debt should never have been issued in
the first place
• "We've passed through an era of
profound irresponsibility. We cannot go
Aggregate losses of japanese banks to the kind of risk-taking that leads to
30% of GDP BUBBLES THAT INEVITABLY BURST”.
No economic reality for the
boom that Japan had
Questions on the Size of the bubble
&
The capacity to overcome
Size of the Japanese bubble
In comparison
Appears to be much higher

At the beginning of the crisis


Japan had Total Debt to GDP ratio of 260%
US presently has a Total Debt to GDP ratio of over 350%

25% of US public debt is


owed to foreigners
Global Scenario
Contractionary forces are circular self-reinforcing:
• – Loans are going bust
• – Asset prices are falling
• – Credit markets are deteriorating
• – Financial institutions are going bankrupt
• – Business and consumer confidence is deteriorating
• – Demand is declining
• – Production is plunging
• – Job losses are rising
• – Economy is shrinking
World trade is projected to contract by 9.0 per cent in 2009
Global GDP is projected to shrink by 2.9 per cent
All advanced economies – US, Europe and Japan - having gone into recession,
the contagion of the crisis from the financial sector to the real sector has been
dramatically severe.

Russian Economy has fallen into a deep recession. and Russian “ruble”
has lost about 35% of its value against the $ since mid-July.
Recession hard on the Young

•  Young people face the highest unemployment rates of any age


group. 19% of young adults are unemployed compared to only 7% of 30
and over.
•  Young adults are 2.5 times more likely than older adults to have
been impacted by a job loss.
• Thirty percent of young adults ages 18-29 say they or a member of their
family has been impacted by a job loss. Among adults ages 40 and over,
only 12 percent report a job loss in the household.

•  More young people face cuts in wages or work hours than older
adults, especially if they hold part-time jobs.

Young adults carry increasingly large amounts of debt with 37 %having more than
$5,000 in debt, over mortgages and student loans.
 Young adults are among the least likely to have health insurance – now job loss
is causing even more to lose coverage.
 Young adults are making choices, in response to their economic challenges,
that have long term consequences such as delaying school or marriage.
Could Japan loose
Another decade

Cumulative losses 15 T $
Length of US Recessions,1929-Present*
Japan GDP figures 1st Q 2009 are the worst ever - an
annualised plunge of more than 15 per cent, USA
worsened from -3.8% to -6.1%
50 Months in Duration Current recession began in
45 43 Dec. 2007 and is already the
40
“We will rebuild. longest since 1981. It is now
35 We will recover.”-- also the longest recession since
30 President Barack Obama the Great Depression.
25 addressing a joint session
20 of Congress 18
OIL SHOCK
16 16
15 13
February
11 10 24, 2009
10 11
10 8 8 8 8
6
5
0
Aug. May Feb. Nov. July Aug. Apr. Dec. Nov. Jan. Jul. Jul. Mar. Dec.
1929 1937 1945 1948 1953 1957 1960 1969 1973 1980 1981 1990 2001 2007

* As of May 2009, inclusive Economic Research; Insurance Information Institute.


S&L Crisis
• The US market which peaked earlier in the decade
at 17 plus million units per annum is now down to
an annualised rate of 9.5 million units
• Sales have fallen by almost 40 percent since 2008
and are now less than sales in the Chinese market
• March Unemployment in US Increases to 8.5%

Joseph Tainter/Colin Renfrew


How societies choose to
Fail or succeed- The collapse of complex societies
J Diamond
Elites
Under stress complex societies
Insulate
lack the option to diversify,
Themselves
Often minor reasons
cited that appear
insufficient to cause
Complex societies rose rapidly, flourished for major effects like
some time and came to a rather sudden end- collapse
Examples
(old) Egypt 2500 BC invasions? Underlying reason is change in
Akkad 2200 BC environmental? structure
Harappa 1800 BC environ. /Aryans?
Minoan Palaces 1400 BC vulcanoes? „Evolution“ of a society
Hittites 1200 BC „barbarians“? – steady increase
Classic Maya 800 AD environmental? of complexity
Anasaz 1300 AD environmental Initially: Strong growth, large
rewards for early complexity
Mesopotamia, “Cradle of Civilization” Saturation, marginal
benefit
(Modern Iraq: Assyrians, Babylonians, of complexity decreases
Sumerians- 6000 BC – 500 BC. Mineral Reserves depleted,
salts from repeated irrigation, no crop
rotation decimated farming by 2300 BC). makes society prone to collapse
Fertile no more.
Is societal collapse a possibility?
Environment + Economics =Tipping Point
(It wouldn’t be the first time!)
• “...what is perhaps most intriguing in the
evolution of human societies is the
regularity with which the pattern of
increasing complexity is interrupted by
collapse…” (Joseph Tainter 1995, The Sustainability of Complex Societies).
Atmospheric Carbon Dioxide:A 30% Anthropogenic Increase in
a Century
•Extra resources produces diminishing returns.
•Then negative returns.
•Along comes a systemic shock.
• Shock might be internal (resource exhaustion)
•Or external (foreign war).
•And the shock triggers collapse.
•When collapse occurs, it almost always
occurs rapidly.
•Things decay to a lower state of complexity.
Why do some societies make disastrous decisions?
• Failure to anticipate
• Failure to perceive that a problem has arisen
• Rational bad behavior (ISEP-It is somebody else’s problem)
– Conflicts of interest between elites and the masses
• Disastrous societal values
– Religion
• Irrational failures
• Unworkable solutions
• Poor leadership
– Isolated elites
• An in-built capacity of human brain/mind system
• ‘An act or the power of foreseeing, prescience’
• ‘An act of looking forward, a view forward’
• ‘Action in reference to the future, prudence’
What is Foresight?
The Ultimate Driver: The Second Law of
Thermodynamics

• Any spontaneous change in an isolated


system reduces its potential and
increases its entropy.
• The same basic forces apply to the
Michio Kaku ECONOMY.
Hyperspace: a Scientific
Odyssey Through Parallel • Degradation is the primary process in the
Universes, Time Warps, universe.
and the 10th Dimension,

Status of the Second Law


• “[Thermodynamics]…holds the supreme position among the
laws of nature… (Sir Arthur Eddington).

[Thermodynamics] is the only theory of a general nature of which I am


convinced that it will never be overthrown” (Albert Einstein)
Extreme Future
More risk more opportunity

International
Innovation Index
Led by
USA,
Japan

Juan Enriquez: Tech evolution will eclipse the financial crisis


Engineering of Cell, Tissues, Robots, Nano Technology, will drive
Technology accounts for one-half of output (GDP) growth in all industrialized nations
March 2009

US research has found that:


– A third of US output growth stems from productivity enhancing
innovations at the workplace level (Sandra Black & Lisa Lynch on
organisational innovation and productivity, 2001, 2004)
– When employees are highly engaged, their companies achieved 26%
higher labour productivity, lower turnover and 13% higher returns to
shareholders over last 5 years (Watson Wyatt WorkUSA Survey
2008/09)

The global financial crisis changes everything...


But for innovation and skills, it changes nothing.
Our challenge is to link short-term fiscal stimulus to longer term
competitive advantage.
Jim Carroll - Innovators get out in front of the recession

65% of the children


In Kindergarten
today will
WORK IN JOBS
THAT DO NOT
EXIST YET

VIJAY GOVINDARAJAN -World's leading expert on strategy and innovation


In these troubled times, innovation is more critical than ever because
it paves the way to increased profitability, business solutions and growth.
Innovation: Key driver of
GLOBAL GDP
Labor Hours/ What Is Increasing Productivity?
Vehicle
Recession is above us
Innovation is within us
Future is ahead of us
• Ford
– 35.79 hours
• Daimler/Chrysler
– 33.71 hours
• GM
– 33.19 hours
• Honda
– 32.51 hours
• Toyota
– 29.4 hours
• Nissan
– 28.46 hours

Source: Detroit Free Press, June 2, Source: 2005 National Innovation Survey, Council on
2006 Competitiveness
EXPONENTIAL DRIVERS

NO HISTORICAL LIMITS
Moore’s
Law In 1965 Gordon Moore, co-founder of
Intel predicted that the number of
transistors per integrated circuit would
double every 18 months

Integrated circuit
is a miniaturized
electronic circuit
of semiconductor
embedded in the
substrate of
semiconductor

PLICATION: Price performance of computing will continue to


improve exponentially
COMPUTING+ COMMUNICATION TECHNOLOGIES=MOBILE
INNOVATION LEAPFROGS WITH CONVERGENCE

India World No 2- 441 M


Theoretical Foundations-
CONVERGENCE
Radio CC:
Phone-1900’s Game theory, Network algorithms Scale,
complexity, interactivity Network design
Internet Algorithms, Social Computing Reliability Security, privacy, intrusion
Computer Networks detection

CSP:
Signal processing for wireless
Analog Communications Multimedia signal processing
Phone -1983
Collaborative/distributive signal
processing Hybrid networking
CC
CCSPCSP …
Computing
Signal ProcessingCCSP:
Power efficiency Computation versus
communication tradeoff compression,

Operations research
Physical, Biological, Social Sciences
A Few Tech Capacity Growth Rates Are Almost Independent of
Socioeconomic Cycles

• There are many natural cycles: Plutocracy-


Democracy, Boom-Bust, Conflict-Peace…
• Ray Kurzweil first noted that a generalized, century-
long Moore’s Law was unaffected by the U.S. Great
Depression of the 1930’s.
The key issue for the 21st century
Sigma curve vs. exponential
growth
The exponential
growth of computing
Intergated
goes back 100 years Circuits (2D)
– 5 paradigm
shifts so far Discrete
Paradigm shifts transistors
keep exponentialVacuum
growth going tubes

Relay based
computers

Electromagnetic
calculator
DISRUPTIVE Fundamental Drivers of Convergence in
TRANSFORMATION computational acceleration
• Moore’s Law:
• Doubling of processing power every 18 months at same cost.
• Metcalf’s Law:
• Value of a network increases geometrically as the network
endpoints increase.
• Reed’s Law:
• The utility of large networks, particularly social networks, can
scale exponentially with the size of the network.
• Market Law:
• As competition increases, industry players with appropriate
Scale will innovate and drive consumer costs down.

