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1.INTRODUCTION.......................................................................................................................................5 2.THE SUBPRIME CRISIS..........................................................................................................................6
DEFINITIONS................................................................................................................................................6 U.S SUBPRIME CRISIS :..............................................................................................................................10 D) ECONOMIC CONTEXT...................................................................................................................................14 E) CREDIT DEFAULT SWAPS ............................................................................................................................16 F) FIXED INCOME TOOLBOX..............................................................................................................................16 3. IMPACTS ON U.S....................................................................................................................................18
FINANCIAL MARKET IMPACTS, 2007: ............................................................................................................23 FINANCIAL MARKET IMPACTS, 2008:.............................................................................................................24 ON REAL-ESTATES............................................................................................................................27
4. IMPACTS ON INDIA..............................................................................................................................25
5. MEASURES TAKEN BY INDIAN GOVERNMENT ........................................................................28
AND MONETARY POLICY PACKAGES:...........................................................................29 i) Stimulus Package I............................................................................................................................29 ii) Stimulus Package II..........................................................................................................................30 iii) Stimulus Package III.......................................................................................................................33 C) RBI MEASURES .......................................................................................................................................35 D) REACTIONS : MIXED REACTIONS FROM THE INDUSTRY..............................................................................36 E) MEASURES PROTECTING THE POOR AND THE VULNERABLE:.............................................37 F) MEASURES SAFEGUARDING WORKER’S RIGHTS....................................................................37 G) SOCIAL DIALOGUE..........................................................................................................................39 H) CONCLUDING REMARKS................................................................................................................39 6. ACTIONS TAKEN BY U.S. GOVERNMENT......................................................................................40
FEDERAL RESERVE RESPONSES TO THE SUBPRIME CRISIS:.................................................................................40 REGULATORY RESPONSES TO THE SUBPRIME CRISIS:.........................................................................................41 C) ECONOMIC STIMULUS ACT OF 2008:............................................................................................................42 D) HOUSING AND ECONOMIC RECOVERY ACT OF 2008.......................................................................................42 E) FAILURES AND GOVERNMENT BAILOUTS OF FINANCIAL FIRMS:............................................................................43 7. CONCLUSION.........................................................................................................................................44
This paper was submitted as a final year project, BBA department, ravenshaw university March 2009. Its goal is to give a profound insight to the subprime crisis from a fixed income perspective. Following essential definitions and economic context setting, a deep look into the roots of the subprime crisis will be taken, with the U.S. as a reference. Then, the yield curve is analyzed as a prediction tool for past crisis, the current one, and future ones. It is concluded that the crisis could have been foreseen, eventually dampened, but not avoided. This is due to the complexity of the financial system. The TED spread will also be analyzed in the same way and gives an insight to the severity of the crisis – probably the largest one since the great depression! Finally, an insight to what has been happening and what it is like to work for such a hard-hit bank during times of crisis will be given. The goal is to provide other Master students with a deeper understanding of the subprime crisis, of fixed income tools and of an internship at an investment bank in such times.
“Information’s pretty thin stuff unless mixed with experience” – Clarence Day, The Crow’s Nest The above quotation reflects the reason behind our choice to undertake a practical thesis. However, given our lack of experience, this task proved to be more difficult than We thought. In consequence, the goal of this thesis is to transform our knowledge into something that a person, typically another student, can learn from. The following pages are an attempt to make a profound review of the subprime crisis and its effects from a fixed income perspective. There are no proofs or theorems but some interesting results. It is merely the effects that we observed as an intern within the department of Fixed Income at UBS Investment bank, Geneva. This is a summary of most of what we’ve done and seen, with some suggestions of what I would do if I had more time. In this context, we would like to express our deep-felt gratitude to our advisor, Mr.. , of the Ravenshaw University, BBA Department, for his advice, encouragement, enduring patience and constant support. Additionally, I want to express my warmest thanks to those who encouraged me during the perepartion of this project report which is actually way above our capabilities.
The main objectives of doing this project on global financial crisis during this time of economic slowdown are as follows: • • • • • • • To study about sub-prime crisis. To study the main reasons of this crisis. To study why did it turn into global economic crisis. To study the impacts of crisis on U.S. economy. To study the impacts of crisis on Indian markets. To study the measures taken by U.S government as well as Indian Government. To study the reactions of various sectors against the measures taken by the government.
theory and history will be provided before moving on to its predicting power. but more importantly it shall suggest future work that could be done which could lead to very interesting results that would not only be applicable to this crisis. as this is the department from which the crisis originates. as well as its tools. These two chapters together constitute the bulk of this thesis. examples. 5 . but to the coming one too. or perhaps it will have the complete adverse effect! In chapter 2. There are no particularly revolutionary findings within the following lines. which can be viewed as a measure of the amplitude of a crisis.INTRODUCTION The goal of this thesis is to provide a better understanding of the subprime crisis. This chapter is closely linked to the next one. and that it may have been avoided. causes and consequences. The conclusion will summarize the various aspects developed in this thesis. the economic context in which this thesis is written will be described. This is an important aspect in order to understand the rest. but there is a true explanation and linkage making between the various factors. the necessary definitions will be provided in order to ensure a smooth reading. Third will come its consequences and then finally we shall suggest some solutions/improvement/steps in order for this not to happen again (the true question being whether it can it ever be prevented!) The third chapter will be dedicated to the yield curve and its applications. a deep economic and financial explanation of the subprime crisis will be provided. and will allow us to realize the depth and importance of this crisis.1. This will be achieved from a fixed income point of view. In this chapter. Definitions. Then the fixed income department will be described. Second. as long as the key players in this crisis. First. This may also inspire other students to join such a team. where the same steps will be taken regarding what is called the TED-spread. the true explanation will unravel.
Reasons for this include poor credit rating. which includes payment delinquencies. This is known as the “origination-distribution” model. The volume of MBS originated and traded reached $3 trillion in 2005 in a U. as well as lax documentation and credit checks.The subprime crisis a) Definitions The term “subprime” refers to mortgagees who are unable to qualify for prime mortgage rates. as in any given environment of economic growth and prosperity. They have enabled banks and mortgage companies to increase the velocity and turnover of loans as banks and mortgage companies securitized and sold off these loans. and low introductory adjustable rate mortgages. When these conditions disappeared.S.2. bankruptcies. these were ignored. subprime mortgages simply mean lending to house borrowers with weak credit. These defaults caused an implosion of the mortgage-backed securities (MBS) and the collateralized debt obligations (CDOs) industry. Securitization enabled banks and mortgage companies. Lenders did so by providing teasers like minimal or zero down payment. The blow out surfaced in June 2007 with the collapse of two subprime mortgage hedge funds managed by Bear Stearns. charge offs. the first to default were subprime borrowers. there were some forerunners to this spectacular blow out. These subprime loans were fine as long as the housing market continued to boom and interest rates did not rise. Mortgage-Backed Securities (MBS) are the securitization of housing mortgages. quickly followed by the suspension of three other funds managed by BNP Paribas. the originators of these loans. large exiting liabilities and high loan value ratios. In other words. Interestingly. Total subprime loans form 25% of the housing mortgage market. 6 . However. and these could be observed already as of march 2007. housing mortgage industry of $10 trillion. to take on more loans as they moved the securitized loans off their books. low credit scores.
The volume of CDOs issued tripled between 2004 and 2006 from $125 billion to $350 billion per year (Bloomberg). financial innovation took these MBS to a higher level in terms of complication and leverage with the introduction of collateralized debt obligations (CDOs). CDOs are simply the bundling of a class of asset-backed securities into a special purpose vehicle and then rearranging these assets into different tranches with different credit ratings. this was totally ignored . it is considered trivial that the CDOs were a complete disaster. thus theoretically spreading the risks as much as possible. can choose which tranche to invest in. An investor. For example. complicating the pricing of these CDOs. these CDOs were used as underlying assets and repackaged to the next level of CDOs. the more removed it is from the actual underlying security. depending on risk propensity. Bank of China alone is exposed to $9 billion of ubprime CDOs. This is referred to as CDO squared and after another round. These CDOs were distributed far and wide. the loss ratio is no more than 10% . These subprime MBS are then divided into AAA tranche (70%). This was ignoring the underlying assumptions. It was not only banks throughout the world that bought these CDOs. interest rate payments. The defaults are confined not only to the underlying securities. Using historical rates of default and recovery. The higher the level of CDO. To further complicate matters. and priority of repayment.In the early nineties. 7 . and subordinated tranche (10%). but it should be pointed out that not more than a year ago. The AAA tranche pays lowest interest rate. it can be assumed that in an extreme case of default. a CDO could consist of 100 subprime MBS. but also the contracts written (CDS) on the traded securities. In this day. mezzanine tranche (20%). Layered on top of these are CDOs of credit default swaps (CDS) that multiplied the risks further. However. but also establishments such as town councils in far flung places like Australia that were chasing for higher yields. these were marketed as spreading the risks! They were seen as a revolutionary tool to combine all different asset classes covering a wide range of investment possibilities into one product. it becomes CDO cubed. but provides highest priority in terms of debt repayment.
