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    Economic Analysis: Sub Prime Crisis Us & World Economy

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    Tushar Panchal
    The document discusses the subprime mortgage crisis and its impacts. It began in 2007 with rising mortgage defaults and foreclosures in the United States. This caused the values of securities tied to subprime mortgage loan portfolios to plummet, damaging financial institutions globally. Major US investment banks collapsed and the US economy suffered job losses and declines in GDP, home values, and state budgets. Central banks cut interest rates in response. The crisis also harmed economies worldwide through falling markets and trade.

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    Economic Analysis: Sub Prime Crisis Us & World Economy

    Uploaded by

    Tushar Panchal
    43 views29 pages
    The document discusses the subprime mortgage crisis and its impacts. It began in 2007 with rising mortgage defaults and foreclosures in the United States. This caused the values of securities tied to subprime mortgage loan portfolios to plummet, damaging financial institutions globally. Major US investment banks collapsed and the US economy suffered job losses and declines in GDP, home values, and state budgets. Central banks cut interest rates in response. The crisis also harmed economies worldwide through falling markets and trade.

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    Economic Analysis

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    The document discusses the subprime mortgage crisis and its impacts. It began in 2007 with rising mortgage defaults and foreclosures in the United States. This caused the values of securities tied to subprime mortgage loan portfolios to plummet, damaging financial institutions globally. Major US investment banks collapsed and the US economy suffered job losses and declines in GDP, home values, and state budgets. Central banks cut interest rates in response. The crisis also harmed economies worldwide through falling markets and trade.

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    Attribution Non-Commercial (BY-NC)
    Download as PPS, PDF, TXT or read online from Scribd
    Download as pps, pdf, or txt
    43 views29 pages

    Economic Analysis: Sub Prime Crisis Us & World Economy

    Uploaded by

    Tushar Panchal
    The document discusses the subprime mortgage crisis and its impacts. It began in 2007 with rising mortgage defaults and foreclosures in the United States. This caused the values of securities tied to subprime mortgage loan portfolios to plummet, damaging financial institutions globally. Major US investment banks collapsed and the US economy suffered job losses and declines in GDP, home values, and state budgets. Central banks cut interest rates in response. The crisis also harmed economies worldwide through falling markets and trade.

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    of 29

    ECONOMIC ANALYSIS

    SUB PRIME CRISIS AND ITS IMPACT ON US & WORLD ECONOMY

    INDEX
    Introduction Definition Sub Prime & Sub Prime Lending Causes of Crisis Impacts on US Banks and Markets Impacts on Non-US Banks Impacts on US Economy Impacts on World Economy Responses on Sub Prime Crisis Summary Conclusion Q&A

    INTRODUCTION
    The sub prime mortgage crisis is an ongoing economic problem which became more apparent during 2007 and 2008, and is characterized by contracted liquidity in the global credit markets and banking system. The downturn in the U.S. housing market, risky lending and Borrowing practices, and excessive individual and corporate debt levels have caused multiple adverse effects on the world economy. Like the increased unemployment and possibility of Global Recession. The crisis has passed through various stages, exposing pervasive weaknesses in the global financial system and regulatory framework.

    What is Sub Prime ?


    Sub Prime :

    In the US, borrowers are rated either as primeindicating that they have good credit ratings based on their track recordor as sub prime, meaning their track record in repaying loans has been below par.

    Sub Prime Borrower:


    A credit rating lower than 620. (In US Credit Ratings are between 350850) A debt to income ratio greater than 45%. (meaning 45% or more of the gross income pays for housing and other debt) A combined loan to value ratio of more than 90%. (meaning borrower is paying down payment of less than 10%) Borrower History of non-payment, repossession and forclosure.

    What is Sub Prime Lending ?


    Sub Prime Lending:
    Loans given to sub prime borrowers are charged with high interest rate charges than normal. Banks are reluctant to give this loans as the chances of default are high on this loans. In the United States, mortgage lending specifically, the term "subprime" refers to loans that do not meet Fannie Mae or Freddie Mac guidelines. Sub Prime lending encompasses a variety of credit instruments, including mortgages, car loans, and credit cards.