Convergent and predictable developmental forces


Contingent and unpredictable evolutionary choices we may use
to create unique and creative paths
Increasing intimacy of the human-machine
and physical-digital interface.
Creative networks seed
disruptive transformation by
QUANTUM LEAPS

Living in times of exponential change


• Over 7 billion searches on Google / month
• Number of SMS text messages sent daily > 12 BN,
Pager > 3 BN when ( world’s population 6.7 billion, 2007)
“Convergent Evolution”:
Troodon and the Dinosauroid Hypothesis

Dale Russell, 1982: Few


dinosaurs developed bipedalism,
binocular vision, complex hands
with opposable thumbs, and
brain-to-body ratios equivalent to
modern birds. They were
intelligent pack-hunters both
diurnally and nocturnally.
Dominant planetary species had
superior intelligence, hunting, and
manipulation skills lost with the K-T
event 65 million years ago.
Disruptive innovation/Transformation
improves a product or service in ways
that the market does not expect
BPR
Networking drives Innovation Six Sigma
at all stages in the value chain Supply Chain

CREATOR, CONNECTOR, DOER, DEVELOPER


Creator - “Gets it out ” Connector - “Gets it together ”

• Finds and digs for opportunities • Translates vision into options,


• Sees the need and initiates solutions
• Sometimes jumps from ‘Create ’ to • Connects the dots

Focus onabstractthinking/processes
‘Do ’ • Planning, Policy & Research,
• Traditional role of politicians and Scientist
senior management but can be • Learns by thinking
Focus o

anyone
‘r
nea’e
l xperiences

Doer - “Gets it done ” Developer – “Gets it better ”

• Delivers, makes it happen, gets it • Gets it ready to go, makes it work


done • Engineer, IT Developer,
• Project Manager, Front -line Accountant, HR
staff, Enforcement • Learns by thinking
• Learns frompractical experience • Developers think “creators not
• Doers and Connectors are focused ”
opposites • Creators: “Developers don ’t see the
big picture

ModernizationDivisionIMinistryofGovernmentServices
Duck-rabbit optical illusion . A
paradigm shift could cause same
information to be seen in a different way.

LAW OF ACCLERATING
RETURNS

Technological change is
exponential and this
century may see more like
20,000 years of progress.
Within a few decades,
machine intelligence will
surpass human
intelligence,
15 separate lists of key events in human history show an
exponential trend on a logarithmic graph. Clear trend of
SMOOTH ACCELERATION of change and
complexity through biological evolution and then
technological evolution. QUANTUM LEAPS
Q
U
A
N
T
U
M
We tend think of a But we are doubling our
future period at rate of progress every
today’s rate of ten years…
progress…
So in this century we will
our memories are experience 20,000 years of
dominated by progress at today’s rate.
DARPA Accomplishments-Father of Internet

1960
UCAV Global Hawk
Saturn Vela
Hotel

Ground
1970 TMR MEMS
Surveillance Radar ATACMS 2000

JSF
M-16 Rifle MALD
JSTARS

1980
Uncooled IR
Stealth Fighter Arpanet 1990 BAT

Sea Shadow GPS Taurus Launch Predator


Vehicle
Defense Advanced Research Projects Agency
(DARPA)
Explores quantum biology
Quantum mechanics and IT
Faster, more powerful computers,
next-gen radars and radios, and
encryption that’s all-but-impossible to break

"QuBE," "Quantum Effects in Biological Environments."


Scientists have recently discovered that
quantum energy transfers allow plants and cynobacteria
to convert sunlight into chemical energy nearly instantly,
and with almost 100 percent efficiency.
INNOVATION TAKING QUANTUM LEAPS
S “I set the date for the
I
N Singularity- representing a
G profound and disruptive transformation in
U human capability- as 2045.
L
A The nonbiological intelligence created in
R that year will be one billion times more
I powerful than all human intelligence
T today."
Y
The Singularity is Near, When
Humans Transcend Biology - Ray
Kurzweil (2005)

ACCLERATED
INNOVATION
WEALTH CREATION
Time as a critical success factor IS NOW KNOWLEDGE
DEPENDANT
Know-how-
Information concept concept

knowlege-
concept
concept
net
Computing’
concept
KHC

concept
‘Personal

virtual
agricultaural concept
Change potential

MONEY NC VC
LAND IS WEALTH

IS
WEALTH PC-C

industrial- VC Quantum
Concept Economy
NC KC
PC-C
KHC

1781 1981 1993 1997 1999 2005 time

THE GRAPH FOR CHANGE POTENTIAL WHICH IS INFORMATION &


PC-C = Personal Computing concept; VI = virtual concept; NC = net-concept; KC = knowledge concept; KHC= Know-how-concept

© Wertprozessmanagement/Wirtschaftsinformatik, Universität Innsb ruck


Seite 8
KNOWLEDGE BASED RISES VERTICALLY AT ALMOST 90 Degrees
India’s GDP growth contribution is mainly SERVICES

Services is 54% of GDP


Better understanding of the
“knowledge” economy
WORK ON INTANGIBLES
“Old economy” = tangibles
traditional machines,
production lines etc

Intangibles assets =New


In 2007
Economy
– Know how, Software design
Tangible Assets=Knowledge or Intangible Assets
– Reputation, Brand
– Trust in the company,
– Structure of the company,
– Strategy (balanced scorecards)
– Relations with personnel,
– Relations with clients,

Better understanding
of innovation:
Value of Intangible Assets has increased Relate intangibles to innovation
With Knowledge and Innovation
$3 trillion
missing from
our accounting
of capital stock

NBER paper by
Corrado, Hulten
and Sichel

"Intangible Capital and Economic Growth."

Intangible
Assets
140%>
Tangible
Assets
(70.4%) (60%)
Results for (29.6%) (25%)
(15%)
U.S
Economy, Source: Corrado, Hulten and Sichel (2005)
Basic Determinants of Sources of
Growth/ Growth Accounts Model
Output is key measure of
standard of living

Output is driven by
capital (K)
labor (L)
intermediate inputs (E, M, S)
productivity (LP, MFP)

Capital and labor can by divided


into
quantity
quality/composition

Output increases that


cannot be explained by
these “inputs” are
attributed to multifactor
productivity (MFP)
Even in the Traditional Growth Accounts System the
Knowledge Economy Features Strongly but Unequal
4.0
1980-1995 1995-2004

3.0 The
knowledge
economy
2.0

1.0

0.0

ICT capital (IT hardware, communications equipment)


-1.0
EU15ex USA-SIC Japan EU15ex USA-SIC Japan

Other capital
(plant, Hours worked Non-ICT Capital
machinery, ICT Capital Labour Composition
buildings) MFP
Fast Growing Countries Get Bigger Bang from
Knowledge Economy, Notably MFP
5.0 During the period 1978-04 -Bosworth & Collins
MFP contributed
4.0 3.8% to growth for China
1.6% growth for India
3.0

2.0

1.0

0.0

-1.0
GER ITA LUX DNK BEL FRA AUT NLD SWE UK ESP USA FIN
Hours worked Non-ICT Capital
ICT Capital Labour Composition
MFP
Higher-Order Skills Have Grown in
Importance, Driven by Technological Change

and Globalization

HIGHER PRODUCTIVITY
Means INNOVATION

U.S. Productivity Growth


Has Accelerated,
Increasing Its Lead over
Europe and Japan
Entrepreneurship
& FDI
Follow
High
Productivity
Growth rate of High Tech Exports World exports by type of industry ($ b.)
Higher than any &
Other segment Export growth rates, 1990-2000 (% p.a.)

1800 1990
1600 1995
1400 2000
1200
1000
800
600
400
200
0

RB mnf

Hi-tech
Medium-tech
Low-tech
18%
16% Industrial
14% D eveloping
12%
10%
8%
6%
4%
2%
0%

LT

HT
T
RB
tal

M
d
ar
To

re
im

tu
Pr

ac

High Tech Exports are dependant on


uf
an
M

Productivity & Innovation


Shares of world manufactured exports by technology: note when
RB, MT and LT shares peak (1976 to 2000, %)
35

30 Resource
based
High
25 Medium
Technolo
20
Technolo gy
gy
15

10
International
competitiveness
5
has
Low become
0 an essential
Structural ‘drivers’ of competitive performance:
Technolo precondition
1978

1980

1986

1992

1998

2000
1976

1982

1984

1988

1990

1994

1996
Skills, FDI, domestic technological effort,
gy for growth
ICT infrastructure.
The share of high tech exports
in some OECD countries 1988-2001
In the advanced countries high tech growth export came to
predominate
30
% of total exports of goods USA
Japan
25 United
Kingdom
20 Netherlands
FINLAND
Switzerland
15 France
Sweden
EU
10
Germany
Denmark

0 Norway
1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001

2006 China with 16.9% share (EUR 217 Mn) overtakes US, EU-27
Source: Statistics Finland, according to the OECD product catalogue defined in 1995
In High Technology Exports
GROWTH OF WORLD MERCHANDISE EXPORTS TO GDP
World Exports have on average
grown MORE
THAN
TWICE THE GDP
Growth of Exports has enabled
growth of GDP

High Technology
Exports have been
the fastest
growing segment

• Indeed Value creation is linked to knowledge applied to


knowledge.
•  This new tool of production is more important than
capital and technology because capital becomes less
important than knowledge in the value creation process
India's High Technology Exports is less than 5%

1.2 China’s Exports India’s Exports 175


TN •High Technology •Resource based BN
2007 •Low Technology •Primary products 2008
The Competitive Advantage of Nations
Michael Porter’s competitive advantage model advocated success via
national competitive advantages in firms, clusters, innovative products.