sometimes tranched and often rated.Fig01: Graph of houses purchased with prime and sub-prime mortgages A special. and medium term notes (MTNs) and capital. company that purchases mainly highly rated medium and long term assets. Some SIVs are sponsored by financial institutions that have an incentive to create off balance sheet structures that facilitate the transfer of assets off their balance sheet and generate products that can be sold to investors. The aim is to generate a 9 spread between the yield on the asset portfolio and the cost of funding by managing the credit. General descriptions of the methodologies employed for SIVs by the agencies are publicly available on their web sites. investment vehicle (SIV) is a limited purpose. Capital is usually in the form of subordinated debt. or structured. 8 . The SIV funds these purchases with short-term asset backed commercial paper (ABCP). (for example. The basic approach is to determine whether the senior debt of the vehicle will retain the highest level of credit worthiness.rating) until the vehicle is wind-down for any reason. AAA/A. The level of capital is set to achieve this AAA type of rating. bankrupt remote. market and liquidity risks.
The size of the market is approximately US$2.with capital being used to make up possible short falls. Given the low risk of the bonds and the perceived low risk of the structured transactions insured by monolines. the portfolio is gradually liquidated. MBIA and AMBAC. Only the two major ones. they have a very high leverage. 9 . According to S&P. The total outstanding amount of bonds and structured financing insured by monolines is around US$2. have been able to inject enough new capital to keep their sterling credit rating. In recent years.5 trillion (Bloomberg). with more than half of municipal bonds being insured by monolines (Bloomberg). municipalities. both started out in the 1970s as insurers of municipal bonds and debt issued by hospitals and nonprofits groups. MBIA and AMBAC. The two largest monolines. or at least with an AAA level of certainty. Since the end of 2007 monolines have been struggling to keep their triple-A rating.6 trillion. before the vehicle ceases to exist. much of their growth has come in structured products such as asset backed bonds and CDOs. Monoline insurers provide insurance to investors that they will receive payment when investing in different types of assets. No debt will be further rolled over or issued and the cash generated by the sale of assets is used to payoff senior liabilities. with outstanding guarantees amounting to close to 150 times capital. If a trigger event occurs and the SIV is wind-down by its manger (defeasance) or the trustee (enforcement). on repayments on subprime home loans and face potential losses of US$19 billion . and a few others less exposed to subprime mortgages such as Financial Security Assurance (FSA) and Assured Guaranty. at least partly. Monolines carry enough capital to earn a triple-A rating and this prevents them from posting collateral. monolines insured US$127 billion of CDOs that relied.S. This insurance wrap guarantees a triple-A rating to the bonds issued by U. The vehicle is designed with the intent to repay senior liabilities. Winddown occurs if the resources are becoming insufficient to repay senior debt.
what is credit default swaps? CDS is essentially a form of insurance in which the buyer of the swap makes a series of payments to seller of the swap and in return has the right to payoff if the financial security he has invested in defaults.development rate was very high. with a objective of giving a house to every poor and young people at US.indicating that they have a good credit rating based on their track record . The era when US economy is going with a very good time. Now the intial topic CDS (credit debt secutirties )comes into picture. interest rate charged by US central bank with a mortgage of security.let us see how ? Fannie Mae buys loans from mortgage originators. meaning their track record in repaying loans has been below par.The US Clinton govt..b) U. repackages the loans as mortgagebacked securities and this mortgage backed securities (MBS) is a type CDS. Typically. because of increased risk. The banks started granting these loans. Fannie mae sells these MBS to investors in the secondary mortgage market in whole global market with a guarantee that principal and interest payments will be passed 10 . Loans given to sub-prime borrowers. 1. it is the poor and the young who form the bulk of sub-prime borrowers.S Subprime Crisis : What is a sub-prime loan? In the US.huge liquidity in stock markets. till now everything is going in a simple way but Freddie Mac and Fannie Mae the 2 govt subsidary companies made whole situation complicated. borrowers are rated either as 'prime' . interest rates are going down. Fannie Mae facilitates liquidity in the primary mortgage market by ensuring that funds are consistently available to the institutions that do lend money to home buyers. who functions as an intermediary in the U. And in this era. something banks would normally be reluctant to do.S by purchasing and securitizing mortgages. And the loan given by violation of these prime guidelines is known as sub prime loans. are categorised as sub-prime loans.or as 'sub-prime'. 1993.no inflation.usually not all default occur at one time but this time it does happened. eased these prime guidelines by giving loan on very small or even on no security and the interest rates made higher by 2% for these loans. Concept :The prime guidelines of US regulation to give a simple loan with rules of minimum.
Subprime borrowing was a major contributor to an increase in home ownership rates and the demand for housing.FII become impatient and started putting out their money from all over the world stock market. American home prices increased by 124%. in February 2007 with the $10. Almost all the public companies have MBS and CDS are in their portfolio in huge amount.By purchasing the mortgages. Three of the five either went bankrupt like Lehman Brothers or were sold at fire-sale prices to other banks like Bear Stearns and Merrill Lynch during September 2008. Fannie Mae and Freddie Mac provide banks and other financial institutions with fresh money to make new loans. creating instability in the global financial system. govt. Also. which increased their vulnerability to the MBS losses. Jan 2007. 3. 11 .2%.through to the investor in a timely manner. There was huge increase in subprime loans and The overall U. The biggest 5 investment banks reported over $4. Biggest result of these crises came when the Dow dropped below 13. All the MBS or CDS are become worthless because the people whose loans are made as gurantee for them are no more.Morgan.S. August 15. Fannie Mae may hold the purchased mortgages for its own portfolio. home ownership rate increased from 64% in 1994 (about where it was since 1980) to a peak in 2004 with an all-time high of 69. Sept 2007. The financial sector began to feel the consequences of this crisis.and all stock market gone down. 2007. started increasing lending rates and there is too much supply of homes upto that time. The remaining two converted to commercial bank models. This demand helped fuel housing price increases and consumer spending.S. The top five US investment banks each significantly increased their financial leverage during the 2004–2007 time period.000. This all started a race between banks to make subprime loans and generting more revenues and become market leader and the greedy loan agent helped out them too.5 billion writedown of HSBC which was the first major CDO or MBO related loss to be reported 2. Sub prime Credit holder started doing defaults and at time came when huge subprime credit holder made default at a time and that was a real mess up situation for us economy. subjecting themselves to much tighter regulation like J. a figure roughly 30% the size of the U. inflationary pressure started coming on america's economy. Immediate impacts 1. Many financial institutions borrowed enormous sums of money during 2004–2007 and made investments in mortgage-backed securities.P. economy.1 trillion in debt for fiscal year 2007.
any crisis affecting these investors sees a contagion effect through the world. • c) IMF (International monetary Fund) The International monetary Fund works as :I. II.the preception of equating the sphosticated compliacted CDS with the simple life insurance of many finance company like AIG. any crisis in the US has a direct bearing on other countries. there are two major ways in which the effect is felt across the globe. Promoting the growth of trade. Promoting exchange rate stability. which implies the impact of US subprime crisis on Europe is when Germany 's IKB Deutsche Industrial bank accepted USD$11. since global equity markets are closely interlinked through institutional investors. Prospective purchasers for the mortgage lender are still being looked for. Impact on world:1. • First. BNP Paribas. Thus. Fannie Mae and Freddie Mac which resulted all of them into big bail out packages and US govt. subsidisation themselves and fall of whole world economy. China and to a lesser extent India. Increasing international monetary cooperation.2 billion pertaining to investment funds as the true value of the investment portfolios could not be ascertained. Another instance in Germany. particularly those with large reserves like Japan. 2007. Also. the US is the biggest borrower in the world since most countries hold their foreign exchange reserves in dollars and invest them in US securities. Northern Rock.1 billion from the Government as a bailout pertaining to its various United States mortgage investments. which was an eminent mortgage lender took refuge in the Bank of England for purposes of emergency financing in the month of September. That was not CDS instrument that made all went wrong. Apart from the fact that banks based in other parts of the world also suffered losses from the subprime market. It stopped all withdrawals from a fund of USD$2. III. 12 .Main culprit :-At the end of day I hope u all people are supposing CDS as the main culprit to make a big messing US subprime financial crises but the story was not like that. but the wrong implementation of the security instrument. • Some of the instances which shows world is affected by subprime crises:• • • The oil prices which were gone upto 150 US$ per barrel is now came to less than 60 US $. the French Bank was compelled to take some drastic steps.
