Global Financial Crisis of 2008

Introduction
The Global Financial Crisis of 2008 was a pivotal event in modern
economic history, impacting global markets and leading to widespread
recession.

It threatened the collapse of large financial institutions, which was

prevented by the bailout of banks by national governments, but stock
markets still dropped worldwide. 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 U.S. dollars, and
a downturn of economic activity leading to 2008-2012 global
recession. and contributing to the European sovereign-debt crisis.

The active phase of the crisis, which manifested as a liquidity crisis,

can be dated from August 9, 2007, when BNP Paribas terminated
withdrawals from three hedge funds citing "a complete evaporation of
liquidity". The crisis costed $1488Bn.
What Led to the Crisis?
In 2001, the U.S. economy underwent a minor, short - lived recession

Although the U.S. economy nicely withstood terrorist attacks, the bust of the
dot-com bubble and accounting scandals, the fear of recession was the top
concern for everyone.

To keep recession away, the Federal Reserve lowered the Federal funds rate
11 times-from 6.5% in May 2000 to 1.75% in December 2001 creating
enormous liquidity in the economy.

To make things merrier, in October 2004, SEC relaxed the net capital
requirement for five investment banks - Goldman Sachs, Merrill Lynch,
Lehman Brothers, Bear Stearns and Morgan Stanley- which freed them to
leverage up to 30-40 times their initial investment.

This easy and excess money found its prey in restless bankers and borrowers
with little or no income, also referred as Subprime borrowers.

These subprime borrowers wanted to realize their life's dream of acquiring a

home. More home loans -> More home buyers -> More appreciation in home
prices. It wasn't long before things started to move just as the cheap money
wanted them to.
The Downward Spirals
The Mortgage lenders wanted more money to lend to their
homebuyers, so they sold their existing loans to banks & to
Freddie Mac & Fannie May, which in turn sold these to
investment banks. This environment of easy credit & upward
trajectory of asset prices made investments in higher yielding
subprime mortgages look like a new rush for gold.

The investment banks combined these loans with hundreds of

others into what are known as collateralized debt obligations
(CDOs) and sold these to investors worldwide as mortgage-
backed securities (MBS).

The returns on these securities depended on monthly payments

on the loans. CDO issuance hit $634 billion in 2007.

Insurance companies (AIG) used Credit Default Swaps to cover

investors' losses if homebuyers defaulted on loans. When the
derivatives lost value, AIG didn't have enough cashflow to
honor all the swaps.
Bank Failures
Housing prices started falling in 2006 and homebuyers began defaulting on
their loans, which meant insurance companies couldn't honor all their credit
default swaps.

Within a few weeks in September 2008, Lehman Brothers, one of the world's
biggest financial institutions, went bankrupt, which sent shockwaves through
the financial system, causing widespread panic and loss of confidence.

£90bn was wiped off the value of Britain's biggest companies in a single day

Banks panicked when they realized they would have to absorb the losses.
They stopped lending to each other.

They didn't want other banks giving them worthless mortgages as

collateral.

As a result, interbank borrowing costs, LIBOR, rose. This mistrust within the
banking community was the primary cause of the 2008 financial crisis

Federal Reserve began pumping liquidity into the banking system via the
Term Auction Facility to mitigate the contagion effect
Government Interventions
Governments worldwide implemented bailout programs and
stimulus packages to stabilize financial markets and prevent a
complete economic meltdown. Central banks also engaged in
quantitative easing to inject liquidity into the system.

Global Economic
Impact
The crisis led to a global recession, with widespread unemployment
and economic contraction. Stock markets plummeted, and
consumer confidence hit record lows, causing a ripple effect across
various industries and countries.
Conclusion
The 2008 financial crisis resulted in regulatory reforms,
increased scrutiny of financial institutions, and a shift in
risk management practices. Its impact continues to be felt
in the form of slower economic growth and a lasting legacy
of financial instability.

The Global Financial Crisis of 2008 served as a stark

reminder of the interconnectedness of global financial
systems and the need for prudent risk management. Its
enduring impact underscores the importance of
safeguarding against systemic risks and maintaining
financial stability.
Thanks!
Appendix?
Notes
1. Boom in the World Economy & Thriving Asset Prices

Following the global slowdown of 2001 -> the world economy

recovered rapidly, posting record growth rates in 2004, 2005 and
2006. The long period of abundant liquidity and low interest rates
prior to the crisis led to a global search for yield and a general
underpricing of risk by investors. This led to increased lending
volumes, due to a decline in lending standards & increased
leverage contributing to bubbles in asset prices and commodities.

2. Growth in US Economy - Interest Rate Cuts & Deregulation

There was 'global imbalances' -> the phenomenon of huge current

account surpluses in China and few other countries coexisting with
the unsustainably large deficits in the US. This imbalance was
caused by the propensity of the countries with high saving rate to
park their savings often at low yields, in the US. The flood of money
from these countries into the US kept interest rates low, fuelled the
credit boom and inflated real estate and other asset prices to
unsustainable levels.
Notes
Rapid Increases in Credit

Against the backdrop of the historically low interest rates and booming
asset prices, credit aggregates, along side monetary aggregates, had been
expanding rapidly. Despite the rapid increase in credit, however, the
balance- sheets and repayment capacity of corporations as also the
households did not appear to be under any strain. The high level of asset
prices kept the leverage ratios in check while the combination of strong
income flows and low interest rates did the same with debt service ratios.

Failure of the US Leadership in Anticipating the Crisis

During the housing boom, most of the US authorities failed to comprehend

the problem. The then head of Federal Reserve, Alan Greenspan related the
boom to a froth of small local bubbles that'd never grow to a scale that
could threaten the health of the overall economy. It is believed that the
leaders in US were aware of the possibility of real estate bubbles but they
did not anticipate its devastating consequences. As a result, the speculative
housing market got considerable encouragement in terms of investment
leading to tangible losses to all stakeholders in the event of the crisis
Bailout Packages