Based on industry case studies in 10 nations, Porter developed


his “Diamond Model” of four key interlinked production
factors. Pro-active governments can stimulate these factors,
but they’re very difficult for firms to duplicate, resulting in
national competitive advantages. For example, outsourcing
occurs because cheap labor is unavailable inside advanced
economies. Ease of technology flows undermine any absolute
and comparative advantages they may have over Third World.

• Factor conditions – created by sustainable,


heavy investments in specialized production
factors: skilled labor, capital, infrastructure
• Demand – domestic pressures for quality
• Related & supporting industries – facilitate
continuous info exchanges promoting
innovation
• Firm strategy, structure & rivalry – firm
organization & nature of domestic rivalries
European Innovation Scorecard

INDIA CAN SCALE WITH INNOVATION


Prosperity depends
on the productivity
with which a nation

uses its
Prosperity
Prosperity
human,
capital, and
natural
Productivity
Productivity resources.

Innovative
Innovative Capacity
Capacity

Competition the driving force for Productivity- • Efficiency •


Best practices • Creating products and processes • Innovation
World Bank study shows
Unweighted by Population
INNOVATION IN INDIA
Moves up with developed economies

During the period 1993-04 MFP contributed


In growth 4% for China 2.3% for India
China’s
exports
comparable
with those of
mature
economies
REVEALED COMPARATIVE ADVANTAGE
BALASSA INDEX CHINA INDIA
High Tech 1.5 0.2
Low Tech 1.2 2.0
Medium-High 0.7 0.6
India a global innovator for high-tech products and services
is Underperforming relative to its innovation potential—
CHINA ACCLERATES FROM 1999

India’s total exports less than half of


China’s High Technology Exports

China High Tech consists of - Electronics


Telecommunication, Computers-Office Machines
VERTICAL SPECIALIZATION &
PRODUCTION GLOBALIZATION
• Production is now global making recession impact
greater.
• Stage(s) of production to be followed up by another
country (ies).
• World Trade has increased by 30% due to
vertical specialization as per Economist.
Processing trade accounts for 57% of China’s
foreign trade, in 2006 and exports have a high dependency
ratio on imports, especially in Foreign-invested Enterprises
Telecommunication equipment, computer, other electronic
equipment, transport equipment, electric equipment and
machinery, chemicals, metals smelting and pressing, metal
products have vertical specialization beyond 50% in China’s
Exports.
Investment

India 23%

China 44%

Household
Consumption

India 65%
China 41%
Net Exporter, High Investment, Exchange Rate
67000 -100,000 Shops shut in 6 months Exports down 25%

Shoe
factories,
clothing,
toys,
furniture,
Lighting
fixtures
shutting
down,

BANK ASSETS
Than
175%
Of the GDP
FINANCIAL SYSTEM
Oil Shock 1973, Savings & Loans Crisis 1981
Technology bubble of 2000
NO EFFECT ON INTANGIBLE INVESTMENTS

Intel During
chief: Technology
Bubble
Recession
can't Facebook
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GROWTH IN KNOWLEDGE ECONOMY


RECESSION PROOF
China is supported by a three-legged stool,
but two legs are now broken- Hard landing
• China’s economic growth is supported by three primary legs:
• Export-led growth - US and European cannot consume at the
debt-supported levels they have at the past.
• Real property growth - Rising unemployment, price declines in
real property have slowed sales.
• Government spending -The consensus among economists is “no.”
• And even more worrying, is the belief that Chinese government policy response could
make the global financial crisis worse.

BSE &
Shanghai composite
Compared
China’s Job Bazaar
• About 5,590,000 graduates in 2008
• About 6,100,000 graduates in 2009
• 2008 graduate employment rate was 70%
• 2009 summer most difficult time for Chinese economy.
• In 2009, 24-30 Mn rural migrants look for
employment, alongwith 7 Mn graduates
• In 2009 Guangdong job fair more then 20,000
graduates with Master degree compete for 4,000 jobs
Overcapacity/closure
in several manufacturing industries
China may look to increase
Services sector to GDP beyond 40%
& Compete with India
Upscale
Creativity competencies

AT Kearney ranks India ahead of China,


Czech Republic & Philippines on
attractiveness for Offshore

Can we hold the advantage for long in the competition


NEED to
UPGRADE
SKILLLS

•McKinsey states only 25 per cent of engineering graduates,


•15 per cent of our finance and accounting professionals
•and 10 per cent of professionals with degrees, in India,
•are suitable for working in multinational companies.
Philippines BPO market
Almost equals India’s
BPO market of
USD 13 BN
China Knocking at the door

India has
80 of the
World’s
117
SEI CMM
Level-5
companies
Complimentary vibes

"Asia should not be painted with one brush;


India has separated itself from the pack; it is
not unduly dependent on external demand, and it has an
increasingly powerful IT-enabled, services-led growth
dynamic."

Stephen Roach Chief Global Economist & Managing Director Morgan


Stanley
"India is not just about IT or business process outsourcing.
We see it as an incubator for giant global corporations driven
by IT strategy.“ Prof Warren McFarlan Harvard Business
School
The economic dominance of the US is already over.
What is emerging is a world economy. India is becoming
a powerhouse very fast. I think India’s progress is far
more impressive than China’s.
Peter Drucker Management Guru In Fortune
TURBOCHARGING INNOVATION

INFRASTRUCTURE
INNOVATION SKILLS
I
N
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O I
V N
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T O
I V
O A
N T
I
I O
S N

T I
H S
E
T
K H
E E
Y
K
E
INNOVATION IS THE KEY DRIVER FOR GROWTH Y
Notwithstanding the financial crisis, the United States is the most
competitive economy in the world, a position it has held for several years.
The country has a strong footing to ride out business cycle shifts and
economic shocks.
Competitiveness as
the set of institutions,
policies, and factors
that determine the
level of productivity
of a country.

• Productivity of a country determines its


ability to sustain a high level of income.
• In the long run, standards of living can be
expanded only with technological
innovation.
• Innovation is important for economies as
they approach the frontiers of knowledge
IMD World Competitiveness Yearbook 2008

• United States is first in the rankings, in 2008. In 1989, Japan


was 1 and US 3rd .

Japan’s then competitiveness seemed unassailable, with a strong


domination in economic dynamism, industrial efficiency and
innovation.
Japanese crisis followed a period of economic boom, real estate
price follies and exuberant assets expansion. Liberalization took
place without the appropriate regulatory environment.
Japanese crisis spread from the stock market to real estate and
then developed into a credit crunch and finally into a major crisis
of the financial system. As a consequence, no bank was too big to
fail!. Will this happen to the US?
The US has a few trumps in hand:
the Japanese breakdown of the 1990s
provides some forewarning.
The future belongs to person who has
Large collection of tools/skills to draw

Creativity

Logical Thinking

Abstract thinking.
Demand for mundane is diminishing

Thinking and understanding about


complex things in simple ways.
Rudich www.discretemath.com
Bisociation-The idea accelerator

Convergence
of seemingly
unrelated
concepts
Arthur Koestler "The Act of Creation" used this term to distinguish analogical
thinking that leads to great creativity from the more pedestrian thinking
is called the
The Mathematician’s Mathematician
for 600 conjectures! NEWMAN in M.Klein (Ed.) Math in
the Modern World, 1969. -Now Ramanujan’s work is
applied to Computer Science, Cancer research,
Polymer chemistry, crystallography, string theory etc.