2. Banking sector already gone with this mess.Low demand. GE Capital.Reverse Repo etc. 13 . there are proposals to hike this limit to 49%. US Success stories in this sector include Citicorp. which strengthen the liquidity crunch.SLR.But in this money pulling the real looser is not the FII but the small investor because FII pulled out their huge money in bull rally. IT. Backing of FDI :. Establishing a system of multilateral payments. because the crisis starts only because. 2.with. Pakistan 9. However. Telecom sector. US companies that have successfully entered this field in India include New York Life.6 billion. low sales.even in some sectors out way to the non performer employees. IMF has issued bail out packages of many countries slashing economy like Iceland US$ 6 billion. The Job Scenario :1. The US investor community was sharing confidence in the future of the Indian economy. which is open for private participants. In the current prices. All the export oriented industries jewellery. and American Express.handicrafts and many more. Increase in banking rates :. and encouraging progress towards convertibility of member currencies. FDI in banking is permitted up to 49%.from the banks. Several areas like infrastructure. The insurance sector in India is opened up for up to 26% FDI. Both government-to-government level and business-to-business level conduct regular interactions with each other to promote and strengthen the trade and economic interactions between the two countries. USA covers almost every sector in India. low revenue. energy and other knowledge industries such as pharmaceuticals and biotechnology. India : The liquidity crunch :1 .and leave the small investor in the bear market with huge stock market fall. On investment front.all the big banks of world are facing problem. 3. eliminating exchange restrictions which hamper the growth of world trade.Building a reserve base.textile. AIG etc. low profits simply means to stand by in present scenario cost cutting is only way and this cost cutting converts into no new recruitment at all.08% share in FDI inflows to India.To control the inflation RBI made a cut in all its key lending and policy rates like CRR.USA has 17.Repo. FII money pull out :-As I already explained how FII pulled out their money from India and other part of world stock market.all suffering from liquidity crunch around the world. possess immense potential for progressing economic cooperation between India and the US. The job scenario changed drastically in last one year and all because of above financial muddle.IV. V.
S. where in many US companies are reaping the advantages offered by India's IT sector. Tecumseh Products (India) Limited. or have failed. which offers huge cost benefits to the US MNCs. Treasury and Federal Reserve helped to broker 14 . 3M. pistons. Europe. U. other segments of the credit markets. Fish and seafood (frozen shrimp). 4.India's sizable population and growing middle and higher income class makes India a potentially large market for U. Oracle Corporation. Panicing environment :This is not that much fundamentals of liquidity crunch effect the market but the influencing panic environment all over the country. Sun Microsystems.General Electric. Textile floor coverings. India's main exports to US are precious stones. 5.S. Agilent Technologies Inc. Whirlpool Ford (India). transmission shafts. Organic chemicals and Machinery (taps. Australia and Asia and it is feared that write-offs of losses on securities linked to U. Texas Instruments. Woven apparel. goods and services. totalled US $5. with losses since the start of 2007 at leading banks and brokerage houses topping US$250 billion. Banks have suffered liquidity problems. Proctor and Gamble (India). subprime mortgages and. It has brought the asset backed commercial paper market to a halt. Adobe Systems Inc. IBM Corporation. metals (worked diamonds & gold jewellery). The U. English speaking personnel.1 billion. According to the figure from government sources.A very important aspect of US India economic relations comes with the emergence of Business Process Outsourcing. could reach a trillion US dollars . d) Economic context The credit crisis of 2007 started in the subprime mortgage market in the U. exports to and imports from India in 2003. gears. India offers a large pool of trained. valves. by contagion. hedge funds have halted redemptions. as of April 2008 (Bloomberg). EDS.S.S. Among the major multi national corporations of USA that are doing a profitable business in India are. Iron/steel products. resulting in the nationalizing of the troubled mortgage lender. Knit apparel.0 billion and US $13. respectively. miscellaneous textile article. Intel. Financial institutions are expected to write off an additional US$80 billion in the first quarter of 2008 .S. The investor don't want to invest his money into any asset class because he don't perceive his money safe in any asset class by investing it to any asset class rather he belives best to keep his money safe in his bank account. Export decrease :. It has affected investors in North America. Pepsi. Credit related problems have forced some banks in Germany to fail or to be taken over and Britain had its first bank run in 140 years. and special investment vehicles have been wound-down. Microsoft. etc).
S. to preserve their regulatory capital ratios. tighter credit conditions could directly subtract 1.25 percentage points to 2 4 percent between August 2007 and June 2008 in order to address the risk of a deep recession (Bloomberg). causing a decline in lending to companies and consumers. from 340 basis points (bps. high-yield bond spread has reached 700 bps over Treasuries. corporate credit markets. have been charging each other much higher interest rates than normal in the inter bank loan markets.5 points from the secondquarter growth . from 600 bps at the start of the year. The severity of the crisis on bank capital has been such that U.S. According to some economists. The deepening crisis in the subprime mortgage market has affected investor confidence in multiple segments of the credit market. For example. leverage buy-out loans (LBOs). and has taken on mortgage debt as collateral for cash loans. 2008. auctionrate securities. and 2. The biggest danger to the economy is that. The Fed has also been offering ready sources of liquidity for financial institutions. 100bps = 1%) to 490 bps. The Fed lowered its benchmark interest rate 3. the cost of insuring against default by European speculative bonds had risen by almost one-and-a-half percentage point over the previous month. and parts of consumer credit.S. concerned about the magnitude of future write downs and counterparty risk. banks have had to cut dividends and call global investors. that are finding it progressively harder to obtain funding. credit conditions have tightened for all types of loans since the subprime crisis started nearly a year ago. for capital infusions of more than US$230 billion. 15 . banks will cut off the flow of credit. the fifth Wall Street investment bank. In January 2008. This alone represents one of the largest cuts in interest rates in U. They have been wary of lending to one another and consequently. such as sovereign funds. such as credit cards and car loans. The credit crisis has caused the risk premium for some financial institutions to increase eightfold since last summer and is higher than the cost of raising cash for non-financial firms with the same credit rating. while the U. by JP Morgan Chase during the week-end of March 17. with problems for commercial mortgages unrelated to subprime. Banks. history. including investment banks and primary dealers.25 percentage point from first quarter growth in the U. have been trying to keep as much cash as possible as a cushion against potential losses. as of May 2008.the rescue of Bear Stearns.S. based on data compiled by Bloomberg. The effects of the crisis have affected the general economy.
All that brain storming led to the birth of a new concept-CDS. Liquidity:-Illiquid capital markets have made it hard for them to finanace their own debt. hard core drinks and music. or corporate bank debt. All of them under attack. Confidence :-Falling confidence has damaged inter-bank lending and made depositors jittery.Unprecedented losses have depleted financial institution's capital faster than their ability to raise new capital. such as stocks. preferred stock is also considered to be fixed income. 16 . Capital :. Somewhere in Florida -The sea beach with sexy gals. The guys were there to have a brain storming session about the money which US regulation make them to keep aside in case of their investment get bust. The modern financial system rests on 3 pillars: 1. 1994. Liquidity 3. The most basic tool in fixed income is the bond.e) Credit Default Swaps The monster that ate US economy. Confidence Currently. This money hardly earned any return. Capital 2.5 trillion US $. f) Fixed income toolbox Fixed income refers to any type of investment that yields a regular return. the bankers of J. This brainstorming on ways to obviate the risk of default in financial securities and free up the reserve money for investment. Such securities can be contrasted with variable return securities. lavishing food. Morgan met for an offsite weekend.P. (Credit Default Swaps). The total estimated fianacial damage till now is 1. People who invest in fixed income securities are typically looking for constant and secure return on their investment. At UBS Investment bank.
It is the difference between the yield of interbank loans (rates at which the banks loan to each other) and government loans (which are directly derived from the rates set by the Fed).Interest rates change over time. 17 . and viceversa. bonds). The TED-spread is also a fixed income tool that is directly linked to interest rates on bonds. it is obvious the most important aspects within fixed income are the interest rates. The term yield refers to the percentage that measures the cash returns to the owners of a security. its yield goes up. The yield of a bond is inversely related to its price today: if the price of a bond falls. base on a variety of factors. which is the relation between the interest rate and the time to maturity of the debt for a given borrower in a given currency. Based on the above. we derive the yield curve. The interest rate will directly affect the yield of a bond. particularly the rates set by the Federal Reserve (regarding U. From this. it will have to pay the investor a premium in order for them to buy their bonds in order to attract them to their security. This tool will be one of the foci of this thesis.S. Otherwise investors would buy government bonds which are considered to be 100% secure. When a company is issuing a bond. To complicate matters a bit. just like stocks. along with the TED-spread. fixed income securities are traded on the open market.
