FINANCIAL AND GLOBAL CRISIS 2008-09

GLOBAL-FINANCIAL CRISIS 2008-2009

INTRODUCTION

The global financial crisis of 2008–2009 was an ongoing major financial crisis. It became prominently visible in September 2008 with the failure, merger, or conservatorship of several large United States-based financial firms

. Beginning with failures of large financial institutions in the United States, it rapidly evolved into a global credit crisis, deflation and sharp reductions in shipping resulting in a number of European bank failures and declines in various stock indexes, and large reductions in the market value of equities (stock) and commodities worldwide.

The crisis led to a liquidity problem and the de-leveraging of financial institutions especially in the United States and Europe, which further accelerated the liquidity crisis, and a decrease in international shipping and commerce. World political leaders and national ministers of finance and central bank directors have coordinated their efforts to reduce fears but the crisis is ongoing and continues to change, evolving at the close of October into a currency crisis with investors transferring vast capital resources into stronger currencies such as the yen, the dollar and the Swiss franc, leading many emergent economies to seek aid from the International Monetary Fund. The crisis was triggered by the subprime mortgage crisis and is an acute phase of the financial crisis of 2007–2009.

CAUSES:

NEW BANK CAPITAL REQUIREMENTS:

Some experts believe that an international regulation (Basel I) that came into effect in 1988 contributed to the financial crisis. This regulation mandates that banks hold more capital if they make riskier loans or investments. This encouraged banks to get rid of risky loans by turning them into securities to be sold to investors.

ROLE OF THE CREDIT RATING AGENCIES:

Many experts blame ratings agencies such as Moody’s, Standard & Poor’s and Fitch for the crisis because they granted AAA ratings to risky mortgage backed securities (MBS). Profits of ratings agencies grew rapidly over the last decade. Almost all agencies follow an ‘issuer-pays’ revenue model, and this poses a potential conflict of interest, which some experts contend led to inappropriately high ratings for risky MBS.

RISKIER INVESTMENTS DECISIONS BY BANKS:

Some experts blame poor decision-making on the part of banks for the crisis. Banks kept huge amounts of MBS on their balance sheets in spite of the sub-prime risk involved. They financed these and other risky assets with short-term market borrowing and with a decline in the housing market, banks found it difficult to roll over short-term loans against these MBS and hence were forced to sell the assets at a substantial loss.

MARK-TO-MARKET ACCOUNTING RULES:

Financial regulation such as mark-to-market accounting stipulates that financial firms must treat potential losses as cash losses. Even though many financial instruments may still yield returns in the future, their current asset price is highly devalued. This concept makes firms ripe for forced liquidation, chases away capital, and leads to further decline in asset values.

MISLEADING ECONOMIC STATISTICS:

Some statisticians believe that government statistics (e.g. GDP and unemployment rate) have been revised over the years to show the best possible picture of the US economy. These experts hold that such revisions in economic statistics are misleading and were used by Wall Street to sell their over-valued product.

IMPACT: GLOBAL ECONOMIC SLOWDOWN

IMPACT ON STOCK MARKET:

World stock markets have taken a beating, leading to a loss in confidence amongst investors

who are stepping back in spite of several cuts in lending rates by the banks.

E.g. DJIA fell below 10,000 mark (first time in 4 years) plunging more than 800 points in

a single day in October. The fall was mirrored in stock markets, such as NASDAQ, NYSE,

Nikkei 225, London’s FTSE, Germany’s DAX, etc

LOSSESS TO INVESTORS:

Both institutional investors and individual investors have suffered huge losses both in MBS

and related products, and in equities

Banks alone are reported to have suffered USD 600 Bn of credit-related losses globally.

According to IMF estimates, American and European banks are predicted to loose USD 10 trillion of assets.

INCREASING UNEMPLOYMENT:

There have been job cuts in many companies across various sectors around the globe. This

trend has not been limited to the financial sector alone.

High number of layoffs were announced in the US through September 2008: 111,000 in

financial sector, 95,000 in automotive sector, 62,000 in transportation, 51,000 in retail,

28,000 in telecommunications and more in other sectors.

DECLINE IN BUSINESSES GLOBALLY:

There is considerable decline in business all over world marked by reduced output and consumer spending, particularly in Britain, France, Germany and Japan. The industries being impacted include automotive, airline, building materials etc. Automotive companies such as GM, Ford and Toyota reported 45%, 30% and 23% decline in sales respectively, in October 2008.

FUTURE OUTLOOK:

CONSOLIDATION AND RECONSTRUCTURING OF BANKS:

• Bank of America taking over Merrill Lynch.

• Bank of China acquiring 20% stake in private banks such as Rothschild.

• Barclays acquiring Lehman Brothers.

• BNP Paribas expected to take a majority stake in the Belgian and Luxembourg operations of Fortis.

EMERGING ECONOMIES TO HELP OUT DEVELOPED NATIONS:

Cash rich economies of world (developing nations and their Sovereign Wealth Funds) are expected to bailout the developed nations from the current crisis. As stock prices of the big banks from developed nations fall, they are expected to attract investors from developing nations. Some experts believe that China will act as the savior of developed economies facing the risk of recession by buying their banks.

WORSENING FINANCIAL CRISES DUE TO THE UNRAVELING OF Alt-A MORTGAGES:

This is the segment of mortgage loans given to prime borrowers but without complete documentation.

From 2002 to 2007, Alt-A mortgages as a percentage of total mortgages have risen from 2% to ~13%, and

experts say that the defaults on this category of mortgages will impact the financial market even more than

sub-prime lending.

CONCLUSION:

The answer to this question can be summarized in just one word: greed. Greed is the factor behind all the misbehavior that eventually led to the crisis. Greed made people no longer use common sense when it comes to their financial behavior. So there was a big bubble, a seemingly fast expansion that actually had no strong foundation. When the bubble eventually burst and caused a global financial crisis, people – even economic experts – were surprised.

SUBMITTED TO:
MR.GURDEEPAK SINGH

SUBMITTED BY:
GAGANVIR SINGH DHALIWAL

MBA1-A