When two seemingly unrelated things are shown to


have unanticipated connections.
Quantum field theory & Topology of 4D diff. manifolds;
K-theory, Diff.Geometry & Elliptic PDE; Wavelets & Data
analysis [genomics], Quantum gravity
Renaissance- a Medici contribution
Leonardo da Vinci, Michelangelo and Raphael

 38% of doctors in the USA


 12% of scientists in the USA
 36% of NASA scientists
Top 5 American employers in India:
 34% of Microsoft employees
General Electric:: 17,800 employees
 28% of IBM employees
Hewlett-Packard : 11,000 employees 17% of INTEL scientists
IBM : 6,000 employees  13% of XEROX employees
American Express: 4,000 employees
Dell At intersection of
: 3,800 employees
fields, disciplines,
150,000 IT pro’s in cultures, you can
Bengalru against combine existing
120,000 in Silicon concepts into a large
Valley. number of extraordinary
new ideas
Synectic Synectic thinking is the process
thinking of discovering the links that
unite seemingly disconnected
elements by using TRIGGERS
1 Subtract 9 Change Scale 17 Prevaricate
2 Repeat 10 Substitute 18 Analogize
3 Combine 11 Fragment 19 Hybridize
4 Add 12 Isolate 20 Metamorphose
5 Transfer 13 Distort 21 Symbolize
6 Empathize 14 Disguise 22 Mythologize
7 Animate 15 Contradict 23 Fantasize
8 Superimpose 16 Parody

Synectics mobilizes both sides


of the brain, the right brain (the dreamer), and the
left brain (the reasoner) by combination and or
Two-way process
Empowerment
of mentoring
Dumbledore: Headmaster

‘Mentor and at Hogwarts.
coach benefit He
from the continually
offers Harry
networking, Potter
sharing of ideas advice and
is a
and interaction. MENTOR

Lifelong to him.

friendship and • Mentoring is a


process rather
betterment. than an event.
• Mentors must see
‘Behind every successful person, themselves as
managers of a
somewhere, somehow, someone process.
cared about their growth and development

Dr Beverley Kaye, Up is Not the Only Way, 1997


PSPD Model
®

Value of Infosys Employee


Around Rs 1 Crore
MENTOR Quality
People
Transparency

Predictability Sustainability
Maintenance Translating clients to partners

Long-term relationship

It is not our Offshore Software


Development Centers
Abilities that
“Our assets show
walk out of the What we are, it is
Our choices Growth
door each
evening.
We have to Higher value services
Exposure limits for client concentration
Increase revenue productivity
make sure that Exposure limit for dotcom businesses
Offshore model - Global Delivery
they come Upsell to existing customers
Exposure limit for opportunity
businesses (like Y2K)
back the next Iterative Model of Development Geographical diversification
morning.”
Profitability De-risking
The consequences of our actions are always so complicated, so diverse,
that predicting the future is a very difficult business indeed.
Enhancing creativity

Task Empowerment
Giving autonomy
Actions Trusting and delegating

Ideas guidance
Exchange Giving resource support for creativity
Giving advisory feedback
Behaviours Giving rewards and recognition for creativity
Giving supportive encouragement to be creative
Not criticizing ideas
Person Having integrity with other’s ideas

Characteristics Social support


Being approachable
Being fun to work with
Being accessible to employees

Creative Orientation
Being Creative
Willingness to Change
Openness to ideas and optimism
Distinguishing characteristic of cubism is the presence of
multiple viewpoints, in physics -coordinate systems
“Cubism” 1905-1939

"I start with an abstraction in order to arrive at


true fact."

Cubist painting
shows the front,
back and side
views of an
object – all at the
same time,
B
Four Kondratieff waves in U.S.
B
U
U
S
S
I US T Bond, US PPI
US Stock-S&P 500 I
N ABX-Mining
N
E
E
S
S
S
S
C
C
Y
Y
C
C
L
L
E
E
S
S

In 1926, Kondratieff published "Long Waves in Economic Life". Report seen


as a criticism of Joseph Stalin's total collectivization of Agriculture and executed.
Existence of 50- to 60-year Business cycles also shown by Dutch economists , J. van Gelderen
and Samuel de Wolff, in 1913.
K-Wave interpretations range from “Evolutionists“, Neo-Marxists and Neo-Schumpeterians
In K Wave Technology & Innovation play a pivotal role
WITH HISTORICAL REGULARITY

Neo-Schumpeterian Economics deals with dynamic processes causing


qualitative transformation of economies driven by the introduction of
novelties.

•It studies innovation and learning behavior on the micro-level of an economy.


•Industry dynamics on the meso-level
•Innovation driven growth and competitiveness on the macro-level of the
economy.
Financial bubbles arise in each period of Technology Revolution
LESSONS FROM THE PAST BUBBLE ARE FORGOTTEN

IMPORTANT we are in it right now?


The world’s best Technology Companies
Like IBM and Cook report speak highly of
Carlota Perez and her works on
Technology and innovation
We have passed through it

Canals Railways Roads Airports

Buckingham
Madras Railway 1954
canal
But history also shows that
EACH MAJOR TECHNOLOGY BUBBLE IS FOLLOWED
BY A GOLDEN AGE

RECOMPOSITION
INSTALLATION PERIOD DEPLOYMENT PERIOD

INSTABILITY
RECESSION
Bubble Golden Age
the five revolutions in parallel

1 Canal mania The great


1793–97British leap

2 Railway mania
1848–50
The Victorian Boom

New frontier
1893–95 The Belle Époque
3 bubbles
(Europe)
The Progressive Era
(USA)

4 The Roaring
Twenties
The post-war
1929–43
Golden Age

5 Internet mania
2001–??
?
Irruption Frenzy Synergy Maturity
COLLAPSE
COLLAPSE
V
US Corporations
W Have lost about
$ 8 trillion value
Since Jan 2008
U
Global equity loss
$17 trillion
L

US Housing market has


Lost $ 6 trillion value
in 2006-08
China’s GDP in 2007 Job losses in 18 months
3.4 trillion 6 Million in US
Around to retire are
The WORST HIT
V U W L-An Answer
• The key question is therefore how long this recession will last? The
blog's research has highlighted 4 main scenarios:

• V-shaped. The optimistic view is that recovery is just round the


corner. But this seems unlikely, given the headwinds of the credit
crunch and looming over-capacity in many key chemical products.

• U-shaped. This is the blog's base case. It implies the recession


bottoms in 2010/11, and then begins to recover. Early decisions to
close high-cost plants, and cancel unnecessary new capacities,
would also be required.

• W-shaped. This is often seen in serious recessions. Severe


destocking leads to an apparent early recovery, as the value chain
restocks. But demand then slips back again, before properly
recovering.

• L-shaped. This is the worst case scenario, as it implies demand


could fail to recover by 2011, and might instead remain at a low
level. This would mirror Japan's experience post-1990.
Clinton administration- Home ownership rate increased 1.94 percent per year
Bush administration- Home ownership rate increased 0.37 percent per year
AND IN THE END A WELFARE PROGRAM ENDED IN A MESS
Loss of manufacturing jobs:
Only in the U.S.?
Manufacturing jobs: 1993
normalized to 100

3m jobs
lost in
the U.S.

It’s a worldwide
phenomenon!
Does the trade deficit cause unemployment?
The New US Economy- The US is now an Unemployment
“information economy” drops

Since
• Manufacturing continues to shrink, while 2000
services continue to grow
• Information sectors comprise over 60% of Trade Before
total GNP value added in the private sector deficit 2000

• • Information services (consumer and expands


industrial) dominate the US economy
Income Concentration Stress-
Incredible greed

Historian Douglas Astolfi sees “Incredible greed"


in three periods. First in the 1870s during a
speculative boom, next the Roaring '20s and
third is in progress

Inequality of Distribution: top 1% and 10% have largest


share since 1928; In 2005 income rose by 9%, but actually fell for bottom 90%
FINANCIAL EXCESSES HAVE CONTRIBUTED TO THIS
The Wealth Concentration Stress
Bubble had been “corrupting” the ethos of Japanese society, therefore excess
must be purged from system.
Specifically, BOJ Governor Mieno Yasushi (from December 1989 till
December 1994) declared that the late 1980s boom had “hastened a decline
in morals”, fostered “inequalities in the distribution of wealth”, and
“undermined the stability…of Japanese society by weakening the
ethos of labor, the notion of working by the sweat of your brow.”
(quotes on p. 132 of Flath)

In 1920 the richest 5% received 30% of the national income down to


15.6% by 1969 and disparity is back. Among the Industrialized nations the US
has the highest concentration of individual wealth-roughly 3 times of Germany.
Casino Capitalism flourishes best with Income and Wealth concentration

The Wealth Concentration Stress


• Wealth concentration in 1929 imposed an
extraordinary stress on the economic
system, a threat not approached again
until the most recent decade

‘Casino capitalism,' an instability a phenomenon which Susan Strange links to five trends:
innovations in the way in which financial markets work; the sheer size of markets;
commercial banks turned into investment banks; the emergence of Asian nations as
players; and the shift to self-regulation
In practice… because of the way society assimilates a
revolution
THE DIFFUSION PROCESS IS BROKEN IN TWO
First 20-30 years Second 20-30 years
INSTALLATION PERIOD TURNING DEPLOYMENT PERIOD
POINT

TURBULENT
“CREATIVE GOLDEN AGE
DESTRUCTION” OF GROWTH
INSTABILITY
AND
UNCERTAINTY Expansion of new
Emergence of the new
and “renewed”
Decline of the old
economy

ESTABLISHMENT FULL FLOURISHING


OF THE NEW OF THE TRIUMPHANT
PARADIGM PARADIGM
modernizing the old and gestation of the next
2000
1971

Time
We are here
The special conditions
for FINANCIAL FRENZY
... EXCITE financial capital
in the Installation Period and ATTRACT
of a technological revolution all available money towards
the technological revolution
The amazing
SUCCESSES
of the new Spectacular
entrepreneur profits Excess demand
s… and growing in the stock marke
capital gains ends up leading to
ASSET INFLATION

The MASSIVE DELUSION


makes many unprofitable
projects appear viable…

ting even more funds and preparing the inevitable c


Genesis of a Crisis
Originate-and-
Distribute
Model Mortgage
Excess Securitization
Global
Mispricing
Liquidity
of Risk
Scant
Regulatory Credit
Oversight Default
Swaps
Rising Real
Estate Prices Deterioration of
Underwriting
Excessive
Low
Standards
Financial
Crisis
Interest Leverage
Drive to Increase
Rates
Investment Returns
© Mauro F. Guillén, The Wharton School.
25 years ago, economists were extolling the virtues of financial deregulation
and innovation; a maverick ( colleagues called him radical to crackpot)
Hyman P. Minsky maintained a more negative view of Wall Street; that
played the role
bankers, traders, and other financiers periodically
of arsonists, setting the entire economy ablaze.
Wall Street encouraged businesses and individuals to take on too
much risk, generating ruinous boom-and-bust cycles. Government to
step in and regulate the moneymen.

