2008

CRISIS
Financial Crisis
U.S. housing policies are the root cause of the current financial crisis.
Other players-- “greedy” investment bankers; foolish investors;
imprudent bankers; incompetent rating agencies; irresponsible housing
speculators; short sighted homeowners; and predatory mortgage brokers,
lenders, and borrowers--all played a part, but they were only following the
economic incentives that government policy laid out for them.
- Peter J.Wallison
 01
In 2001, the US economy underwent a minor,
short-lived recession. Although the US economy
nicely withstood terrorist attacks, the bust of
the dot-com bubble and accounting scandals,
the fear of recession

02
BEFORE THE To keep the recession away, the Federal Reserve
lowered the Federal funds rate 11times - from 6.5%
in May 2000 to 1.75%in December 2001.

BEGINNING 03
To make things merrier, in October 2004, SEC
relaxed the net capital requirement for investment
banks - which allowed them to leverage up to 30
times or even 40 times their initial investment

04
This easy access money found its prey in restless
bankers and borrowers with little or no Income, aka
Subprime Loans. More home loans, more home
buyers and more appreciation in home prices.
Fed Rate

01
The environment of easy credit and
the upward spiral of home prices
made investments in higher-
yielding subprime mortgages look
like a new rusk for gold. Some
lenders started using predatory
lending practices to generate
mortgages.
WHAT
HAPPENED
THEN?
02
Mortgage lenders needed more
funds to lend to give out more
loans to meet the increasing
demand for houses. They sold the
existing assets to investment
banking companies, who then
turned them into something called
mortgage-backed securities
03
Credit Rating Agencies rated
those mortgage-backed
securities with an AAA rating -
the best of the best, even after
knowing the backing source of
those. People perceived them as
high yielding low risk securities.
they kept on pouring more
money into them
 While the investors, traders, and bankers were
throwing money into the US housing market, the US
prices of homes were rapidly increasing.

HOUSING
The new lax lending requirements and low-interest
rates drove housing prices, making the mortgage-
backed securities and collateralized debt obligations
(CDOs) seem like an even better investment.

BUBBLE All this was a bubble and bubbles have an annoying

tendency to burst. And this one did. People couldn't
pay for their incredibly expensive houses or keep up
with their ballooning mortgage payments. Borrowers
started defaulting, which put more houses back on the
market for sale. But but but

There was no one to buy!!!!!!

Housing Prices
 There was another financial instrument that financial
institutions had on their books, that exacerbated all
these problems-- unregulated, over-the-counter
derivative called Credit Default Swaps.

FUEL TO AIG decided to cash in on the trend. They insured

MBSs and CDOs through credit default swaps.

THE FIRE AIG believed that defaults on these loans would be

insignificant. And then foreclosures on home loans
rose to high levels. AIG had to pay out what it had
promised to cover. AIG ended up incurring about $25
billion in losses.

It was clear that AIG was in danger of insolvency.

 01
Fall of many financial
institutions

THE
Decline in home prices helped to spark the financial crisis of
2007-08, as financial market participants faced considerable
uncertainty about the incidence of losses on mortgage-related
assets.

AFTERMATH In the spring of 2008, the investment bank Bear Stearns was
acquired by JPMorgan Chase with the assistance of the
Federal Reserve. In September, Lehman Brothers filed for
bankruptcy, and the next day the Federal Reserve provided
support to AIG, a large insurance and financial services
company. Citigroup and Bank of America sought support from
the Federal Reserve, the Treasury, and the Federal Deposit
Insurance Corporation.
 02
Economic Downturn
US gross domestic product fell by 4.3 percent, making this the
deepest recession since World War II.

THE The FOMC (Federal Open Market Committee) lowered its

target for the federal funds rate from 4.5 percent at the end of

AFTERMATH
2007 to 2 percent at the beginning of September 2008. As the
financial crisis and the economic contraction intensified in the
fall of 2008,

The FOMC accelerated its interest rate cuts, taking the rate to
its effective floor – a target range of 0 to 25 basis points – by
the end of the year. In November 2008, the Federal Reserve
also initiated the first in a series of large-scale asset purchase
(LSAP) programs, buying mortgage-backed securities and
longer-term treasury securities.
 03
Indian Economy
The global crisis has affected India through three distinct
channels: financial markets, trade flows, and exchange rates.

THE Financial Markets: The Indian banking sector has remained

more or less unaffected, at least directly, by the global crisis. In

AFTERMATH
fact, during the third quarter of FY2008, banks in India
announced encouraging results. The most significant change
was observed in the case of FIIs, which saw a strong reversal of
flows, which led to the equity market crash by more than 60%.

Trade Flows: Exports fell down drastically which resulted in a

retrenchment of more than 300,000 workers.

Exchange Rates: The Indian rupee has tumbled by 27% vis-à-

vis the US dollar. At the same time, foreign exchange reserves
have also fallen by US$60 billion.
Foreign Investment Inflows
Indian Foreign Exchange Reserves
(FER) and Exchange Rate
Thank You
Hitesh Sancheti Jain
Intern of the Month: October 2022