3. “We do not expect significant spillovers from the subprime market to the rest of the economy or the financial system”.S. 18 . The chain reaction from the described problem can be summarized as in the figure below: At the end of spring 2007. The Bank of Canada issued a statement that it pledges to “provide liquidity to support the Canadian financial system and the continued functioning of financial markets” . Chairman of the Federal Reserve. IMPACTS ON U. the European Central Bank injected 95 billion euros (US$131 billion) and informed banks that they could borrow as much money as they wanted at the bank’s current 4% base rate without limit. At the start of August. stated. Ben Bernanke.
5. During the same week.1 billion (US$1. The Russian Central Bank injected Rbs 43.13 trillion over the last week. causing the yen to increase 4% against the dollar. The FTSE 100 index declined by 4. Citigroup.1%. the Fed injected US$5 billion into the money market through 14 day repurchase agreements and another US$12 billion through one day repurchase agreements.4%. Traditionally. Also during this period. the low levels of interest rates during the past few years has meant that many of these issuers moved away from the CP market and issued low cost debt with maturities ranging from 5 to 10 years. 18 prime corporate names used the CP market to finance short term cash needs. Foreign investors had started to flee the ruble debt market.3% against the Euro.5% against the Australian dollar. President of the St. The Unwinding of carry trades caused a sudden 2% increase in the yen/dollar exchange rate. 10. The Fed took the unusual step of issuing a public statement that Mr.7 billion) into the banking system. each borrowed US$500 million from the Fed . Louis Federal Reserve publicly argued against a rate cut (August 16). Four banks.8% against the pound. with investors buying Treasuries. the Fed reported that the total commercial paper (CP) outstanding fell more than US$90 billion to US$2. Bank of America and Wachovia.3% against the New Zealand dollar and 11. causing a liquidity squeeze. 5. Fed has done similar in the US. with hedge funds and institutional investors unwinding carry trades. a flight to quality occurred.3% and Standard Chartered fell 7. William Poole. The European Central Bank has pumped money into Europe’s overnight money markets. The yield on the three month T-bill fell from approximately 4% to as low as 3. Further unwinding occurred two days later. Poole’s comments did not reflect Fed policy. with financial companies being the hardest hit.In the second week of August.6%. Man Group fell 8. JP Morgan. Bank of America and Wachovia. The current lack of demand for CP made it very difficult for borrowers to rollover debt. However. In a statement. JP Morgan. stated that they have substantial liquidity and have the capacity to borrow 19 .
Institutional investors switch from commercial paper to Treasuries. during the day. They were trying to encourage other banks to take advantage of the lower discount rate at the Fed window. the flight to quality continued. and by the end of day. other parts of fixed incomes markets continued to function. in April 2008.money elsewhere on more favourable terms. The table below summarizes the top 15 announced losses per bank. the more worrying aspect.04%.5 billion in senior unsecured notes. with investment grade companies issuing debt: Comcast Corp sold US$3 billion 19 in notes. During the third week of August. The volatility in the foreign exchange market caused some hedge funds to close their yen carry trade positions. investors poured US$42 billion into money market funds. At the start of trading in New York. Indeed. the key word being announced. Today. However. 20 . The consequences have not fully revealed themselves. it fell to 2.90%. for investment banks and securities dealers that give them the possibility to borrow against a wide range of securities as collateral for cash loans. Bank of America sold US$1. the Fed took the unprecedented measure of introducing a new lending facility. More recently. are the reports that state that today’s announced losses may represent only one third of the actually losses that have been or will be incurred by this crisis . yet.51%. the yield on the 3 month T-bill was 3. Among other things the securities pledged by dealers must have market prices and “investment grade” credit ratings . and inflation as well as economic downturn in the industrial sector are only starting to point their noses . as of July 2008. the losses incurred by this crisis are enormous.5 billion in notes and Citigroup US$1 billion in notes. it closed at 3. Between August 16th and 22nd. called the Primary Dealer Credit Facility (PDCF). There was a rare high yield issuing by SABIC Innovative Plastics. It sold US$1.
On April 2nd told a congressional committee that output was unlikely to “grow much. The hangover's duration will depend on many things. Ben Bernanke. from the strength of foreign economies to the degree to which American firms cut jobs and investment. over the first half of 2008 and could even contract slightly”.Since the beginning of this year.6% a year earlier and non-farm payrolls have declined 6 months in a row. if at all. The labour market figures point to a shrinking economy: As of June 2008. chairman of the Federal Reserve.S. are the fate of 21 .5% from 4. economists and government officials have had great concerns over a recession taking place in the U. given the recession's origins in the property bust and the credit crunch. Although not official yet. But top of the list. it is becoming increasingly obvious that the American economy has slipped into recession. there has been a jump in the unemployment rate to 5. losing 438’000 jobs since January 2008.
the odds are against catastrophe but on a lasting headache. was down 45 percent from its 2007 high. had dropped to $8. Total retirement assets. Housing prices had dropped 20% from their 2006 peak.3 trillion. it seems unlikely. with futures markets signaling a 30-35% potential drop. By early November 2008. stock index. Total home equity in the United States. suggests that crashes typically last about four years and are often accompanied by banking crises. But given the scale of America's housing binge and of the financial crisis the bust has spawned.8 trillion by mid-2008 and was still falling in late 2008. Perhaps this time will be different. these losses total a staggering $8. from $10. Taken together. which was valued at $13 trillion at its peak in 2006.S. dropped by 22 percent. Between June 2007 and November 2008. Americans lost more than a quarter of their net worth. Economies end up 8% smaller on average than they would have been had they carried on growing at pre-crunch rates .the housing market and the resilience of consumer spending. On both counts. An analysis by the fund of post-war housing busts in rich countries. the S&P 500. The IMF's gloom is based in part on its reading of history . and the hangover will soon be gone. Americans' second-largest household asset. written in 2003. During the same period. No one knows by how much. savings and investment assets (apart from retirement savings) lost $1.3 trillion in 2006 to $8 trillion in mid-2008.2 trillion and pension assets lost $1. a broad U. 22 . or for how long.3 trillion. America's economy will be weighed down.
Profits declined from $35. In all of 2007. wrote down its holdings of subprime-related MBS by $10. Bank & Thrift Profitability By Quarter The crisis began to affect the financial sector in February 2007. some of which has been invested into food and raw materials. Financial speculation in commodity futures following the collapse of the financial derivatives markets has contributed to the world food price crisis and oil price increases due to a "commodities super-cycle. or announced that they were negotiating seeking merger partners. when HSBC.2 billion in 2006 Q4 billion to $646 million in the same quarter a year later.S. the crisis caused panic in financial markets and encouraged investors to take their money out of risky mortgage bonds and shaky equities and put it into commodities as "stores of value". down 31% from a record profit of $145 billion in 2006. insured depository institutions earned approximately $100 billion.3 billion in 2008 Q1. a decline of 46% . a decline of 98%.U. Mortgage defaults and provisions for future defaults caused profits at the 8533 USA depository institutions insured by the FDIC to decline from $35. During 2007." Financial speculators seeking quick returns have removed trillions of dollars from equities and mortgage bonds. During 2007.5 billion. 2007 Q4 saw the worst bank and thrift quarterly performance since 1990.6 billion in 2007 Q1 to $19. at least 100 mortgage companies either shut down.a) Financial market impacts. As the crisis deepened. suspended operations or were sold. the first major subprime related loss to be reported. Top management has not escaped unscathed. the world's largest (2008) bank. more and more financial firms either merged. as the CEOs of Merrill Lynchand Citigroup resigned within a week of each other in late 2007. 2007: FDIC Graph . 23 .
quadrupled shortly after the Lehman failure. 2008: As of August 2008. and other central banks was immediate and dramatic. About $750 billion in such losses had been recognized as of November 2008.5 trillion. When Lehman Brothers and other important financial institutions failed in September 2008. These losses have wiped out much of the capital of the world banking system. This credit freeze brought the global financial system to the brink of collapse. these central banks purchased US$2. Thus the massive reduction in bank capital just described has reduced the credit available to businesses and households . 24 . $150 billion were withdrawn from USA money market funds. financial firms around the globe have written down their holdings of subprime related securities by US$501 billion. In effect. Banks headquartered in nations that have signed the Basel Accords must have so many cents of capital for every dollar of credit extended to consumers and businesses. the crisis hit a key point.5 trillion of their holdings of subprime MBSs. the money market was subject to a bank run.b) Financial market impacts. the European Central Bank. During the last quarter of 2008. in world history. This was the largest liquidity injection into the credit market. During a two day period in September 2008. The average two day outflow had been $5 billion. The IMF estimates that financial institutions around the globe will eventually have to write off $1. by purchasing newly issued preferred stock in their major banks. The money market had been a key source of credit for banks (CDs) and nonfinancial firms (commercial paper). and the largest monetary policy action. The governments of European nations and the USA also raised the capital of their national banking systems by $1.5 trillion of government debt and troubled private assets from banks. The TED spread(see graph above). a measure of the risk of interbank lending. The response of the USA Federal Reserve.
