Beruflich Dokumente
Kultur Dokumente
S. S. Das
ssdas@nic.in
"A certain idea of globalisation is drawing to
a close with the end of a financial
capitalism that had imposed its logic on the
whole economy and contributed to
perverting it. The idea of the absolute
power of the markets that should not
be constrained by any rule, by any
political intervention, was a mad idea.
The idea that markets are always right was
a mad idea.”
Nicholas Sarkozy,
Outline of the
Presentation
What is Recession?
Why Financial Crisis?
The Genesis of the current problem
Impact on world financial system and
world Economy
Global Response
Impact on India
India’s Response
Way Ahead
What is Recession?
DEPRE SSION
3. Misallocation of Resources
Post Asian Crisis reaction: Self Insurance
Accumulation of huge hard currency assets by
some countries (4.4 Trillion $) coupled with
huge US current account deficit;
China alone has a Foreign Currency reserve of
US$ 2 Trillion
4. Huge Current Account surplus in these countries
supported by huge Current Account deficit by US
& UK
Genesis of Current
Crisis….
3. Diversion of some of these reserves into
Sovereign Wealth Funds
Reserves mostly invested in US Treasury
Bonds puts pressure on bond yields and
interest rates;
Lead to diversion of some Investments into
higher yielding assets than U.S. Treasury and
other government securities.
Invested in High Tech Business till the collapse
of Dot Com Boom in 2000;
After the dot-com bust, more “hot investment
capital” began to flow into housing markets —
in the United States and other countries of the
world.
Genesis of Current
Crisis….
4. Housing Boom in US encouraged by Govt.
Policies
Lower long term interest rates
5. Housing boom coincided with greater popularity
of the Securitization of Loan Assets
Particularly Mortgage debt (including subprime
mortgages)
Pooling of Loans and reselling them as asset-
based securities: Collateralized Debt
Obligations (CDOs).
Securities are repacked, leveraged, tranched,
and resold many times over camouflaging the
underlying risks
7. So called innovation of exotic products;
Rocket Scientists of the
Wall Street??
Thought that by slicing and dicing, structuring
and hedging, using sophisticated
mathematical models to understand and
manage risk, they can “create value” by
offering investors combination of risk and
return which are more attractive than those
available from direct purchase of underlying
credit exposures.
Credit Default Swaps
(CDS)
A type of insurance contract (a financial
derivative) that lenders purchase against
the possibility of credit event associated
with debt, a borrowing institution, or other
referenced entity.
A default on a debt obligation, bankruptcy,
restructuring, or credit rating downgrade.
As long as the credit events (defaults)
never occurred, issuers of CDSs could earn
huge amounts in fees relative to their
capital base.
Since CDSs were technically not insurance,
Rise of CDS business
As the risk of defaults rose, the cost of the
CDS protection rose.
Investors (mostly investment bankers)
could arbitrage between the lower and
higher risk CDSs and generate large
income streams with what was perceived
to be minimal risk.
In 2007, the notional value (face value of
underlying assets) of CDS had reached $62
trillion
more than the combined gross domestic
product of the entire world ($54 trillion),
Genesis of Current
Crisis…..
8. Emergence of highly Leveraged
Investment Banks
Not subjected to capital adequacy norms
applicable to commercial banks
Could raise and invest funds as high as
30 times their equity base
9. Globalization of the financial system
leading to large scale arbitrage of funds
and flight of capitals
Collapse of Mortgage
Market
CDSs generated large profits for the
companies involved until the default rate,
particularly on subprime mortgages, and
the number of bankruptcies began to rise.
The leverage that generated outsized
profits began to generate outsized losses,
Defaults and declines in values of CDO’s
put big holes in balance sheets of financial
institutions;
By October 2008, the exposures became
too great for companies such as AIG.
The spread of the crisis
Banks around the world have similar
exposures to subprime and other declining
assets
Nearly universal uncertainty about bank
solvency
Crisis of Confidence and credit freeze
Inter bank lending almost stops
Crisis spread to other assets and institutions
Flight of capital leads to
Meltdown of the stock markets across the
Impact of the Crisis
Current crisis appears worse than even a
liquidation crisis
Lack of mark to market accounting creates
uncertainty as to who is solvent
Government rescue policies inconsistent
(Lehman was allowed to sink)
Nobody knows who will survive and parties
refuse to lend to each other
Financial system freezes!
Spread of the Crisis and
Impact
Meltdown of stock prices across the globe
Market price of stock in Freddie Mac plummeted from
$63 on October 8, 2007 to $0.88 on October 28, 2008.
reflected huge changes in expectations and lead to
flight of capital from assets in countries even with small
increases in risk.
From Emerging Markets, BRICs
Mark to Market Accounting System to value that
stock according to market values
capital base of banks shrank and severely
curtailed their ability to make more loans : Lead
to Credit Freeze
Investors fled stocks and debt instruments for
the relative safety of cash
Lead to rise in Demand for Dollar and fall in
Impact of the Crisis
Collapse of Financial Institutions in several
parts of the world
Lehman Brothers; AIG, Freddie Mac and
Fannie Mae etc.
Central Banks in vulnerable countries such as
Iceland become Bankrupt
Investors across the globe lost huge amount
of their investments
Severe Credit squeeze and Liquidity crunch
for the industry
Housing; Automobiles; Retail; Services etc.
Impact of the Crisis….
Crisis of confidence leads consumer
aversion to spending
Fall in housing and real estate prices
Fall in Demand for goods and services
Resorting to Trade Distorting Protectionism
Leads to drop in international trade in
commodities and services
Gets into a Vicious Cycle
Job cuts and serious unemployment
problem followed
Onset of a recessionary spiral
tarting Point = Unwillingness to buy
How to come out of recession
Governments in Market economies do not have
direct control on Producers’ & the Consumers’
behavior; But, they can influence millions of Producers
& Consumers with Government’s policies;
Governments have 2 policy instruments
Individuals take
Demand picks
2] Lower the
interest rates more loan up; Market
can recover;
3] Use its own It becomes an
reserved income to Govt.
money to buy to inject money
Govt. bonds into the market
Global Response to the
Crisis
Varied Response and Intervention to protect
financial system and the tumbling economy
Short term Keynesian response to boost
demand for goods and services to revive the
economy by pumping in more money to the
system
Structural adjustment to correct the
distortion in the financial system
Long Term solution : Address the problem of
misallocation of resources
Global Response: First
phase of intervention
First and Immediate intervention by the
governments across the globe has been to
prevent collapse of the financial system.
Effort has been made
to stop the financial bleeding,
to coordinate interest rate cuts, and pursue
actions to restart and restore confidence in
credit markets.
rescue of financial institutions considered to be
“too big to fall,”
Government take over of Banks and Financial
Institutions on the verge of Collapse to prevent the
financial system collapsing
Freddie Mac and Fannie Mae; AIG etc.
First Phase…..
Injections of capital and government takeovers
of certain financial institutions,
Government guarantees of bank deposits and
money market funds, and government
Facilitation of mergers and acquisitions.
Large Scale Government bailout packages for
affected industries
US Bailout package for affected Industries;