    SUB PRIME LENDING

    CAUSES OF CRISIS
    How sub prime loans turned into Crisis
    The main reason was the inability of sub-prime borrowers to pay back the money. As a result, some defaulted. Some started force selling their houses due to which property prices came down, which made it more difficult for other sub-prime borrowers to refinance their mortgages into loans with lower rates. The result, more and more defaults! On the securities side the hedge funds leveraging these Loans got distressed due to the defaults by borrowers. Investors who invested there money in these funds wanted there money back causing forced selling of securities which reduced the prices of these securities in the market.

    CAUSES OF CRISIS
    Crisis Continues.

    Since hedge funds are highly leveraged, a small decrease in their asset values is enough to make them bankrupt. As a result several funds filed for bankruptcy. Thus the sub-prime crisis showed its red face!

    CAUSES OF CRISIS
    Other Important Factors for Crisis:
    Flawed

    borrowing practices Excessive speculation High-risk lending practices Flawed oversight by mortgage brokers Excessive underwriting of high-risk mortgages Weak oversight by credit rating agencies

    IMPACTS OF SUB PRIME CRISIS


    Effects on Financial Markets
    In Summer 2008, all three major stock indices in the United States (the Dow Jones Industrial Average, NASDAQ, and the S&P 500) entered a bear market. Dow Jones Industrial plunged 504 points (4.4%) while the S&P 500 fell 59 points (4.7%). Asian and European markets rendered similarly sharp drops. Effects on financial institutions: Profits of US Banks declined from $35.6 billion to $19.3 billion during the first quarter of 2008 versus the prior year, a decline of 46%

    IMPACTS OF SUB PRIME CRISIS


    IMPACT ON US BANKS:
    Bear Stearns: The 5th largest Investment Bank in the US was acquired by J.P. Morgan Chase for $1.2 Billion or $10/share Lehman Brothers: The 4th largest investment bank in the USfile for bankruptcy under chapter 11. The 94 year-old Merrill Lynch agreed to sell itself to Bank of America for $50 billion.
    Freddie Mac and Fannie Mae have effectively been nationalized to prevent them severe crisis. Major insurance firm AIG (American Insurance Group) is also under severe pressure and has asked for a $40 billion bridge loan from Fed to tide over the crisis.

    IMPACTS ON US BANKS

    IMPACTS ON NON-US BANKS

    In September 2007, Northern Rock, a British Bank, experienced trouble raising liquidity. Within one day, customers had withdrawn an estimated 1 billion. The Bank of China (the #2 bank in China) announced that it held $9.7 billion dollars of US sub prime debt.

    Financial institutions from around the world have recognized sub prime related losses and write-downs exceeding U.S.$501 billion

    IMPACTS ON NON-US BANKS


    IMPACT ON INDIAN BANKS:
    The crisis also affected Indian banks which have ventured into the USA. ICICI, India's second largest bank, has reported mark-to-market loss of $263 million in its loans and investment exposures. Other state owned banks such as State Bank of India, Bank of India and Bank of Baroda have refused to release their figures.

    IMPACTS ON US ECONOMY
    Due to the Sub Prime crisis Dollar value declined significantly in the Q1 and Q2 of 2008. According to Standard & Poors report in March 2008 GDP drop by 2.2 %. Spending at State agencies dropped by 7% Major states like New York have done a budget cut of $600 Million. Economist from Global Insight expected a recession of 40% after collapse of Bear Stearns .

    IMPACTS ON US ECONOMY
    Effect on Employment:
    According to the Department of Labor, from August 2007 until August 2008 financial institutions have slashed over 65,400 jobs in the United States. Apart from this there are 84000 job cuts and termination of contracts of external consultants in other industries like IT due to the credit crunch. Unemployment Rate jumped to 6.1% in August. Highest level in 5 years.