References to Minsky’s hypothesis have become commonplace in the


reports of Wall Street analysts.
5 stages of Minsky’s Model of Credit Cycle

Displacement-
when investors get excited about something

Euphoria
Banks and lenders
extend credit to
ever more dubious borrowers,

Boom

Profit taking

And panic.,
A Longer-Term Perspective on Home Prices
Did the origins of the Housing bubble lie
in the Technology bubble
1890=100
220 220
Current
Boom Median
200 200
Home
Price
180 To 180
Great
Depression Median
160 Income 160
World World 1970’s 1980’s
War I War II Boom Boom
140 140

120 120

100 100

80

60 In real terms, the cost of constructing a home


hasn’t1970
1890 1900 1910 1920 1930 1940 1950 1960 really
1980changed much
1990 2000
80
2010in the last 27
years, while home prices, in real terms, have
doubled.
60

Source: Robert J. Shiller,  In 2005, 1,283,000 new single-family houses were sold, compared
2006.
with an average of 609,000 per year during 1990–1995.
How to Recognize a Housing Bubble
• In the long run, house prices nationally have followed inflation
• In the long run, house prices have risen more or less with rents (same market)

CRA

The
Technology
bubble lead to the
Housing bubble ?

Unless some fundamental factor has changed, then the run-up since
1997 is a bubble. Largest home builders, such as D. R. Horton, Pulte,
and Lennar, saw large share prices and revenues in 2004–2005
A bubble or a speculative mania is a trade in high
volumes at prices that are considerably at variance from
intrinsic values

Social psychology factors

Greater fool theory - driven by perennially optimists (fools)

Greed - irrational exuberance of overly bullish investors are


favored by the greed
Herding a self-fulfilling prophecy or bandwagon effect
Wishful Thinking Bias exaggerate that their team/idea will win.
Liquidity - excessive monetary liquidity in the financial system
inappropriate lending standards by the banks,

causes asset markets to be vulnerable to volatile hyperinflation


caused by short-term, leveraged speculation
Financial instability hypothesis:

‘Each stage [of the business cycle]


nurtures forces
that lead to its own destruction.’

Stability accompanied by financial innovation


and reduction in the ‘margin of safety’

•Casino Finance Three cyclical financial states:


Investment strategy
classified as extremely high risk. hedge’,

Using borrowed money (margin) ‘speculative’,
to invest is riskier
because leverage results in amplified and ‘Ponzi’ finance
gains and losses.

Result: Minsky’s “Financial Instability” Hypothesis

Financial Innovation is at the Heart of Economic Change


Linked Innovation of Schumpeter with Keynes Recognition of Business Cycles
Minsky argument
• Financial complexity and fragility increases during periods of stability
• Competition drives both borrowers and lenders to take on more risk
• Financial system dominated by Ponzi finance dependent on rising asset
prices and further borrowing
• Vulnerable to small rises in interest rates
• Credit crunch may be triggered by ‘not unusual event’
Minsky argument
• Crisis creates danger of debt deflation, requiring intervention by authorities
• Intervention to prevent debt deflation leads to appearance of another ‘new era’
• However, it encourages fresh risk-taking which increases probability of
another crisis
• Intervention also raises chances of stagflation

Percentage of Population
Sub Prime
30
FICO<620,
Loan to Value >80% & 27

25 Income to loan repayment ratio >45%

20 18
National
15
Distribution of FICO 15
13
Scores 12

10 8

5
5
2

up to 500-549 550-599 600-649 650-699 700-479 750-799 800


499
Minsky argument: Greenspan reflation
• Federal Reserve has intervened on numerous occasions to prevent a financial
crisis from having ill-effects (e.g. October 1987, early 1990s, LTCM)

• ‘Greenspan put’ encourages greater risk-taking: each of these interventions


created a new source of instability (e.g. junk bond mania, Mexican crisis, tech
boom)

• Fed saw off threat of debt deflation after collapse of stock market bubble in 2002

• Deflation avoided but no return to financial conservatism

• Rising leverage increases risk of another financial accident

FDIC List of Problem Banks


Greenspan & Buffet
When the tide goes out that you
learn who's been swimming naked.

• Greenspan stated: US housing construction with low interest rate would


stimulate other entrepreneurial economic activity and stop the US from sliding
into a recession.
• As predicted : housing construction and prices zoomed upwards, thousands
of new jobs were created and the US growth leapt forward.
• Speculative selling or buying of houses, is not as easy as speculating in
securities. Sellers have to incur substantial transaction costs like brokerage
fees and taxes and these costs act as dampeners to speculation.
• Greenspan overlooked a financial innovation called "mortgage-backed
securities" a type of "derivatives". The burst housing bubble carried "the mess
they created" not only in the United States but also to other parts of the world.

Warren Buffett whose financial acumen Americans respect the most,


described the destructive power the derivatives wield as

“Weapons of mass destruction",


“Contracts devised by madmen"
" Like hell easy to enter and almost impossible to exit."
Minsky argument: supporting evidence
• Stock market bubble
accompanied by record
corporate sector financial
deficit
• Telecoms firms and
dotcoms were ‘Ponzi’
finance units, dependent on
rising asset prices and
access to capital
• When capital markets
closed the bubble collapsed,
triggering a corporate credit
crunch

• The dot-com burst affected


Primarily business capital
spending – which constitutes
10-12% of GDP
• Housing bubble felt in
consumption and construction

accounting for 78% of the GDP Source: Wynne Godley, Levy Institute
(consumption alone is over
70% of the GDP)
Minsky argument: supporting evidence
Rising household sector financial deficit

• Ponzi nation: since the bubble


burst household sector has run
an increasing financial deficit
• consumer borrowing (net new
lending) running at c.15% of
personal disposable income in
2004

Home mortgage debt increased 100%


from 4.9 T in 2001 to 9.8 T in 2007
Minsky argument: supporting evidence

• Household sector’s margin of


safety has declined (Debt
liabilities exceed liquid
assets)
• Balance sheets buoyed by
illiquid residential housing
assets
• Debt-service levels at record
highs despite low interest rates
• Mortgage borrowers turning to
exotic finance: hybrid
adjustable-rate mortgages,
interest-only and ‘pay option’
ARMS.

A household sector where millions of


Source: Andrew Hunt Economics
households are insolvent, into negative
equity territory and may loose homes;
Payment Structure, by
Mortgage Type
$200,000, June, 2004
Loan Product Initial Reset Reset Payment Increase
Payment Payment Date Increase (%)

30-Year FRM $1,237 $1,237 None $0 0% Unpaid


interest
added to
3/1 ARM $1,039 $1,420 June, $381 37% the
2007 mortgage
balance
3/1 I-O ARM $786 $1,462 June, $676 86% Owing
more on the
2007 Mortgage
In
Option ARM $643 $1,555 August $912 142%
NegAm
“teaser rate''
2007
Assumptions: Option ARM has a 7.5% annual increase limit and a 110% negative amortization cap; Option ARM
interest accrual is based off 1 year ARM rate as reported by Fannie Mae; Option ARM Minimum Payment is
equivalent to a 1% interest rate; FRM is from Fannie Mae 30 Year FRM Index; ARM is set from LIBOR plus a 2.25%
margin; 3/1 Interest Only ARM amortizes in 30 Years.
Example: The Teaser Mortgage
Carpenter, wife two children RESULT:
• initial mortgage payments
Annual income $50,000
$279.16 per month
• after 30 months
• $350,000 house in Phoenix, Arizona mortgage payments
• $15,000 down $3,977.78 per month!
• PAYMENT SHOCK!
• $335,000 mortgage
• So...
TERMS • Today $350,000 house in
• Phoenix worth about
1% annual interest 30 months
$245,000
• zero amortization • Mortgage $335,000
• Adjustable rate: Equity: -$90,000
– after 30 months interest rate goes to 7% • Probably a non-recourse
– amortization goes to 10 years loan Besides no other
assets
129
2-28, $200,000 Hybrid ARM,
No Change in interest Rates

$2,500 100%
Monthly Payment (Principal & Interest)

90%

$2,000 80%

Post-Tax Debt-to-Income
70%

$1,500 60%

50%

$1,000 40%

30%

$500 20%

10%

$- 0%
Teaser Rate Fully Indexed Rate
Monthly Payment $1,311 $1,948
Post-Tax DTI 61% 90%

In "payment shock." the repayments may go up --as much as double or triple—


With income barely sufficient to meet the installments
Subprime ARM resets were one of the catalysts for the mortgage crisis.

Dean Baker, co-director of the Center for Economic and Policy Research
"it's almost impossible to imagine any bank or financial institution going
unscathed and the losses will easily exceed that of the S&L debacle”.
Reasons for Credit Card Debt

48% car repairs


38% home repairs
34% major
household
appliance
29% an illness or

medical expense

25% a layoff or job

loss
21% college tuition
Minsky argument: supporting
evidence
• Financial operators taking
advantage of stability to
play the carry trade (Ever
greening of outstandings)
• Rising leverage in private
equity, mortgage-backed
securities, etc. Source: Portales Partners, Bianco Research

• Leverage ratio at
Investment Banks
• “The quieter the markets
get, the greater the
leverage.” Gerald Lucas, chief
bond strategist, Bank of America
(FT, 17 June 2004)
Level 3 assets( illiquid, valuation based on management
Dependence on Debt? Assumptions) as percentage of equity:

Leverage Ratios At Bear Sterns 313%, Morgan Stanley 235%,


Biggest Investment Banks Goldman Sachs 192%, Lehman Brothers 171%,
Merrill Lynch 130%,

Total assets to total shareholder equity


40
March 2008
March 2008
35 March 2001

30

25

20

15
Bear Morgan Merrill Lehman Goldman
Stearns Stanley Lynch Bros.* Sachs
Note: * the latest figure is as of December 2007
Impact of leptokurtosis : under-estimating risk during turbulent market periods by using Value-at-Risk
Sources: Bloomberg.
methodology based on normal distribution assumption. VaR incorrectly assumes that all risks can be
quantified
‘Flawed’ SEC Program Failed to
Rein in Investment Banks

SEC rules required the investment


banks to limit their debt-to-net-capital
ratio at 15 and limits on their risky
investments along with capital as
cushion for asset defaults.