demand for India investment and cost thereof and decreased consumer demand affecting Indian exports. the impact will be on the cost and related risk premium. The debate. Also.4. The impact of which. The concerted intervention by central banks of developed countries in injecting liquidity is expected to reduce the unwinding of India investments held by foreign entities. again. Indian companies which had access to cheap foreign currency funds for financing their import and export will be the worst hit. but fresh investment flows into India are in doubt. foreign funds (through debt and equity) will be available at huge premium and would be limited to blue-chip companies. will be three-fold: Reduced capacity expansion leading to 25 . The impact will be felt both in the trade and capital account. correction in the asset prices which were hitherto pushed by foreign investors and demand for domestic liquidity putting pressure on interest rates. therefore. can only be on the extent of impact and how resilient India is to withstand the storm with minimal damage! In the light of the fact that the Indian economy is linked to global markets through a full float in current account (trade and services) and partial float in capital account (debt and equity). a)ON IMPORT-EXPORT While the global financial system takes time to “nurse its wounds” leading to low demand for investments in emerging markets. we need to analyse the impact based on three critical factors: Availability of global liquidity. IMPACTS ON INDIA Globalisation has ensured that the Indian economy and financial markets cannot stay insulated from the present financial crisis in the developed economies. The impact of this will be three-fold: The element of GDP growth driven by off-shore flows (along with skills and technology) will be diluted.
b) ON FINANCIAL INSTITUTIONS: The impact on the financial markets will be the following: Equity market will continue to remain in bearish mood with reduced off-shore flows. increased interest expenses to affect corporate profitability and increased demand for domestic liquidity putting pressure on the interest rates. India cannot wish away from the negative impact of the present global 26 . once again.supply side pressure. Given the dependence on foreign funds and off-shore consumer demand for the India growth story. The impact of which. other income from cross-border business flows and distribution of investment products will take a hit. The banking sector will have the least impact as high interest rates. while the inflation would stay under control. limited domestic appetite due to liquidity pressure and pressure on corporate earnings. while RBI would inject liquidity through CRR/SLR cuts. maintaining growth beyond 7% will be a struggle. reduced exports will further widen the trade gap to put pressure on rupee exchange rate and intervention leading to sucking out liquidity and pressure on interest rates. leading to lower demand for Indian goods and services. Banks with capabilities to generate low cost CASA and zero cost float funds will gain the most as revenues from financial intermediation will drive the banks’ profitability. increased demand for domestic liquidity will push interest rates higher and we are likely to witness gradual rupee depreciation and depleted currency reserves. thus affecting the Indian exports. increased demand for rupee loans and reduced statutory reserves will lead to improved NIM while. will be three-fold: Export-oriented units will be the worst hit impacting employment. on the other hand. Overall. Consumer demand in developed economies is certain to be hurt by the present crisis.
But. now as the fate of these investment banks is uncertain.financial crisis but should quickly focus on alternative remedial measures to limit damage and look in-wards to sustain growth! c) ON REAL-ESTATES The crisis in the US financial market will hit the Indian real estate sector hard. 27 . This will put severe constraint on availability of funds in India. Consultants said that in the present circumstances the real estate prices will go for a sharp correction in the short to medium term. they are depended on foreign funds through FDI route for their fund requirements. A large player in the sector said that as the availability of funds from banking sector is restricted for the realty sector. As RBI has already put restriction on Indian banks to finance real estate companies in the country. a senior consultant said following the development in US. besides restricting the fund flow in it. they are forced to borrow from the high net worth individuals at high interest rates at around 20%. The sector was already reeling under tremendous pressure as RBI increased the interest rates to contain inflation. The source said that many of these private equity funds were launched by investment banks. many of the private equity funds are returning back to their mother countries. The financial crisis in the global market will affect the availability of fund for the domestic realty sector. their capability to raise funds in their country is doubtful. But.
amount of another 20’000 Crore for the next 2 years. felt the aftermath of the financial crisis emanating from the US rather quickly. The overall stimulus package adds up to around US$8 billion that is less than one percent of the GDP. Amongst other proposals. Sectors which were exposed to the global market to a high degree such as civil aviation. As External Commercial Borrowings (ECBs) got dried up. Goernment is aware that announced measures (providing an economic stimulus to economy) need to be extended beyond the current financial year. gems and jewellery and so on were suddenly faced with a decline in demand that led to job loss and/or adjustments in wages and salaries. First the crisis appeared as a crash in the stock market following the steady withdrawal of funds by the Foreign Institutional Investors. This should keep the potential for liquidity constraints in banks minimal. Suddenly it was realized that the economy was not going to realize its expected growth rate of 9 percent. Even though measures like further tax cuts is unlikely to be announced.5. This in turn led to a credit crunch giving rise to soaring interest rates especially in the money market. which was widely believed to be less integrated with the global economy. There is some concern that these measures would lead to an increase in the fiscal deficit significantly (approx. The Prime Minister of India had a review meeting with captains of Industry on the impact of the ongoing global financial crisis and constituted an apex group under his 28 . A Stimulus Package for US $ 4 billion was announced on 6 December 2008 and was followed later by a second package on 2 January to prevent a further slow down of the economy. 3-5%) which is a concern to many stakeholders. leather. It is in this background that the Government of India came out with two stimulus packages. Government is finalising Plan and Non-plan expenditure that will be required for the next financial year to maintain the same momentum. many Indian corporate firms turned to the domestic market for their credit needs thus compounding the problem. Hence. given the already growing fiscal deficit of India. b) improve access to credit and liquidity for enterprises and c) to boost local demand for selected goods and services. the plan will include recapitalisation of public sector banks with an app. MEASURES TAKEN BY INDIAN GOVERNMENT a)BACKGROUND: The Indian economy. Official circles talked about a 7 percent growth rate while independent estimates came out with predictions that were less than this rate. These stimulus packages were intended to rebuild confidence in the economy basically to a)support most affected sectors. textiles.
0 percent. and its reverse repo rate . Danske Bank: 8 December 2008) . The other embers of this high powered committee are the Ministers of Commerce and Industry.Full refund of service tax paid by exporters to foreign agents . India’s central bank (The Hindu.Export duty on lumps for steel industry reduced to five percent The RBI also announced that it will extend a line of credit to small scale industries and housing finance banks: 29 .100 billion through tax-free bonds .500.2 million .Import duty on naphtha for use by the power sector is being reduced to zero . . billion (Rs. This included enhanced credit for exports. Deputy Chairman.000.Interest subvention of two percent on export credit for labour intensive sectors . Planning Commission and the Governor of the Reserve Bank of India. the package will. According to the Deputy Chairman of the Planning Commission Mr. b)FISCAL AND MONETARY POLICY PACKAGES: i) Stimulus Package I Amount : First Package US 4.000 crore) (the Indian News: 7 December 2008) The first fiscal package.Limits under the credit guarantee scheme for small enterprises doubled . Montek Singh Ahluwalia. 5 November 2008).5 percent.India Infrastructure Finance Co allowed to raise Rs. Finance. was intended to keep the domestic demand high as well as to provide incentives to some selected export sectors. (Flash Comment. a modest one. the rate at which it borrows overnight to 5. and up to Rs.Lock-in period for loans to small firms under credit guarantee scheme reduced .chairmanship to monitor and coordinate the government’s response to the crisis. the rate at which it lends to commercial banks -to 6. relief to the dooming housing sector and SMEs.Incentives for loans on housing for up to Rs.Export duty on iron ore fines eliminated . cut in excise duties. Monetary /Fiscal A cut in interest rates by India’s central bank: The Reserve Bank of India reduced its repo rate. The Prime Minister also approved a Committee of Officers under the chairmanship of the Finance Secretary to consider the issues raised by the Industry on daily basis.Norms for government departments to replace vehicles relaxed . “minimize the impact of weak global economy on the Indian economy” and help achieve a 7% growth rate. 20.Additional allocations for export incentive schemes .
