GLOBAL FINANCIAL CRISIS

BY : PRAGYA SINGH
INTRODUCTION
 The 2007–2012 financial crisis, also known as the Global Financial
Crisis and 2008 financial crisis.

 It resulted in the threat of total collapse from large financial

institutions, the bailout of banks by national governments, and
downturns in stock markets around the world.

 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 US dollars, and a
downturn in economic activity leading to the 
2008–2012 global recession and thus contributing to the 
European sovereign-debt crisis.

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CAUSES OF CRISIS
The immediate cause or trigger of the crisis was the bursting of the 
United States housing bubble which peaked in approximately 2005–2006.

The key causes leading to crisis can be listed as :

 Housing price increase during 2000-2005, followed by a levelling off and price decline

 The bailout of banks by national government

 Increase in the default and foreclosure rates beginning in the second half of 2006
 Collapse of major investment banks by 2008
 Avoided investigations of GSEs
 2008 collapse of stock prices

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 Why the Economic Crisis.?
. US Federal Reserve – to
The
get economy out of recession
(IT bubble burst-2000) -- cut
interest rates,
Large Increase in money
supply & Liquidity with banks
----(cheap credit
availability )
Increased housing & real
estate prices (low interest
rates, excess liquidity --
lending for houses quite
attractive)
As housing prices declined,
sub-prime households
started defaulting in making
their installments
During Housing & credit
booms… oversupply is there–
- [no. of CDO (MBS) investors
throughout the world greatly
increased…..]
Banks provided Sub-prime -
housing prices kept rising
Banks as well as CDO
investors suffered heavy
losses.. .. Leading to
‘Liquidity Crunch’…
Financial investment
institutions went bankrupt &
lacked liquidity…. Leading to
‘Credit Crunch’
Consumption demand and
investment adversely affected
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BACKGROUND :
 SUB PRIME LENDING :

Intense competition between mortgage lenders for revenue

and market shares, and the limited supply of creditworthy
borrowers, caused mortgage lenders (i.e. pvt. securitizers)
to relax underwriting standards and proliferate risky
mortgages to less creditworthy borrowers.

Subprime mortgages remained below 10% of all mortgage

originations until 2004, when they spiked to nearly 20% and
remained there through the 2005–2006 peak of
the United States housing bubble.
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

Source: US Census Bureau, Harvard University, State of Nation’s Housing Report ,2008

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 GROWTH OF HOUSING BUBBLE :

Between 1997 and 2006, the price of the typical American

house increased by 124%. 
During the two decades ending in 2001, the national median
home price ranged from 2.9 to 3.1 times median household
income.
This ratio rose to 4.0 in 2004, and 4.6 in 2006.This 
housing bubble resulted in many homeowners refinancing
their homes at lower interest rates, or financing consumer
spending by taking out second mortgages secured by the
price appreciation.

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03/31/2022 8
 EASY CREDIT CONDITIONS:

Lower interest rates encouraged borrowing. From 2000 to 2003,

the Federal Reserve lowered the federal funds rate target from 6.5%
to 1.0%.

This was done to soften the effects of the collapse of the 

dot-com bubble and the September 2001 terrorist attacks, as well as
to combat a perceived risk of deflation.

Additional downward pressure on interest rates was created by

the high and rising U.S. current account deficit, which peaked along
with the housing bubble in 2006.  

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OTHER BACKGROUND REASONS :

 Weak and fraudulent underwriting practices

 Predatory lending
 Increased debt burden or over-leveraging
  Financial innovation and complexity
  Incorrect pricing of risk
  Boom and collapse of the shadow banking system

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IMPACT ON FINANCIAL MARKET
 Financial institutions:

The first notable event signaling a possible financial crisis, occurred

in the United Kingdom on August 7, 2007 when BNP Paribas,
citing "a complete evaporation of liquidity", blocked withdrawals
from three hedge funds.

The significance of this event was not immediately recognized but

soon led to a panic as investors and savers attempted to liquidate
assets deposited in highly-leveraged financial institutions.
The financial institution crisis hit its peak in September and
October 2008.