SEC in 2004(after "heavy lobbying")


increased leverage for additional debt.
Used to purchase MBS based on self
generated computer models to
determine financial risk.

5 US investment banks had $4.1 trillion Increased leverage for Investment Banks
debt in 2007, roughly 30% size of the In 2004 SEC ruling expecting
U.S. economy. Self regulation a great
CASINO LOBBYING, as three went
Increased financial leverage added to Bankrupt at fire sale prices
the vulnerability. creating instability in the
Global financial system.
Wall Street and the Subprime Disaster - Investment Banks Fueling the Subprime
Boom, Making Billions, and Causing a worldwide crisis.

Wall Street's best and brightest, lauded in Barron's and Institutional Investor for their
superior investing acumen and unrivalled ability to gauge and manage risk
·
I: Investment banks’ subprime motive: billions in revenues
and bonuses. CDO’s replaced tech stocks, as the hottest products

· II: Investment banks provided subprime lenders


with essential funding.
Investment banks supplied with lines of credit like Purchase agreements and
Warehouse lines of credit that were tapped on a daily basis

III: Pressure from Wall Street caused spike in predatory lending.


The investment banks pushed lenders to produce more loans with high rates and prepayment penalties

IV: Investment banks pumped up demand for risk-laden subprime bonds.


Set inflated prices for the bonds and encouraged investors to purchase the
bonds, including financial products that were largely untested.

·V: The big five investment banks paid more than $38 billion as bonus in 2007
INVESTMENT BANK REVENUES AND BONUSES ROSE TO NEW RECORDS ON STRENGTH OF
SUBPRIME WAVE
Minsky argument: supporting
evidence
• Narrowing risk spreads:
– credit default swaps
– VIX index (Chicago Board
Options Exchange
Volatility Index, a popular
measure of the
implied volatility of
S&P 500 index )
Lower quality high yield issues
– emerging market and high 40

yield spreads 35

30

• Record low quality of high


25
Percent

20

15

yield issuance in 2004 10

0
1983

1984

1985

1986

1987

1988

1989

1990

1991

1993
1992

1994

1995

1996

1997

1998

1999

2000

2001
Percentage of High Yield New Issuance, Senior Equivalent B- or Lower

Source: Leverage World


Minsky argument: supporting evidence
• Financial innovation to evade
regulation and increase
leverage: CDOs-squared, etc.
• Rapid growth of credit
derivatives and other structured
financial products
• Financial system increasingly
vulnerable to liquidity risk
• Likelihood of another financial
accident high
FOMC concluded on
30.01.2008

There is no singular reason


for risk management failures
on this scale. Source: Fitch Ratings
Financial Alchemy

Wall Street has a way to transform


1.The CDO 2.Multiply CDOs
risky debt into CDOs rated AAA or Aaa.
A CDO is a company typically incorporated A CDO with collateral consisting of pieces of
offshore that buys collateral such as bonds, other CDOs is called a CDO squared. When a
mortgage-backed securities and loans and sells CDO is built of CDO squareds, it’s called a CDO
debt securities with varying degrees of risk cubed.

Interest payment

$ CDO squareds

COLLATERAL SECURITIES
CDO CDO

CDO CDO

Bonds
AAA
CDO cubeds

Mortgage- Other asset- CDO CDO CDO CDO

backed Backed AA- BBB CDO CDO CDO CDO

securities securities
Unrated equity(toxic waste) CDO CDO CDO CDO

Potential losses CDO CDO CDO CDO

$ Source: Bloomberg Markets, July 2007


•Higher ratings were believed justified by various credit enhancements
including over-collateralization (pledging collateral in excess of debt
issued), credit default insurance, with investors to bear the first losses.
Rating agencies lowered the credit ratings on $1.9 trillion in mortgage backed
securities from Q3 2007 to Q2 2008
With securitization, the model became
"originate to distribute" model, with transfer of credit risk through MBS.
Investment-grade ratings to MBS, loans with
a high risk of default could be originated and packaged to others.
From Sow’s Ear to Silk Purse
Alchemy of securitisation (act 1) Structured Securities
A “new” firm with opaque assets
Static pool, so stuck with assets for life
Capital structure created from scratch

MB Assets ‘Slice and Dice’ CDO’s

Sub-
NINJA Loans,
Teaser Rates

prime
mort-

Credit Rating
gages BBB

Agencies
AAA

e hgi H, yksi R er o M
Mortgage Investment Pensions,
Lender Banks Hedges, Banks
The proliferation and the uncertainty about the real values of the Derivatives
accelerated the recent collapse of the investment houses and magnified the panic
Source: Invesco Perpetual. For illustrative purposes only.
which crippled the global financial system.
Back to Sow’s Ear
Alchemy of securitisation (act 2)
Opaque structures
Of CDO’s
MB Assets ‘Slice and Dice’ CDO’s

Sub-
NINJA Loans,
Teaser Rates

prime
mort-

Credit Rating
gages BBB

Agencies
AAA

i Y r e hgi H, yksi R er o M
??
Mortgage Investment Pensions,
Lender Banks Hedges, Banks

CDO Managers collect a series of BBB tranches and repackage them


with a cascading cash waterfall so that the top tiers are paid out first
Source: Invesco Perpetual. For illustrative purposes only.
on all the tranches – thus allowing them to be rated AAA by rating agencies
The additional problems with complicated structures
Typical Mezzanine CDO of ABS
Underlying
loans Typical Underlyin CDO of
RMBS g ABS
AAA 100%
AA
A 90%
A
A
80% Potential loss
BBB
BBB Super 75%
AAA 70%
BBB senior
BBB
BBB 60%
BBB
BBB 50%
BBB
BBB 40%
BBB
BBB
30%
AA BBB AAA
BBB
Potential BBB 20%
A AA
loss 10% BBB
BBB BBB A 10%
BBB- BBB
Equity
Unrated CDO 0%

The crisis was triggered, transmitted and fueled not by widespread defaults on debt
instruments as in past credit crises but through excessive leverage (borrowing)
Source: Citi. and widespread securitization of complex structured financial products.
The leverage amplified even small changes in real (or perceived) risk associated with the underlying debt
instruments which were then transmitted globally via securitization
Rating Agencies Failed Public says SEC

Piggy backing
Schemes
By renters

Excess spread, Overcollateralization


Financial support, to cover stressed scenarios
Subordination, Wrapped Securities
Letter of Credit, Credit Insurance

Credit enhancement is a key part of the securitization transaction


in structured finance, and is important for credit rating agencies
when rating a securitization which is subject to ingoing surveillance
Asset valuation crisis in CDO’s Basket Valuation

Three factors to value an asset are price


transparency, liquidity and methodology of valuation.

Hedge funds needed tradable prices to value CDO


and found no bids. Hedge funds incurred heavy
losses in CDOs in mid 2007 due to difficulty in pricing
these complex instruments.

French bank BNP Paribas shut down three funds in


Aug 2007 with exposures to the U.S. sub-prime
market because it said it could not value the funds.

SEC began checking the books at


Wall Street to ensure a consistent
method for valuing sub-prime
mortgages in the inventory.

And also whether they have marked


down their own positions when they
marked down the value of their
clients' assets.
Subprime and CDOs: Illiquifying the Liquified
Opacity

Financial regulators hampered by the opacity of over-the-counter


CDO where only “qualified investors” may peruse
the deal documents and performance reports.
Currently none of the bank regulatory agencies (OCC, Federal Reserve, or FDIC) are
deemed “qualified investors.” Regulators must receive permission from each issuer.

The pipeline of CDO deals can be difficult to assess with details of the transactions
inaccessible. Many deals are put together on a reverse inquiry basis or as private
transactions and the credits underlying the deals are not revealed.

Modeling the cashflow structures that underlie something like a CDO-squared, for
example, is immensely complicated and very different to doing a standard credit analysis
by looking at financials and credit ratios.
In managing a CDO one has to be comfortable with the underlying
dynamics of each structure, the fundamentals of the collateral and
with the statistical chance of some of the names going into default.

Looking at the correlation, is a whole different


ballgame in comparison to a straight bond investment.
Mortgage loan market in the U.S. – relative size

of the “subprime” segment

• The share of subprime increased by 130% from 2003 to 2005!


• The percent of loans securitized increased by 60% from 2001 to
2005!

Share of subprime
In total U.S. economy
(measured by GDP):
1% (2001), increasing
to 5% (2005)

Sub prime Securitizations with weak underlying assets were driving the market
AAA RATED MORTGAGE BACKED
SECURITIES
WALL STREET’S FEAR INDEX
The ABX index launched in January 2007,
serves as a benchmark of the market for
securities backed by home loans issued to
borrowers with weak credit and is a key point of
reference for investors navigating the world of
risky mortgage debt.