In the light of the decline in exports by 12%. Accelerated Irrigation Benefit Programme and National Social Assistance Programme. Ltd to raise Rs.In addition: To boost exports. 10. the government has decided to subsidize this sector with an interest subvention of 2% upto March 2009 to pre and post shipment export credit for labour intensive exports like textile. The fiscal incentives announced so far will continue till a new government gets the opportunity to present a full budget after General Elections during mid 2009 (The Financial Express dt. public sector banks were urged to announce attractive home loan packages. Jawaharlal Nehru National Urban Renewal Mission. India Awas Yojana. The government also announced that initiatives are being taken to support Public Private Partnership programme of Rs. marine products and SME sector. To boost housing sector.000 crores through tax free bonds. 5 Jan 2009) . National Rural Employment Guarantee Scheme. 20. leather.The government announced a cut in Centrally-imposed Value Added Tax by 4% to increase spending across-the-board . 30 . Concession is subject to a minimum rate of interest. the government authorized a recently created India Infrastructure Finance Co.000 crore in the current year mainly for critical rural infrastructure and social security schemes such as Pradhan Mantri Gram Sadak Yojana. restored benefits to exporters. announced extra allocation of 70 million dollars. govt.000 core to the highway sector.1 billion The second stimulus package liberalized overseas borrowing norms. 100. set up an alternative channel of finance for non-banking finance companies and allowed state-run India Infrastructure Finance Company Ltd (IIFCL) to issue additional taxfree bonds. The government decided to seek authorization for additional plan expenditure of upto Rs. To boost infrastructure spending. ii) Stimulus Package II Amount: US $ 4.
Recently.In order to give a boost to the corporate bond market Foreign Institutional Investments (FII) limit in rupee denominated corporate bonds in India would be increased from US $ 6 billion to US $ 15 billion.09 announced a set of measures. and c) Non-Banking Finance Companies (NBFCs).An arrangement will be worked out with leading Public Sector Banks to provide line of credit to NBFCs specifically for purchase of commercial vehicles.com. 2. . 50 lakhs to Rs. as second fiscal stimulus package. . (b) To facilitate access to funds for the housing sector. In addition.financial express.Monetary/Fiscal 1. Details will be announced separately. the guarantee cover under Credit Guarantee Scheme for MSME on loans was extended from Rs. under the approval route of RBI: (www.Additional steps are being taken on the monetary. 5 January 2009). dealing exclusively with infrastructure financing. 5 lakh. Ease Access to Overseas Loans and investments . credit and fiscal front to further strengthen the contra-cyclical stance of policy. the ‘development of integrated townships’ would be permitted as an eligible end-use of the ECB. 31 .000 crores (6 billion USD) . The scale of liquidity potentially available through this window is Rs. To Enhance Credit Flows . In order to enhance flow of credit to micro enterprises. would be permitted to access ECB from multilateral or bilateral financial institutions.A Special Process Vehicle(SPV) will be designated shortly to provide liquidity support against investment grade paper to Non-Banking Finance Companies (NBFCs) fulfilling certain conditions. 1 with a guarantee cover of 50%. it has been decided to increase the guarantee cover extended by Credit Guarantee Fund Trust to 85% for credit facility up to Rs. with view to further liberalizing the policy on External Commercial Borrowing (ECB) the Government and the RBI have decided: (a) The “all-in-cost” ceilings on such borrowing would be removed. under the approval route of RBI. under the approval route of RBI: for particular industries. 25.1. The RBI has on 2.
For Exports Exporters are especially hit by the recessionary conditions globally.Taking into account the fact that the rupee has appreciated nearly 4% against the dollar since November 2008. For Infrastructure Capex o States will be allowed to raise in the current financial year add. For Commercial Vehicles States. a number of steps have been taken: . o Authorizing India Infrastructure Finance Company Limited (IIFCL) being enabled to access additional in trenches an additional Rs 30 000 Crore through tax-free bonds to fund additional projects of about Rs. . Market borrowings of . 5000 crore and will provide pre-shipment and post-shipment credit in rupees of dollars to Indian exports at competitive rates. 32 . bicycles.09. To support exports.EXIM Bank has obtained from RBI a line of credit of Rs. 5. will be provided assistance under the JNNURM to buy buses for their urban transport systems Accelerated depreciation of 50% to be provided for commercial vehicles to be bought on or after January 1 2009 and up to March 31 2009.12. 75000 Crore at competitive rates over the next 18 months. the DEFB scheme would be extended till 31.3. it has been decided to restore DEPB rates to those prevailing prior to November 2008. In order to provide predictability and stability of regime in the short term for future contracts. as a one time measure up to June 30 2009. 4.000 Crore for capital expenditure. .5% of Gross State Domestic Product) amounting to about 30. Arrangement to be worked out with leading government-owned banks to provide credit to NBFCs specifically to buy commercial vehicles. agricultural hand tools and specified categories of yarn are being enhanced with retrospective effect from September 1 2008.Duty drawback benefits on certain items including knitted fabrics.
in a financial year subject to RBI and customs guidelines.6. etc for exports w. besides Diamond India Limited. MSTC Limited. the following measures were announced by the Government to further simplify procedures and make life of our exporters a bit more easy:• • Duty credit scrips under Chapter 3 and under DEPB scheme shall now be issued without waiting for realization of export proceeds. which is home to thousands of diamond units with lakhs of diamond workers has been recognized as “Town of Export Excellence”. The Export Promotion Council for Gems and Jewellery and Star Trading Houses (in the Gems and Jewellery sector). incentives of Rs. Surat in Gujarat. Minister of Commerce and Industry on Thursday.4 of Foreign Trade Policy for the purpose of import of precious metals.e. MSTC Limited and STCL Limited have now been added under the list of nominated agencies notified under para 4 A.4 of foreign trade policy for the purpose of import of precious metals. The export facilitation measures as announced today also state that authorized persons of Gems and Jewellery units in Export Oriented Units shall be allowed personal carriage of gold in primary form up to 10 kg. Full exemption from basic customs duty for zinc and ferroalloys. STCL Limited. 325 crores would be provided for leather. textiles. 33 • .f. is being withdrawn. Handmade carpets and Dried vegetables. Other Measures Exemption from Counter veiling duties (CVD) on particular construction materials/cement which were given to contain inflation is being withdrawn. In addition. Diamond India Limited. Gem & Jewellery Export Promotion Council and Star Trading Houses (only for gem and jewellery sector) have been added under the list of nominated agencies notified under Para 4A. 1/4/2009. Stapling machine. iii) Stimulus Package III • The employment oriented Gems and Jewellery sector in India has got a fresh boost with the series of measures announced by Kamal Nath. Export incentives have been provided for certain items like Technical textiles. which was also provided to contain inflation. While a full year policy for 2009-10 will be unveiled in due course by the next Government.
This provision has been extended for the year 2009-10. This will help in closure of a number of pending advance licences. For Advance Licenses issued prior to 1. in case of decline in exports of a product(s) by more than 5%. for textiles and diamonds respectively.4. DEPB/Duty Credit Scrip can be used for payment of duty only on items which are under free category.2002. Export obligation period against advance authorizations extended up to 36 months in view of the present global economic slowdown. Requirement of hard copy of Shipping Bills dispensed with thereafter for Export Obligation discharge. Bhilwara in Rajasthan and Surat in Gujarat have been recognized as Towns of Export Excellence. in case of payment of duty by incentive scheme scrips such as VKGUY. for exports during 2008-09. Govt. In view of the prevailing global slowdown. the requirement of MODVAT/CENVAT certificate dispensed with in case the Customs Notification itself prescribed for payment of CVD.• • • • • • • • • • • • • • • • • Import restrictions on worked corals have been removed to address the grievance of gem and jewellery exporters. the provisions in Foreign Trade Policy have been aligned with the relevant Custom Notifications. The procedural formalities for claiming duty drawback refund and for getting refund of Terminal Excise Duty for deemed exports is further simplified. recognizes Premier Trading Houses based on an export turnover of Rs. Re-credit of 4% SAD. Export through Krishnapatnam seaport has been included for the purpose of Export Promotion Scheme. An independent office of DGFT at Srinagar. At present.f. Electronic Message Transfer facility for Advance Authorisation and EPCG Scheme established for shipments from EDI ports w. for export by ultimate exporter. the threshold limit for recognition as Premier Trading Houses is now been reduced to Rs.4.000 crores in the previous three years and the current year taken together. Export of blood samples is now permitted without license after obtaining ‘no objection certificate’ from Director General of Health Services (DGHS). In case of Advance Authorisation for Annual Requirement where Standard InputOutput Norms are not fixed. 1. The utilization is now extended for payment of duty for import of restricted items also. Value cap applicable under DEPB have been revised for two products.7500 crores. Supply of an Intermediate product by the domestic supplier directly from their factory to the Port against Advance Intermediate Authorisation. 34 . At present. has now been allowed.2009. Authorised person of Gem & Jewellery units in EOU shall be allowed personal carriage of gold in primary form up to 10 kgs in a financial year subject to RBI and customs guidelines. has been allowed. Under EPCG scheme.10. the export obligation for all exporters of that product(s) is to be reduced proportionately.e. FPS and FMS.
