CREDIT RISK ANALYSIS

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PROF. TEHSEEN MOHSIN Assignment# 1 DATE: 18-03-2013

1920- World War

World War I set the global economic conditions for the next twenty years in the global economy. Following World War I, there was political and economic chaos. The boom that followed World War I proved short lived, as deflation and recession followed the end of World War I. Politicians failed to sort matters out at Versailles, the Brussels Conference of 1920, the Genoa Conference of 1922 and other international meetings. The result was a world-wide recession in 1921 and hyperinflation in Germany 1922 and 1923 and other European countries. Few people realize that between 1920 and 1922 most world stock markets crashed, in some cases, more spectacularly than in 1929-1932. First, there were the bubble markets that rose and crashed spectacularly. The United States bull market of the 1920s has been studied numerous times, so there is no need to go into detail on the US stock market other than to establish the United States as a benchmark with which to compare other stock markets. During the 1920s, a plethora of new products flooded the American market, providing increased earnings and growth for numerous new industries, including automobiles, movies, radio, and electric utilities. With Europe in chaos, much of the money remained in the United States.

1937- The Great Recession

The recession of 1937-38 is sometimes called the recession within the Depression. It came at a time when the recovery from the Great Depression was far from complete and the unemployment rate was still very high. In fact, it was a disastrous setback to the recovery. Real GDP fell 11% and industrial production fell 32%, making it the third-worst US recession in the 20th century (after 1929-32 and 1920-21). The arguments for what caused this recession fall into one of three broad categories. The first argument is that it was driven by a shift in monetary policy that caused a credit contraction in 1937. The second argument is it was caused by a premature end to fiscal stimulus (i.e., deficit spending by the government) before the private sector was strong enough on its own to sustain economic growth. And the third argument is that it was triggered by significant (and populist) regulatory and legislative reform programs enacted by the Roosevelt administration, which led to uncertainty and fear on the part of business and a reluctance to continue hiring and investing.

1971- Fixed exchange rate system broke down

In August 1971, U.S. President Richard Nixon announced the "temporary" suspension of the dollar's convertibility into gold. While the dollar had struggled throughout most of the 1960s within the parity established at Breton Woods, this crisis marked the breakdown of the system. An attempt to revive the fixed exchange rates failed, and by March 1973 the major currencies began to float against each other. Since the collapse of the Bretton Woods system, IMF members have been free to choose any form of exchange arrangement they wish (except pegging their currency to gold): allowing the currency to float freely, pegging it to another currency or a basket of currencies, adopting the currency of another country, participating in a currency bloc, or forming part of a monetary union Under this system value was determined on the basis of gold reserve and supply and demand of currency.

1987- Black Monday, which saw a 23% decline in U.S. stock price
A stock market crash is a sudden dramatic decline of stock prices across a significant cross-section of a stock market, resulting in a significant loss of paper wealth. Crashes are driven by panic as much as by underlying economic factors. They often follow speculative stock market bubbles. Stock market crashes are social phenomena where external economic events combine with crowd behavior and psychology in a positive feedback loop where selling by some market participants drives more market participants to sell. Generally speaking, crashes usually occur under the following conditions:[1] a prolonged period of rising stock prices and excessive economic optimism, a market where P/E ratios exceed long-term averages, and extensive use of margin debt and leverage by market participants. There is no numerically specific definition of a stock market crash but the term commonly applies to steep double-digit percentage losses in a stock market index over a period of several days. Crashes are often distinguished from bear markets by panic selling and abrupt, dramatic price declines. Bear markets are periods of declining stock market prices that are measured in months or years. While crashes are often associated with bear markets, they do not necessarily go hand in hand. The crash of 1987, for example, did not lead to a bear market.

1989- Japan Stock Market Bubble deflated

In the decades following World War II, Japan implemented stringent tariffs and policies to encourage the people to save their income. With more money in banks, loans and credit became easier to obtain, and with Japan running large trade surpluses, the yen appreciated against foreign currencies. This allowed local companies to invest in capital resources much more easily than their competitors overseas, which reduced the price of Japanese-made goods and widened the trade surplus further. And, with the yen appreciating, financial assets became very lucrative. With so much money readily available for investment, speculation was inevitable, particularly in the Tokyo Stock Exchange and the real estate market.

With Japan's economy driven by its high rates of reinvestment, this crash hit particularly hard. Investments were increasingly directed out of the country, and Japanese manufacturing firms lost some degree of their technological edge. As Japanese products became less competitive overseas, some people argue that the low consumption rate began to bear on the economy, causing a deflationary spiral.

1997- Asian contagion decimated Asian equity markets

In 1997 the nations of East Asia experienced the worst economic crisis in their history. At the time scholars presented a diverse array of possible explanations for the disaster, but found them unable to agree upon any one cause. We are now in a position to readdress this important question. This article thus reviews the existent scholarly works on the Crisis, in an attempt to find a unifying theme in the diverse analyses. It discovers that though there is a great diversity of opinions as to the most fundamental cause, ranging from accusations of cronyism and the failure of the developmental state to indictments of the evils of liberalization, there seems to be a general consensus that the proximate cause of the crisis was the immense rapid capital flight out of Asia. The article thus begins with an investigation of these capital flows. It contends that whipsaw movement of capital in and out of East Asia in 1997 was inherent to the structure of global finance, showing that the over-liquidity of financial markets and the psychology of investment both predispose financial markets to large, erratic, and potentially dangerous surges. The article concludes with a survey of measures that could protect developing nations from such dangerous flows. It has been shown that enormous and highly volatile capital flows were the proximate cause of the Asian crisis, and that these flows are inherent to an over-liquid global financial market that fosters herd-like investment behavior. Thus plugging-in to global finance always entails some danger, and governments should take appropriate actions to protect their national economies. As domestic reforms will often take a good deal of time to mature, due to both the embedded nature of economic patterns and the presence of powerful actors interested in maintaining the status quo, these nations ought to implement some form of capital controls in the meantime. Whether a particular nation places restrictions on outgoing or incoming capital, what is imperative is that the governments of developing nations take the necessary measures to disconnect their economies from a dangerous global financial market during the period of maturation.

