Study on the 2008

Crisis
Financial Modeling Presentation - Group 4

COP Submitted to prof. Harsh

R Thakrar
Table of contents

Introduction Causes Impact on People

01 What is the 2008 crisis?
What happened?
02 Which factors led to this financial
disaster?
03 Who benefited and who lost? How
and why?

Role of Institutions Impact on Economies 2008 Vs 2020

04 Role of the Credit rating agencies 05 Impact on USA, India and the world 06 Similarities and the differences
between the two crises.
and banks and recovery. economy.

Another crisis? Learning Outcomes

07 Can History repeat itself? Can
something similar happen again?
08 What did we learn? What are our
inferences?
 Introduction
01 What is the 2008 crisis? What
went wrong?
The Beginning

Drastic decrease in interest rates.

● Encouraged investment banks taking loans Fed int rates

● Discouraged investors

6.86% - 1%

Source: Macrotrends.net
Aftermath

● Wall street used leverage to make massive profits

● Investors wanted in
● Banks decided to connect mortgage holders and investors
Home-owners (borrowers) Borrowers

Investment Banks Lenders

Special Purpose Entities CDOs Investors

Collateralized Debt Obligation

● Same underlying asset

● Attract larger audience
● Varied risks and returns
● First fills ‘safe’
● Rest spills over to ‘okay’
● Remaining into ‘risky’
Credit Default Swaps

A, B— Companies looking to borrow

I(1), I(2)— Insurers (those who write
the credit default swaps)
P(1), P(2)— Pension Funds
HF— Hedge Fund
● No repercussions while duly payments made
● CDOs- Instant success
● Banks made millions and paid back loans
● Investor demand shot up
 Causes
02 Which factors led to this financial
disaster?
The Turning Point

● Eventually eligible potential mortgage holders ran out

● Started lending to everyone
● Sub-prime Mortgages
● No down payments, no document verification
When did it all start going South?

● Most parties involved understood the risk

● But it was risky for investors, not them so they did
nothing
● Eventually more and more started defaulting
The Crash

● Prices of houses started to plummet

● Default rates swept the country
● All parties involved were left holding worthless mortgages
● The whole system eventually froze and self imploded
 Impact on People
03 Who benefited and who lost?
People who benefitted
The 3 big names who benefitted
the most were
● Jamie Dimon
● John Paulson
● Warren Buffett
● Mark Baum
There were several others who
also placed a bet against
● Steve Eisman
● David Einhorn
● Meredith Whitney
● Michael Burry
Some of the people who predicted it:
● Michael Burry
● Nouriel Roubini
● William Poole
● Michael Mayo
And a few others like Raghuram
Rajan, Paul Singer, Janet Yellen,
Andrew Redleaf, Economist
Christopher Thornberg.
People who lost
Investment banks such as Lehman
brothers, Bear Stearns and Merrill Lynch
came as the 3 big waves and shocks in
the market.
Vegas Casinos which highlights an
important person Sheldon Adelson who
lost a lot of money because of the crisis.
● Banks like IndyMac, Washington Mutual
and 25 such banks took a hit.
● AIG was taken over the government
● Academic institutions and ivy league
names such as Harvard and Yale also
took a loss during this crisis.
Ordinary citizens

They ended up being much

poorer because of the slow
growth after the crisis followed by
high taxes and a lot of
regulations. Americans were also
to be blame for taking out loans
on cars, homes and other things
they could not afford.
Other groups such as
automakers,
Taxpayers, Billionaires,
Homeowners, etc.
 Role of Institutions
04 Role played by the Credit Rating
Agencies and Banks and Recovery.
Impact on the Crisis

● Moody’s , Standard and Poor’s and Fitch Ratings

gave inaccurately strong ratings to MBS and CDOs

● Lack of transparency with the content of the

securities

● CRAs have been accused of lack of capital market

expertise to understand the complex structure of
AIG's business
Reasons for the Inaccurate Rating

● Manipulation of ratings

● Competitive Pressure to lower

standards

● Unwillingness to spend on human

resources
Role of Banks
● Deregulation
● Securitization
● Growth of Subprime Mortgages
The Bailout Bill
● The implosion of mortgage-backed securities and the collapse of the
housing market that threatened many companies with insolvency

● Congress passed the Emergency Economic Stabilization Act of 2008. The

act created the Troubled Asset Relief Program, which authorized
Treasury department to buy up to $700 billion in toxic assets from
companies.

● The government took control of AIG to prevent the fifth-largest insurer

in the world from going bankrupt
Alternate Options

● Buy Mortgages
● Cut Taxes for Banks
● Do Nothing
 Impact on Economies
05 Impact on US and World Economy.
Impact of the 2008 crisis on
the global economy.

The true impact of the crisis even today

Cannot be completely and accurately
Estimated. Every country was impacted
By the global recession in a different
Way with underlying variables
Pre-crisis playing the bigger roles.
The 2008 crisis not only brought
Forward the short comings of
The USA’s financial systems but put
A large crack in the world’s systems.
A Global Recession
● Over $2 Trillion in the global economy wiped
out.
● Unemployment rampant after the crisis.
● Some of the largest immediate effects - the
annualized rate of decline in GDP was
- 14.4% in Germany,
- 15.2% in Japan,
- 7.4% in the UK,
- 9.8% in the Euro area
- 21.5% for Mexico.
● Arab world had lost $3 trillion due to the
crisis.
Public Debt figures post the crisis

Global debt over the last ten years went from

roughly twice the size of global GDP to—today,
it’s about 2.4 times global GDP. Government
debt has grown very rapidly in advanced
economies.