The mechanism of Special Market Operations (SMO) for public sector oil marketing companies instituted in June-July 2008 taking into account the extraordinary situation then prevailing in the money and forex markets will be instituted when oil bonds become available. The earlier limit was $50 million.. RBI agreed to provide the sum to the lending institutions immediately.5 per cent of their NDTL. 2008. finance ministry relaxed norms to allow companies in the mining. whichever is higher. c) RBI Measures • • • • • • • • • • • • • To improve liquidity and check depreciation of rupee. Nov. 2008. 1. banks permitted to avail of additional liquidity support under the LAF to the extent of up to 1 per cent of their NDTL. At the request of the Government.000 crore as the first instalment.000 crore with a view to enabling banks to meet the liquidity requirements of Mutual Funds.20.5 percent. Under the existing guidelines. Under the Agricultural Debt Waiver and Debt Relief Scheme Government had agreed to provide to commercial banks. Again both repo cut made a liquidity of 40000crore Rs.000 crore. CRR cut by 350 basis points to 5. Furthermore. Special 14 days repo to be conducted every day upto a cumulative amount of Rs.5 percent. only in respect of the CDs held by mutual funds. Banks allowed to borrow funds from their overseas branches and correspondent banks up to a limit of 50 per cent of their unimpaired Tier I capital as at the close of the previous quarter or USD 10 million. exploration and refineries sectors to bring in up to $500 million in external commercial borrowing (ECB) to the country for rupee expenditure. into system. It was decided to relax these restrictions for a period of 15 days effective October 14. they are also not permitted to buy-back their own CDs before maturity. Interest rates on FCNR (B) Deposits and NRE(R)A deposits were increased by 100 basis points each to Libor/Euribor/Swap rates plus 25 basis points and to Libor/Euribor/Swap rates plus 100 basis points. Increased interest rates on Non-Resident deposit schemes by 50 basis points. banks and FIs are not permitted to grant loans against certificates of deposits (CDs). as against the existing limit of 25 per cent.5 per cent. 1Nov. Purely as a temporary measure.• Re-imbursement of additional duty of excise levied on fuel would also be admissible for EOUs. 35 .5 per cent As a temporary measure. respectively. RRBs and co-operative credit institutions a sum of Rs. To reduce the repo rate or its main short-term lending rate by 50 basis points to 7.25. banks allowed to avail of additional liquidity support exclusively for the purpose of meeting the liquidity requirements of mutual funds to the extent of up to 0. or 0. This measure will release additional liquidity into the system of the order of Rs 48. 20 Oct 2008 (RBI) slashed its key lending rate by 100 basis points to 7. 2008.
2 percentage as a proportion to the GDP. Overall: The fiscal package in India does not have an explicit employment target. like interest rates for home loans upto Rs. Further. d) REACTIONS : Mixed reactions from the Industry. as against the Rs. The ministry has demanded specific sops. 5 lakh be reduced to 6. 3 million) be 7. “The second stimulus package unveiled Friday is in the right direction but falls short of expectation that it would be around Rs.5%. 36 . while loans between Rs. as fiscal incentives and monetary policies delay the process and further. Particularly representatives of Industries and Exporters and SMEs stated that both the stimulus packages announced by the Central Government are inadequate and negligible for the Indian Industry when compared to the relief packages offered to the textile Manufacturers in the competing countries like China and Pakistan to manage the global recession. 5 lakhs (Rs. This would amount to app. there are concerns that stimulus packages are not sufficient to boost economic growth.These above are some measures which RBI has taken to face the world crises on India with a special effect of liquidity crunch and inflation at a time. A leading industry lobby said. it primarily focuses on measures to augment liquidity in the system in addition to providing some fiscal incentives especially to the export oriented sectors. 200 billion (US$4 billion).5 percent annually – a senior official’s quote. CMAI. nor do they ensure outreach within a given time due to a slow and weak delivery system or a change in confidence in the market hence increased demand.. The second stimulus package evoked disappointment in the textile sector as it doesn’t contain anything to stimulate the slugging exports in the sector. SIMA and TEA) have requested the government to have a re-look at the various proposals they made for relief and potential bailout. 1 trillion (US$20 bn). Major textile trade bodies 6 (Texprcil. The urban development ministry has asked for additional changes at the last minute to the second stimulus package to make the package beneficial for the end-user. which is required to be a real booster.
However. there is a clear tendency in all the industries towards rationalization of employment and stop of further expansion of employment (no new hiring). Rashtriya Swasth Bhima Yogana for BPL families. f) MEASURES SAFEGUARDING WORKER’S RIGHTS Government is strong against lay offs and job cuts of the private sector. albeit in a limited form. NREGS. One incidence has been particularly delicate which is mentioned below: 37 . Case of Airlines in November 2008). About 14 states have initiated implementation of this scheme. RURAL INFRASTRUCTURE. 2008. while dubbing the decision of some companies to shut down their plants for a few days to combat the economic crisis as “short-sighted. This has very strongly emerged by the words of the PM and the Finance Minister in two occasions (RIT News and Asia Pulse Date Source via COMTEX) With the exception of the PM’s announcement (3 Nov) where he urges corporates and Industries to refrain from “knee jerk reactions” such as large-scale layoffs and emphasized the societal obligation the corporate offices have and the potential that large lay-offs might lead to a negative downward spiral. RIT News). No particular measures have been taken to safeguard worker’s rights.”(Asia Pulse Date Source via COMTEX). most of the employment adjustments have been at the enterprise level. This has now been set in motion. Government intensified efforts for accelerated delivery and more efficient implementation of existing schemes and programmes (housing. and few selective incidences where the Government had to interfere (eg. Working groups have been established in Employers’ associations to seek alternatives to layoffs by taking rational decision and by cutting prices. earlier passed by the Rajya Sabha (Upper House) was subsequently passed by the Lok Sabha (Lower House) in December 2008 through which a statutory body will be established under the chairmanship of Ministry of Labour and employment which will formulate welfare schemes through a consultative process with the state governments. The Unorganized Workers Social Security Bill.). (Rediff News.e) MEASURES PROTECTING THE POOR AND THE VULNERABLE: An important agenda for providing a measure of social security to the informal workers in the Indian economy has been pending with the government for quite sometime. 3rd Nov. There are discussions to intensify and put into practice the existing social security schemes (eg Rajeev Gandhi Shramik Kalyan Yojna which has been put in practice in 2007 and provides 6-months unemployment benefits and ESI for retrenched workers). by way of legislation.
special measures are called for to protect the informal workers. h) CONCLUDING REMARKS Contrary to expectations. 39 . This has resulted in lowering the expectations for growth during the current financial year ending 31 March 2009 as well as in the next year. export oriented industries and services felt the shock suddenly and in significant measure. the Indian economy felt the shocks of the financial and economic crisis in the developed countries rather quickly. Given the overwhelming presence of the informal sector in the Indian economy. one each for Cotton Textiles. Not surprisingly. There have been incidences of adjustments at enterprise/industry levels. Although no direct measures have been taken to create additional domestic demand. the expectation is that employment will be protected to some extent by these stimulus packages. Jute. which were based on social dialogue but no particular incidences to solve employment retrenchment at a tripartite level till date. These are non-statutory Standing Committees constituted with the objective of providing a forum whereby the social partners through dialogue can appreciate the problems of industries and workers affected by economic reforms. Engineering. Ministry of Labour and Employment has constituted Industrial Tripartite Committees (ITCs). Electricity Generation and Distribution. Sugar and Plantation industry. The government has responded with two stimulus packages that are largely in conformity with its policies of economic reforms and reliance on the market mechanism. Road transport.g) SOCIAL DIALOGUE End of December.