1998- Russian debt default and the collapse of the Longterm capital management hedge fund,
The Russian financial crisis (also called "Ruble crisis") hit Russia on 17 August 1998. It resulted in the Russian government devaluing the ruble and defaulting on its debt. Declining productivity, an artificially high fixed exchange rate between the ruble and foreign currencies to avoid public turmoil, and a chronic fiscal deficit were the reasons that led to the crisis. The economic cost of the first war in Chechnya, estimated at $5.5 billion (not including the rebuilding of the ruined Chechen economy), also contributed to the crisis. In the first half of 1997, the Russian economy showed some signs of improvement. However, soon after this, the problems began to gradually intensify. Two external shocks, the Asian financial crisis that had begun in 1997 and the following declines in demand for (and thus price of) crude oil and nonferrous metals, severely impacted Russian foreign exchange reserves. When the East Asian financial crisis broke out in 1997, prices for Russia's two most valuable sources of capital flows, energy and metals, plummeted. Given Russias fragile economy, the rapid decline in the value of those two capital sources resulted in an economic chaos in the country where GDP per capita fell, unemployment soared, and global investors liquidated their Russian assets. On 17 August 1998, the Russian government devalued the ruble, defaulted on domestic debt, and declared a moratorium on payment to foreign creditors. On that day the Russian government and the Central Bank of Russia issued a "Joint Statement" announcing, in essence, that:

1. the ruble/dollar trading band would expand from 5.37.1 RUR/USD to 6.09.5 RUR/USD; 2. Russia's ruble-denominated debt would be restructured in a manner to be announced at a later date; and, to prevent mass Russian bank default, 3. A temporary 90-day moratorium would be imposed on the payment of some bank obligations, including certain debts and forward currency contracts. 4. Russian inflation in 1998 reached 84 percent and welfare costs grew considerably.

2001- September 11 attacks on WTC and U.S equity market collapse,

Major economic effects arose from the September 11 attacks, with initial shock causing global stock markets to drop sharply. The attacks themselves caused approximately $40 billion in insurance losses, making it one of the largest insured events ever. The opening of the New York Stock Exchange (NYSE) was delayed after the first plane crashed into the World Trade Center's north tower, and trading for the day was canceled after 5

the second plane crashed into the South Tower. NASDAQ also canceled trading. The New York Stock exchange was then evacuated as well as nearly all banks and financial institutions on Wall Street and in many cities across the country.

2007-2009- CREDIT CRISIS RESULTING FROM MORTGAGE MARKET MELTDOWN AND HUGE AMOUNT OF BANK LEVERAGE.

The financial crisis of 20072008, also known as the global financial crisis and 2008 financial crisis, is considered by many economists to be the worst financial crisis since the Great Depression of the 1930s. It resulted in the threat of total collapse of large financial institutions, the bailout of banks by national governments, and downturns in stock markets around the world. In many areas, the housing market also suffered, resulting in evictions, foreclosures and prolonged unemployment. The crisis played a significant role in the failure of key businesses, declines in consumer wealth estimated in trillions of US dollars, and a downturn in economic activity leading to the 20082012 global recession and contributing to the European sovereign-debt crisis.

1973- SHOCKS TO PRICE OF OIL, HIGH INFLATION, AND VOLATILE INTEREST RATES,
Oil price shocks affect the economy through different channels: the supply side, the demand side and the terms of trade. Supply suffers as production costs rise in the wake of an oil price shock. Given substitution between production factors, relative price changes result in a reallocation of the means of production. This, in turn, cushions the negative effects. The long-term effects on production capacity are thus less pronounced than the short-term effects, which are dominated by frictions arising as a result of resource reallocations and by uncertainties about the subsequent development of oil prices. First, to the extent that oil is both an important input to production and consumer goods (i.e. petrol and heating oil), results in a reduction in economic activity as energy becomes more expensive. Second, rising oil prices contribute directly to the level of inflation, particularly in energy dependent countries. Over time, the impact on activity and inflation will also depend on policy responses and supply-side effects. Oil prices have an effect into the real economy, by increasing cost to firms and by reducing the amount of disposal income that consumers have to spend. As a consequence, it can be expected that rising oil prices have a negative effect into the level activity of an economy and into its stock markets as well. First, its stock market affects the other stock markets in Asia. Oil shocks affect the stock markets as well as the real economy itself; VAR approach will be the main tool in the present research, since it allows examining the dynamic interaction between economic variables. The effects of the embargo were immediate. OPEC forced the oil companies to increase payments drastically. The price of oil quadrupled by 1974 to nearly US$12 per barrel (75 US$/m3). This increase in the price of oil had a dramatic effect on oil exporting nations, for the countries of the Middle East who had long been dominated by the industrial powers were seen to have acquired control of a vital commodity. The traditional flow of capital reversed as the oil exporting nations accumulated vast wealth. Some of the income was dispensed in the form of aid to other underdeveloped nations whose economies had been caught between higher prices of oil and lower prices for their own export commodities and raw materials amid shrinking Western demand for their goods. Much was absorbed in massive arms purchases that exacerbated political tensions, particularly in the Middle East.