Governments, to one extent or another,

provided financial support to the banking system
and other critical industries - this has made
governments more indebted than ever before.
Household Debt

● Countries like Canada, UK,

Switzerland, Australia, South
Korea took on more household
debt.

● Asian countries like Thailand,

Malaysia, China reduced
household debt.
Impact on Banks and Banking as a whole
● Banks are doing a lot less cross-border
lending.
● Average money that’s moving across borders
is now less than half of 2017
● The banking industry had very high returns up
until the global financial crisis with metrics
like return on equity cut by more than half
since.
● Banking in general not very profitable since
the crisis.
The rise of NonFinancial Corporate Bonds

Banks retrenched from lending, especially to

corporations.

Over the past ten years, as global banks have

retrenched, companies have in fact turned to
bond markets outside the United States.
Impact of the crisis on US Economy

● The stock market plummeted,

wiping out nearly $8 trillion in
value.
● Unemployment climbed,
peaking at 10 percent in
October 2009.
● The average hours per work
week declined to 33
● Americans lost $9.8 trillion in
wealth as their home values
plummeted and their
retirement accounts vaporized.
Output Gap of US Economy & TARP

● Constant downward revision of US potential

output.

● The Treasury Department injected $412

billion into banks, carmakers and other
struggling companies through the Troubled
Asset Relief Program, or TARP. As of the end
of 2017, it had collected everything it had
paid out in bailout funds and then some,
leaving the government with a profit of $12
billion.
Challenging Traditional View of
Recessions - Rebounds

The traditional view of Recessions suggest

that a recession consists of a temporary
decline in output below its trend line, but a
fast rebound of output back to its initial
upward trend line during the recovery
phase.

But data from the 2008 crisis and other

recessions evidence otherwise.
Challenging Traditional View of Recessions - Economic
Development
The economic scars of a recession often
leave a deeper wound than expected.
According to traditional theory, poor
countries should catch up to income levels
of rich countries because they should have a
bigger bang for each buck of investment.

But the historical evidence contradicts this

theory. Instead, poor countries’ incomes
have fallen further behind.
Some other long term consequences

● Inherent Crisis Costs

● Decline in fertility rates
● Decline in net migration rates
● Rise in income inequalities
● Rise in protectionist sentiments
● Dissatisfaction over political parties and
their handling of the crisis
 2008 Vs 2020
06 What were the similarities and
differences between the two crises?
Similarities

1. Uncertainty - Emerged in leading economies and spread globally.

GEPU (Dec ‘20) - 284.13

Similarities

2. Collapse - Common initial drop and considered the largest since GD.

India’s actual GDP drop - 10.29% (2020) - Statista

Similarities

3. Reaction - Better regulation making a comeback.

Source: The Economist

Differences
1. Process -
GFC; Only the demand side
Covid-19; Demand + Supply affected

Source: DSK Research Paper

Differences

2. Speed and Shape

Differences

3. Financial Sector -

● GFC; Private sector on property & mortgage lending

● Covid-19; Corporate debt
● Globalisation of finance is more helpful now with better regulations
● Central bank intervention; greater than before
Differences

4. Multilateralism - Global leadership faded; lack of collaboration.

In a nutshell..

● More differences than similarities

● Covid-19 impacts are hastier and more immediate
● Despite heavy toll on real economy; better recovery than 2008 & GD
● Nuanced Financial system
● Multilateral collaboration is lacking
 Another crisis?
07 Can History repeat itself?
Events occurring after crisis
Stress Testing
● Changes in policies such as carrying more stress tests in banks in
order to prepare them and keep them ready for times of crisis.
● This involved evaluating whether banks had enough capital to
survive adverse economic conditions
● Maintaining buffer to stay afloat in extreme scenarios.

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Dodd-Frank Act
● Acted upon on July 2010
● Process of reducing risk by enforcing transparency and
accountability
● Stricter regulation
● Financial stability oversight council (FSOC)

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Panic in emerging markets

● Turkish Lira depreciation against US dollar

● Banks issued estimated $66 trillion of foreign corporate debts
● Serious issue of paying back debts with high interest rates

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Why 2008 may not repeat..

After the crisis of 2008, governments have taken actions and worked
towards making the financial system stronger in order to handle such
situations in a more stable manner. Evaluating all the facts, it shows that
this crisis was a rare phenomenon backed by certain degrees of fraud
and greed mixed with some irrational decisions.

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 Learning Outcomes
08 What did we learn from this crisis?
Our inferences.
Too big to fail

● Assumption that global banks were too big to fail

● Dodd-Frank act imposed

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Reducing risk on wall street

● Proprietary trading skyrocketed.

● Vlocker rule
● Conflict with clients

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Overzealous Lending in an Overheated Housing Market

● Root of the crisis

● Overinvesting into a bubble
● Unfit borrowers handling securities with adjustable interest rates

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Learnings for the common man

● There is always a cycle

● Avoid too much gearing
● Importance of diversification
● Higher returns comes with higher risk

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 Thank You
Darpan Sheth - B014
Kunal Sharma - B024
Sahaj Talwar - B036
Saj Mishra - B037
Suhani Yadav - B042
Aarushi Mathur - B053
COP Submitted to prof. Harsh
R Thakrar