By appearing to provide a safety


net, derivatives had the unintended
effect
of encouraging more risk-taking.
Instead of dispersing risk,
derivatives had amplified it
Rapid Growth of Alternative Mortgage
Products and Structured Credit
Shift:
1970: <1%of home
Origintions of Sub-Prime Mortgages, Issuance of Sub-Prime Mortgage-Backed mortgages
Securities and Issunce of CDO's of Assets-Backed Securities securitized
700 (U.S.$, billions, annual rates) 700

1980: 10% of home


600 Sub-Prime Originations 600 mortgages
securitized
Sub-Prime RMBS
500 CDO of ABS 500
2007: 56% of home
mortgages
400 400
securitized

300 300

200 200

100 100

0 0
2000 2001 2002 2003 2004 2005 2006 2007
Sources: Inside Mortgage Finance, and Creditflux.
Securitization of
home loans for
SEC regulated
people with
Brokerages
poor credit
But not
— was to
Holding
blame for the
Companies
current global
and
credit crisis-
derivatives
Greenspan

Regulatory Investigations preceded the downgrades


March 2007
U.S. Senate Committee Hearings & New York Attorney General investigation

Bear Stearns and UBS subpoenaed regarding analysts’ recommendations of


New Century and other subprime lenders

June 2007 – SEC investigates subprime mortgage industry


US Tax Code allows 100% tax deductibility of all interest payments and part
of principal payments on loans for housing resulting in tax breaks of 30% to 50%.
Estimates by US Federal Reserve, in 2005, homeowners extracted $750 billion from
equity of their homes (up from $106 billion in 1996), spending two thirds of it on
 personal consumption,
 home improvements, and
 credit card debt.
The financial turmoil 2007-2008: old and
new insights into the nexus between the
financial sector and the real economy
The unfolding of the turmoil
 The unfolding of the turmoil is by now well known and
widely documented
 Six stages:
1. Initial subprime crisis (June/July 2007)

2. Spillovers into other credit markets (July/August 2007)

3. Liquidity squeeze and forced reintermediation (August 07)

4. Broad-based financial sector strains (Sept/Nov 2007)

5. Growth fears and dysfunctional markets (Jan/Feb 2008) had been


6. Continued deleveraging and deteriorating credit cycle
grossly
(March-? 2008) underestimated
Commercial Banks, Investment Banks,
Shadow Banks all in slime

Structured
investment vehicle
(SIV) a fund in the
shadow banking
System set up at
Cayman Islands

SIV’s
Borrows money by
issuing short-term
securities and
buys CDO’s

In 2007, the sub-prime crisis caused widespread liquidity crunch in the


Commercial Paper market as SIVs rely on short-dated CP to fund
long-dated assets by way of frequent refinancing. Citibank announced they would
bring them onto the banks' balance sheets SIV sponsored by them.
Subprime Crisis: SFBC (Swiss Federal Banking Commission)
Investigation Into the Causes of the Write-downs of UBS

UBS was not aware of the extent and the nature of its risk exposure to the Subprime
mortgage and related markets until the beginning of August 2007,

Over-reliance on AAA-rating of ABS and CDOs:


Because these positions were viewed as being
VaR neutral, they were not reflected in key
internal risk reports and thus disappeared from
the radar screen.

The investigation showed that, in hindsight, the stress


scenarios used by UBS were too optimistic.

The issue of whether models could be used to assess Subprime mortgage securities
adequately, or whether the accurate price could be determined by reference to the
ABX Indexes

The front office’s assumption (shared by the control function) that it can liquidate these
ABS positions within one month at an acceptable price proved unrealistic.
Lax Regulatory environment- A Financial
Tsunami once in a century
• Mr Greenspan rejected calls for the Fed to regulate the sub-prime sector
(Edward Gramlich then Member of the Board of Governors Federal
Reserve)
• Complex, risky financial products (Brooksley E. Born, the 57-year-
old head of the Commodity Futures Trading Commission who relentlessly
reiterated that ignoring the risk of derivatives was dangerous )
• SEC admits that self-regulation of investment banks contributed to the crisis.

• The global derivatives market topped $530 trillion as of June 30th 08 (NY
Stock Exchange value 2007 was 30 Trillion) including $55 trillion in the
credit-default swaps. The dollars at risk is a hefty $2.7 trillion, according to
an estimate by the International Swaps and Derivatives Association
• . Derivatives are over 10 times the World’s GDP
Distinguishing Characteristics of the Credit Crisis
Not economies with political risk as in the past
(e.g., Latin America) but large, well established and
sophisticated financial markets, primarily the United States

The crisis was created and exacerbated by some of the largest,


most sophisticated financial institutions in the world,
suggesting a collapse of basic risk management

Regulatory and accounting mechanisms for identifying, monitoring,


quantifying and controlling excessive exposure to credit risk were at
best ineffective and at worst outright failures
– Raises fundamental questions regarding the current nature and
form of regulation, its adequacy as well as necessary proscriptive
changes to prevent such collapses in the future
– Do mark-to-market requirements exacerbate the problem?

Traditional economic policy tools (such as central bank interest rate


reductions and fiscal stimulus initiatives) were not designed to
manage credit and liquidity crises
Compendium of CEO Compensation in Failed or Bailed‐out Financial Firms
• James E. Cayne (Bear Stearns) $290.4 million (1998‐2007)
• Martin Sullivan (AIG) $49.5 million (1995‐2007)
• Hank Greenberg (AIG) $168.4 million (1998‐2005)
• Angelo Mozilo (Countrywide) $246.7 million (1998‐2007)
• Richard S. Fuld (Lehman) $258.9 million (1998‐2007)
• Kerry K. Killinger (WaMu) $123.1 million (1998‐2007)
• E. Stanley O’Neill (ML) $157.7 million (2001‐2007)
• Citigroup CEOs (4) $483.1 million (1998‐2008)
• Lloyd Blankfein (GS) $60 million (2006)
• Ken Lewis (BAC) $25 million (2007)
• John A. Thain (ML) $83.1 million (2007)
• Edward Liddy AIG $14 million (2008)
• Jamie Dimon JPMC $28 million (2007)
• John Stumpf WF $13 million (2007)
Lewis Ranieri
Technology & Innovation
The bond trader who turned home
loans into tradable securities
• The father of securitized mortgages
• Pioneered mortgage-backed bonds in 1980s
• “Mortgages are math”
• Created collateralized pools of mortgages
• Lost connection between original
borrowers and lenders
• But ranked by Business Week
with Bill Gates and Steve Jobs as one of the
greatest innovators of the past 75 years
“Just as the expansion of subprime lending
has increased access to credit, the expansion
of its unfortunate counterpart, predatory
lending, has made many borrowers worse off.

Edward M. Gramlich
Governor Federal Reserve Board of Governors

High Pressure Sales or Deceptive Sales


Tactics
Preys on Lack of Information or lack of
Credit Confidence
Abuses Lending and Credit Practices
Lending Not Beneficial to Homeowner
Repeat of the depression period now
• Multi-layered holding companies allowed securities to be
watered down by stock pyramids to a a few cents
The falling value of CDO’s now is fell documented
Thursday, October 24, 1929
• Banks would originate and repackage highly speculative loans, market them as securities
through retail networks, using brand names in the 30’s
• Wall Street boys have done nothing different
• Pervasive stock-watering schemes, without limit on margin. If you thought the market was
just going up forever, you could borrow most of the cost of your investment in 30’s
• Derivatives or hedge funds know that margin limits are overcome with High rollers, like
credit derivatives, who use leverage at ratios of ten to one, or a hundred to one.

• The corrupted insiders were brokers running stock pools


and bankers as purveyors of watered stock in the 30’s
• Accountants, auditors and stock analysts, who are
supposedly agents of investors, have turned out
to be confederates of corporate executives

• Many of these securities were utterly opaque. Ferdinand Pecora, describing the pyramid
schemes the most notorious of which was controlled by the Insull family, opines that the
pyramid structure was not even fully understood by Mr. Insull.
• No different now
• In the ensuing collapse much of the paper went bad
• Credit derivatives act as net de-stabilizers in the credit crisis
as the bets are often in the same direction -- assuming
perpetually rising asset prices.
High Credit growth
• High Income and Wealth Concentration
• Incredible greed
• Casino Capitalism
• Asset bubbles
• Frenzy by over financing
• Self Regulation
• High Leverage
• Opaque structures
• Speculative and Ponzi schemes and financing
• Excessive Risk
• Fragility of structures
• Failure of Banks
• Reduced liquidity
• Panic & Crisis

Selected Banking Crises-
SWEDEN versus JAPAN

Country Initial Year % Nonperforming Gross Fiscal Cost 4-Year Output Loss
Loans at Peak (% GDP) (% GDP)