4 trillion .S. To date. A total of $1. a) Federal Reserve responses to the subprime crisis: The central bank of the USA. The Fed increased the monthly amount of these auctions throughout the crisis. education. and the discount rate from 5. ACTIONS TAKEN BY U. In October 2008. Undertaken. has taken several steps to address the crisis. GOVERNMENT Various actions have been taken since the crisis became apparent in August 2007. the Fed had purchased $271 billion of such paper. and small businesses. Central banks have also lowered the interest rates (called thediscount rate in the USA) they charge member banks for short-term loans .6. more comprehensive steps to handle the crisis. various government agencies have committed or spent trillions of dollars in loans. By November 2008. the Federal Reserve's response has followed two tracks: efforts to support market liquidity and functioning and the pursuit of our macroeconomic objectives through monetary policy. in July 2008. asset purchases. the Fed announced the $200 billion Term Asset-Backed Securities Loan Facility (TALF). open market operations to ensure member banks remain liquid. In November 2008. In November 2008. to help address continued liquidity concerns. This step was taken to offset liquidity concerns .25%. Federal Reserve Chairman Ben Bernanke stated in early 2008: "Broadly. the Fed expanded the collateral it will lend against to include commercial paper.25% to 2%. In September 2008.6 trillion in loans to banks were made for various types of collateral by November 2008 . new rules for mortgage lenders . the Fed announced a $600 billion program to purchase the MBS of the GSE. the Federal Reserve. out of a program limit of $1. Finalized. guarentees. credit cards. Various agencies and regulators. • • • • • 40 . This took place in six steps occurring between 18 September 2007 and 30 April 2008. This program supported the issuance of assetbacked securities (ABS) collateralized by loans related to autos. in partnership with central banks around the world. as well as political officials. to help lower mortgage rates . Used the Term Auction Facility (TAF) to provide short-term loans (liquidity) to banks. along with other central banks. and direct spending . up from $20 billion at inception. • • Lowered the target for the Federal funds rate from 5. These are effectively short-term loans to member banks collateralized by government securities. began to take additional. raising it to $300 billion by November 2008.75% to 2. major instability in world financial markets increased awareness and attention to the crisis.
. and the licensing and qualifications of lenders. tax policies. credit counseling. Nobel prize winner Joseph Stiglitz has recommended that the USA adopt regulations restricting leverage. rather than the historical 8-10%. British Prime Minister Gordon Brown and Nobel laureate A. Fed Chairman Ben Bernanke stated there is a need for "well-defined procedures and authorities for dealing with the potential failure of a systemically important non-bank financial institution . Major U. a sweeping expansion of the Fed's regulatory powers was proposed.g. or to support their side of credit default insurance contracts . education. Ram Charan has also argued for risk management early warning systems at the corporate board level . in an attempt to maintain competition in the mortgage market. Alan Greenspan has called for banks to have a 14% capital ratio. that would expand its jurisdiction over nonblank financial institutions. the House and Senate are both considering bills to further regulate lending practices . and its authority to intervene in market crises . Further.S. The minimum capital ratio is regulated . bankruptcy protection. Countrywide's VIP program has led ethics experts and key senators to recommend that members of Congress be required to disclose information about the mortgages they take out .b) Regulatory responses to the subprime crisis: Regulators and legislators have contemplated taking action with respect to lending practices. investment banks and mortgage companies) are not subject to the same capital requirements as depository banks. Regulations or guidelines can influence the transparency and reporting required of lenders and the types of loans they choose to issue. each financial institution would pay an insurance premium to the government based on its systemic risk • • • • • • • 41 . based on an assessment by regulators. Michael Spence have argued for an "early warning system" to help detect a confluence of events leading to systemic risk. Congressional committees are also conducting hearings to help identify solutions and apply pressure to the various parties involved . Nondepository banks (e. Economists Nouriel Roubini and Lasse Pederson recommended in January 2009 that capital requirements for financial institutions be proportional to the systemic risk they pose. affordable housing. On 18 September 2008. UK regulators announced a temporary ban on shortselling the stock of financial firms . banks had capital ratios of around 12% in December 2008 after the initial round of bailout funds. Many investment banks had limited capital to offset declines in their holdings of MBSs. However this is considered a drop in the ocean in regards to total lending . The Australian government will invest AU$4 billion in mortgage backed securities issued by nonbank lenders. and preventing companies from becoming "too big to fail. Dr. Responding to concerns that lending was not properly regulated. • • • • On 31 March 2008.
President Bush signed into law an economic stimulus package costing $168 billion. Raises the ceiling on the dollar value of the mortgages the government sponsored enterprises (GSEs) may purchase. Some Congressmen even contemplated a second round of tax rebates to ensure that the American economy would indeed be stimulated.000 borrowers. this rebate coincided with an unexpected jump in gasoline and food prices. mainly taking the form of income tax rebate checks mailed directly to taxpayers.c) Economic Stimulus Act of 2008: On 13 February 2008. Checks were mailed starting the week of 28 April 2008. Secretary of the TreasuryHenry Paulson strongly opposed such initiative . However. in exchange for sharing in any future appreciation in the selling price of the house via the Federal Housing Administration. The Act: Insures $300 billion in mortgages. that will assist an estimated 400. This coincidence led some to wonder whether the stimulus package would have the intended effect. • Helps local governments buy and renovate foreclosed properties. The lender reduces the amount of the mortgage (typically taking a significant loss). Lends money to mortgage bankers to help them refinance the mortgages of owner-occupants at risk of foreclosure. Requires that lenders disclose more information about the products they offer and the deals they close. • • • Creates a new Federal regulator to ensure the safe and sound operation of the GSEs (Fannie Mae and Freddie Mac) and Federal Home Loan Banks. The refinancing must have fixed payments for a term of 30 years. or whether consumers would simply spend their rebates to cover higher food and fuel prices. 42 . d) Housing and Economic Recovery Act of 2008 The Housing and Economic Recovery Act of 2008 included six separate major acts intended to restore confidence in the American mortgage industry .
Washington Mutual (WaMu) was seized in September 2008 by the USA Office of Thrift Supervision (OTS). a USA bank with over $2 trillion in assets. Morgan Chase in March 2008 for $1. United Kingdom taxpayer liability arising from this takeover had risen to £87 billion ($150 billion).P. IndyMac Federal Bank.2 billion. was nationalized on 17 February 2008. Bear Stearns was acquired by J. citing moral hazard. the Australian government announced that it would make AU$4 billion available to nonbank lenders unable to issue new loans. A bridge bank. government announced it was purchasing $27 billion of preferred stock in Citigroup. AIG received an $85 billion emergency loan in September 2008 from the Federal Reserve. encountering difficulty obtaining the credit it required to remain in business. In exchange. The preferred stock carries an 8% 43 . mortgages and other debt with a Notional value of more than $5 trillion . citing liquidity concerns. the Federal government acquired a 79. In November 2008. was established under the control of the FDIC . refused to bail it out . 2008. After discussion with the industry. The UK government made this takeover possible by agreeing to waive its competition rules. As of 8 October 8 2008. this amount was increased to AU$8 billion . The two GSE's guarantee or hold mortgage backed securities(MBS). Merrill Lynch was acquired by Bank of America in September 2008 for $50 billion. while its deposit and branch network are to be sold to Spain's Grupo Santander . America's leading Alt-A originator in 2006 with approximately $32 billion in deposits was placed into conservatorship by the FDIC on July 11.e) Failures and government bailouts of financial firms: Northern Rock. Scottish banking group HBOS agreed on 17 September 2008 to an emergency acquisition by its UK rival Lloyds TSB. FSB. the U. IndyMac Bank. Most of WaMu's untroubled assets were to be sold to J. The sale was conditional on the Fed's lending Bear Sterns US$29 billion on a nonrecourse basis . Lehman Brothers declared bankruptcy on 15 September 2008.P. In October 2008. Morgan Chase .S. after a major decline in HBOS's share price stemming from growing fears about its exposure to British and American MBSs. which AIG is expected to repay by gradually selling off its assets. after the Secretary of the Treasury Henry Paulson. and warrants on 4. The government assumed control of the bank's £50 billion mortgage and loan portfolio. British bank Bradford & Bingley was nationalised on 29 September 2008 by the UK government.9% equity stake in AIG .5% of its common stock. The GSEs Fannie Mae and Freddie Mac were both placed in conservatorship in September 2008.
dividend. we came to the conclusions that: 44 . 7. CONCLUSION After completing this project on how sub-prime mortgage crisis turned into global economic crisis which caused a slowdown in business and cost cutting in all segments of global market. This purchase follows an earlier purchase of $25 billion of the same preferred stock using TARP funds .
The government and few financial institutions like Lehman Brothers never took it seriously. It would be a chain reaction. former Vice-President of Fina Oil Company and founder of the nowadays respected ASPO (Association for the Study of Peak Oil) . industries will close…” . 45 . one bank would fail. but why did these people abruptly become unable to pay? The reason is most important and commentators of the crisis systematically fail to discuss and analyze it. so according to us the government should have taken this thing seriously at that time and should have taken some serious measures. The same was warned by few financial researches made by some institutions. and incompetence on the part of policymakers". So yes. "Expansion becomes impossible without abundant cheap energy. That speaks of a financial crisis. a geologist. it's probable we face the Second Great Depression. Due to the lack of this all these kind of trouble got bigger. and another one would fail. So I think that the debt of the world is going bad. it was a serious mistake to lend money to people who could not afford it. Colin Campbell. unseen. were already announced in as early as 2006 by Dr.• • The current financial crisis was caused both by "dishonesty on the part of financial institutions. probably equaling the Great Depression of 1930. The current events that nobody saw coming.
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