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Several major institutions either failed, were acquired
under duress, or were subject to government takeover.
These included Lehman Brothers , Merrill Lynch ,  
Fannie Mae , Freddie Mac , Washington Mutual,
Wachovia , Citigroup and American International Group
. (AIG).
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Demise of Top ‘5’ of Wall Street
 Mounting subprime losses; paniced financial markets and
sucked out liquidity from the market led to the demise of the
top five investment banks / financial intermediaries of
“The Wall Street” .
Merrill Lynch – Bear Sterns
merged with Bank acquired by JP
of America Morgan Chase

Goldman Sachs – Morgan Stanley –

converted to converted to
commercial banks commercial banks

Lehman Brothers
- liquidated
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 US STOCK MARKET :

The US stock market peaked in October 2007, when

the Dow Jones Industrial Average index exceeded 14,000
points.
- It then entered a pronounced decline, which
accelerated markedly in October 2008.
- By March 2009, the Dow Jones average had reached a
trough of around 6,600. It has since recovered much of
the decline, exceeding 12,000 during most of 2011, and
occasionally reaching 13,000 in 2012. 

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 Stock Market Returns
 As of mid-December of 2008, stock returns were down by
37 percent since the beginning of the year.
 This is nearly twice the magnitude of any year since 1950.
 This collapse eroded the wealth and endangered the

retirement savings of many Americans.

S and P 500 Total Return
60%
50%
40%
30%
20%
10%
0%
-10%
-20%
-30%
-40%
50

53

56

59

62

65

68

71

74

77

80

83

86

89

92

95

98

01

04

07
Sli
19

19

19

19

19

19

19

19

20

20
19

19

19

19

19

19

19

19

19

20
de
Source: www.standardpoors.com
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The Economic Crisis of 2008: Cause of
and Aftermath rev200902 31
THE SHADOW BANKING SYSTEM :

Economist Paul Krugman and U.S.

Treasury Secretary Timothy Geithner explain the credit crisis via
the implosion of the  shadow banking system
“ Without the ability to obtain investor
funds in exchange for most types of mortgage-backed securities
  or  asset-backed commercial paper, investment banks and
other entities in the shadow banking system could not provide
funds to mortgage firms and other corporations.”

This meant that nearly one-third of the U.S. lending mechanism

was frozen and continued to be frozen into June 2009.

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 Wealth effects :

Between June 2007 and November 2008, Americans lost an

estimated average of more than a quarter of their collective
net worth.

 By early November 2008, a broad U.S. stock index the S&P
500, was down 45% from its 2007 high.

Housing prices had dropped 20% from their 2006 peak, with
futures markets signaling a 30–35% potential drop.

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 Total retirement assets, Americans' second-largest
household asset, dropped by 22%, from $10.3 trillion
in 2006 to $8 trillion in mid-2008.

During the same period, savings and investment

assets (apart from retirement savings) lost $1.2 trillion
and pension assets lost $1.3 trillion.

Taken together, these losses total a staggering

$8.3 trillion

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Impact of Global Financial Crisis on INDIA

 FIIs had invested on a massive scale in the

equity shares of several indian companies;
thus, due to this the share prices rose to new
heights… 


Year Sensex Points

2004 6000 mark
2005 8000 mark
2006 10000 mark
2007 13000 mark
2008 21000 mark
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.

 Around this time , US & European markets crashed..!!

 The share prices started falling sharply…& problems of liquidity & credit
crunch assumed grave proportions.
 FIIs to meet the liquidity requirements of their parent companies started
selling shares of indian companies in order to pull out capital from
India…..and the results were…..
Year Sensex
Jan. 2008 21000 points
Sept. 2008 11000 points
Oct. 2008 10000 points
Nov. 2008 9000 points

 Upto Nov 2008, FIIs sold more than $13 billion worth of indian shares…
thus, depreciating rupee against dollars..!

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Lessons from great depression 1929-
1933 to avoid any other great
depression......!!!

Avoid these policies:

◦ Monetary contraction
◦ Trade restrictions
◦ Tax increases
◦ Constant changes in policy; this merely creates uncertainty and delays
private sector recovery.

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This Recession is Likely to be Lengthy

 It will take time for the mal investments to be

corrected and for households to improve their
personal financial situation.
 Danger: Frequent policy changes will retard
recovery.

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What Needs to be Done?
1. The keys to sound policy are :
 well-defined property rights,

 monetary and price stability,

 open markets,

 low taxes,

 control of government spending,

 neutral treatment of both people and enterprises.

2. It should be announced and followed that:

i. The mistakes of the 1930s will not be repeated, including the
uncertainty generated by the frequent policy changes that
characterized the New Deal.
ii.In the future, government spending will be controlled and the
deficit be reduced.

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THANK YOU……………

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