Spain 1977 n.a. 5.6 2.2


Egypt 1980 n.a. 38.1 n.a.
Chile 1981 35.6 42.9 92.4
Senegal 1988 50.0 17.0 32.6
USA 1988 4.1 3.7 4.1
Sweden 1991 13.0 3.6 0.0
India 1993 20.0 n.a. 3.1
Brazil 1994 16.0 13.2 0.0
Mexico 1994 18.9 19.3 4.2
Japan 1997 35.0 24.0 17.6
Korea 1997 35.0 31.2 50.1
China 1998 20.0 18.0 36.8
Russia 1998 40.6 6.0 0.0
Turkey 2000 27.6 32.0 5.4
Argentina 2001 20.1 9.6 42.7
Source: Luc Laeven and Fabian Valencia, “Systemic Banking Crises: A New Database.” IMF WP 08/224.
Mises argument: Mises argument:
Korea’s cautionary Korea’s consumer
tale bust
• Korea stimulates consumer • Authorities move to
credit boom to offset prick consumer
lending bubble in
industrial bust in 1997 late 2002
• and achieves rapid • Followed by credit
economic recovery crunch and
• on the back of rapid credit economic slowdown
• official inquiry
expansion: blames ‘reckless’
– household debt doubles credit card
1999-2002 companies and the
• and other familiar signs of a ‘government’s
credit boom: extreme policy to
prop up domestic
– high returns for lenders demand.’
– collapse in personal savings
rate
– housing boom
• Retailers shutting down shops are:
• Ann Taylor, 117 stores;
• Eddie Bauer, 29 stores;
• Cache, 23 stores;
• Lane Bryant, 150 stores;
• Talbots, 100 stores;
• Gap, 85 stores; •Going out of business
• Foot Locker, 140 stores; •Levitz;
• Zales, 105 stores • Information technology related
• Disney, 98 stores companies
• Home Depot, 15 stores; •CompUSA
• Macy's, 9 stores; •Wickes
• Pep Boys, 33 stores;
• Ethan Allen, 12 stores;
• Wilsons, 158 stores; •, Movie Gallery closing
• Pacific Sunwear, 228 stores; 560 movie rental outlets,
• Bombay Company, 384 stores;
• KB Toys, 356 stores;
• Dillards, six stores.
• Sharper Image 80 stores
• Sprint Nextel 125 locations
U.S. HOUSING BUBBLE: REPLETE WITH
MASSIVE CONFLICTS OF INTEREST
• “Dot-Com” Bursting of the Equity Bubble (2000)

• Real Estate Appealed as the only “safe bet” to many


U.S. investors

• 1% Fed Funds Fed Chairman’s ill-advised strategy—maintaining low rates too long in
an effort to rejuvenate the stock market and the economy. Home prices
soared causing a Housing Bubble.

• Exotic Mortgages Lenders became more creative, enticing new and less credit-worthy
home buyers into the market. This spurred Bush’s Ownership Society.
Low initial payments that later soared!

• Mortgage Brokers Unregulated and motivated by commission. Banks paid higher


commissions on ARM’s due to their profitability.

• Mortgage Appraisers Pressure to provide generous appraisals in order to maintain steady


business with mortgage brokers.

• Collateralized Debt Obligations Bankers sell inappropriately-rated CDO’s to global


institutions as well as unregulated hedge funds.

• Rating Agencies (S&P/Moodys) Compensation to rate CDO’s comes from the


issuers, not the investors. Pressure to provide
strong ratings or lose business.
Regulation, Oversight and Corporate Governance

• Complexity of the financial market, and instruments being used necessitate a review of
this free market approach.

• Sense of the inevitability that the authorities will see a much greater reliance on
government regulation over self- regulation.

» The big problem facing the US regulators, but is now


apparent, is that the whole system is almost by default
'designed' for corporate governance problems.

• Bankers look for more ambitious deals and exotic


investments to squeeze the profit margins. Private equity transactions and
the hedge funds alongwith analysts operate off vastly diffused objectives and incentives
that increasingly emphasise the short term.

• It all adds up to a feeding frenzy


in the financial markets.

• Need for more effective market oversight


and regulation with balance.
WHERE ARE WE NOW?
Early 2008, haven’t hit “bottom” yet
• Financial institutions still
struggling with valuation of
assets
• Full extent of potential losses
not known, particularly
counterparty risk in credit
default swaps ($41-60 Trillion)
U.S. could face $2
• “Worldwide liquidity crisis”
trillion lending shock
keyed to realization that market
due to mortgage
overheated
market losses
Conclusion: Systemic risks in international financial
system have increased
This could force
banks to scale back
their lending by $2
trillion--Goldman
Sachs Chief U.S.
Economist
U.S.
cost adjusted
government original cost
• Marshall Plan for inflation
expenditure
Cost $13 billion
$115 billion
• Louisiana $15 million
$217 billion
Purchase $36 billion
$237 billion
• Race to the $153 billion
$256 billion
Moon $54 billion
$454 billion
• S&L Crisis $32 billion
$500 billion
• Korean War (est.)
$597 billion
• The New Deal $551 billion
$698 billion
• Invasion of Iraq $111 billion
$851 billion
• Vietnam War $417 billion
$3600 billion
• NASA $288 billion
• World War II TOTAL: $7.52 trillion
• Bailout of banks and financial
system (as of 28 Nov 08) $7.76 trillion
.
Estimate the Federal bailout at a meager 2 Trillion
The running total, according to Bloomberg: 12.8 TRILLION.
2 Trillion in Toxic Mortgage Paper equate to 12.8 TRILLION in bailouts?
Includes, the FED, Treasury Dept. FDIC
http://www.ritholtz.com/blog/2008/11/big-bailouts-bigger-bucks/
http://www.bloomberg.com/apps/data?pid=avimage&iid
And US NPL’s in banks could be 40%of GDP
=i0YrUuvkygWs
Globalization and power – Shared relationship with Markets

Power has shifted upwards, from weak states to stronger states


with a global or regional reach beyond their frontiers
• Power has shifted sideways from states to markets
• Some power has ’evaporated’ in so far as no one exercises it

• No longer any state has control over


financial markets & No “lender of last
resort”
• Reduces political accountability; making
a “democratic deficit”.
•“ The impersonal forces of world market… •The same processes that have
are now more powerful than the state’s to
facilitated globalization of ‘legitimate
whom ultimate political authority over society
is supposed to belong ” firms’ have facilitated the creation of
increasingly elaborate global criminal
networks

Importance of state-firm or firm-firm relations in the modern world; erosion of the state is
its inability to make uncontested and binding (sovereign) decisions.
TED spreads a measure of Credit Risk have widened
CREDIT CRUNCH
Who is to blame for the current mess?
ANSWER: Just about EVERYONE!

Consumers have been borrowing irresponsibly for years


Lenders have been doling out money recklessly
-- NINJA mortgages and other loans

Easy money fired up demand for homes from qualified, unqualified buyers
as well as U.S. and foreign speculators

Investors (hedge funds and investment banks),


frustrated by low yields, were demanding securities
with higher returns. "picking up nickels in front of a
bulldozer"
Brokerage firms and banks responded by crafting a panoply of arcane
and complicated securities backed by subprime mortgages that
“promised” higher returns.
Rating agencies stamp AAA approval on bonds they didn’tThe
understand
Economic Outlook Group
CREDIT CRUNCH
Who is to blame for the current mess?
ANSWER: Just about EVERYONE!

MORE….
Regulators ignored warnings of abuses in the
mortgage lending business
Federal Reserve kept short term rates low for too
long
Repeal of the Glass-Steagall Act which had prevented the coupling of
investment banking and lending by President Bill Clinton.

Easy money heated up real estate


activity and swelled household debt
Homebuilders were constructing houses 50%more than underlying
demand
Day of reckoning has arrived!!

The Economic Outlook Group


Costs of the crisis?
Roubini: Total global loss could be $2
trillion (August 2008)
Current estimates of potential
losses from the crisis for the US
Banking System are $1400 bil.
(Revised from 945 Billion IMF ).

Rescue package % of GDP


US:5%, UK:36% Eurozone: 8% The human face of suffering in crises
Potential losses could be higher
Crisis shudders the World
USA US economy shrank in 3rd Q by 0.3% indicating a
recession has begun. Consumer spending, which
13.8T accounts for 2/3rds of the economy, crashed to a 28-
year low in the third quarter.

UK Fall of 0.5 per cent in 3rd Q. Economic growth to


slow to 0.9 per cent in 2008 and further shrink by
2.80T 1 per cent in 2009. Unemployment will rise from
5.3 per cent in 2007 to 7.1 per cent in 2009.

Germany Fall by 0.5 %in 3rd Q over a 0.4 % fall in 2nd Q.

3.32T Worst fall in last 5 years.

France Growth has slowed by 0.14% in 3rd Q. Unemployment


expected to rise to 7.4% from 7.2% in 3rd Q.
2.59T
Japan Japan went into a recession with a second quarter of
negative growth. GDP fell by an annualised 3 per cent
4.3T in 1st Q. Consumer spending has dropped, exports and
industrial output are also weak in 2nd Q.
BUBBLE PROSPERITY OF 2003-07 WAS UNSUSTAINABLE

THE POST-WAR WELFARE STATE


Leaving behind the free market policies of the roaring 1920s unleashed
the prosperity of the 1950s and 60s by
Regulating finance, favoring real investment and redistributing income to
improve demand profiles for suburban living and mass consumption
Market deregulation and Financial globalisation has opened the way for
uncontrolled risk contagion, opaque markets, excessive concentration of risk,
speculation, unethical behaviour and bubbles.
Hypothesis held by the German President and former IMF executive director Mr
Kohler, the Russian President Mr Medvedev and the Italian Minister of Finance, Mr
Tremonti

• Temporary solution to the market saturation problem


• Not reversing the polarization of income
Not solving the asset inflation problem
• nor regulating global finance
• THE ILLUSION OF A MIRACLE CURE,
WITH ITS INEVITABLE BOOMERANG EFFECT
WHERE WILL WE END UP?
• . The time of the casino paper economy is over

• . There will be regulation of finance, global and national

• . Profitable financial investment will be in equity and bonds

• For the production of goods and services

• . Innovation will take place in all industries

• . The gestation of the next technological revolution will prepare


the next big-bang

• . Employment and well being will spread more widely,


nationally and globally

• The stability of the market economy depends on making sure


that the profit seeking behavior of the few results in the benefit
of the many