    IMPACTS ON US ECONOMY
    Decline in commercial real estate market:
    Due to the tightening credit and slowing growth its estimated that office vacancies could go up 5% to 7% and rents decrease by 20% by the end of this year.

    Rise in home-related crime:


    Homeowners are turning to arson as a way to escape from mortgages. As per FBI Reports arson grew 4% in towns and 2.2% in cities during 2007-2008

    IMPACTS ON US ECONOMY
    Decline in homeowners net worth:
    Due to the drop in the real estate prices the home owners net Worth has dropped by 20% approx based on S&P/CaseShiller housing price index

    Decline in minority home ownership:


    There is a disproportionate level of foreclosures in some minority neighborhoods. About 46% of Hispanics and 55% of African Americans who obtained mortgages in 2005 got higher-cost loans compared with about 17% of Whites and Asians, according to
    Federal Reserve data.

    IMPACTS ON WORLD ECONOMY


    International Monetary Fund (IMF) "says that the worldwide losses stemming from the US sub prime mortgage crisis could run to $945 billion.

    Economic Impact on UK as per Ernst & Young:


    Economic growth of only 1.5% in 2008 and 1% in 2009. Consumer spending would drop by 0.2%. 16% Increase in Company Liquidations in Q2 2008. Highest in 5 yrs. As per Office of National Statistics unemployment claims in Aug 2008 increased by 32,500.

    IMPACTS ON WORLD ECONOMY


    Economic Impact on Euro-zone:

    Euro-zones economy declined by 0.2% GDP of Ireland contracted by 1.5% in Q1 2008. 35% fall in Real Estate Prices in Spain by 2011 as per SCB. German Economy declined by 0.5% in Q2 Italian Economy declined by 0.3% in Q2

    Economic Impact on India:


    Stock Markets in India went for roller-coaster ride. Job Cuts in related sectors.

    Responses on Sub Prime Crisis


    The Federal Reserve: Fed lowered the Federal Funds rate from 5.25% to 2% between 18 Sept 2007 to 30 April 2008. Central banks have also lowered the interest rates charged to member banks (called the discount rate in the U.S.) for short-term loans Fed finalized new rules that apply to mortgage lenders The US Government: On 19th Sept 2008 US Govt announced to purchase illiquid, risky securities from FIs estimated to be minimum of $700 Billion. On Sept 23rd Govt official stated FBI was investigating on the possibility of Fraud by Companies such as Fannie Mae and Freddie Mac, Lehman Brothers, and insurer American International Group.

    Responses on Sub Prime Crisis


    Regulations:
    In response to a concern that lending was not properly regulated, the House and Senate are both considering bills to regulate lending practices. Many Investment Banks have been asked to increase there capital reserves to a substantial level. UK regulators announced a temporary ban on short-selling

    of financial stocks on September 18, 2008

    Responses on Sub Prime Crisis


    Housing and Economic Recovery Act of 2008:

    Providing insurance for $300 billion in mortgages estimated


    to assist 400,000 homeowners. Provides loans for the refinancing of mortgages to owner-

    occupants at risk of foreclosure.

    Community assistance to help local governments buy and renovate foreclosed properties.

    Responses on Sub Prime Crisis


    Economic Stimulus Act of 2008:

    On 13 Feb 2008 an economic package of $168 Billion was announced by Bush Administration to in the form of
    Income Tax Rebates to help stimulate economic growth.

    SUMMARY

    CONCLUSION
    Alan Greenspan, X-Chairman of the Federal Reserve, stated: The current credit crisis will come to an end when the overhang of inventories of newly built homes is largely liquidated, and home price deflation comes to an end. That will stabilize the now-uncertain value of the home equity that acts as a buffer for all home mortgages, but most importantly for those held as collateral for residential mortgage-backed securities. Very large losses will, no doubt, be taken as a consequence of the crisis. But after a period of protracted adjustment, the U.S. economy, and the world economy more generally, will be able to get back to business.

    THANK YOU
    Apekshit

    Dhoke Deepika Talokar Pradnya Tarkar ? Ashim Saha

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