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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.
and that it may have been avoided. examples. This is an important aspect in order to understand the rest. the necessary definitions will be provided in order to ensure a smooth reading. as this is the department from which the crisis originates. or perhaps it will have the complete adverse effect! In chapter 2. as long as the key players in this crisis. Then the fixed income department will be described. but there is a true explanation and linkage making between the various factors. where the same steps will be taken regarding what is called the TED-spread. These two chapters together constitute the bulk of this thesis. Definitions. causes and consequences. This may also inspire other students to join such a team. as well as its tools. the true explanation will unravel. the economic context in which this thesis is written will be described. 5 . Second.1. There are no particularly revolutionary findings within the following lines. a deep economic and financial explanation of the subprime crisis will be provided. 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. and will allow us to realize the depth and importance of this crisis. 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. which can be viewed as a measure of the amplitude of a crisis. This chapter is closely linked to the next one. First. The conclusion will summarize the various aspects developed in this thesis. In this chapter. theory and history will be provided before moving on to its predicting power. but to the coming one too.INTRODUCTION The goal of this thesis is to provide a better understanding of the subprime crisis. This will be achieved from a fixed income point of view.
low credit scores. 6 . Lenders did so by providing teasers like minimal or zero down payment. to take on more loans as they moved the securitized loans off their books. Mortgage-Backed Securities (MBS) are the securitization of housing mortgages.S. bankruptcies. Interestingly. which includes payment delinquencies. the originators of these loans.The subprime crisis a) Definitions The term “subprime” refers to mortgagees who are unable to qualify for prime mortgage rates. the first to default were subprime borrowers. as well as lax documentation and credit checks. These defaults caused an implosion of the mortgage-backed securities (MBS) and the collateralized debt obligations (CDOs) industry. These subprime loans were fine as long as the housing market continued to boom and interest rates did not rise. as in any given environment of economic growth and prosperity. and these could be observed already as of march 2007. In other words. This is known as the “origination-distribution” model. When these conditions disappeared. The volume of MBS originated and traded reached $3 trillion in 2005 in a U. housing mortgage industry of $10 trillion. charge offs. Total subprime loans form 25% of the housing mortgage market. quickly followed by the suspension of three other funds managed by BNP Paribas.2. However. 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. large exiting liabilities and high loan value ratios. Reasons for this include poor credit rating. subprime mortgages simply mean lending to house borrowers with weak credit. and low introductory adjustable rate mortgages. there were some forerunners to this spectacular blow out. The blow out surfaced in June 2007 with the collapse of two subprime mortgage hedge funds managed by Bear Stearns. these were ignored. Securitization enabled banks and mortgage companies.
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. complicating the pricing of these CDOs. thus theoretically spreading the risks as much as possible. Bank of China alone is exposed to $9 billion of ubprime CDOs. This was ignoring the underlying assumptions. and subordinated tranche (10%). this was totally ignored . but also establishments such as town councils in far flung places like Australia that were chasing for higher yields. it is considered trivial that the CDOs were a complete disaster. The higher the level of CDO. However. the loss ratio is no more than 10% . these CDOs were used as underlying assets and repackaged to the next level of CDOs. An investor. can choose which tranche to invest in. interest rate payments. In this day. a CDO could consist of 100 subprime MBS. the more removed it is from the actual underlying security. 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. Layered on top of these are CDOs of credit default swaps (CDS) that multiplied the risks further. To further complicate matters. This is referred to as CDO squared and after another round. The AAA tranche pays lowest interest rate. 7 . financial innovation took these MBS to a higher level in terms of complication and leverage with the introduction of collateralized debt obligations (CDOs). depending on risk propensity.In the early nineties. but it should be pointed out that not more than a year ago. For example. These CDOs were distributed far and wide. Using historical rates of default and recovery. but also the contracts written (CDS) on the traded securities. it becomes CDO cubed. and priority of repayment. but provides highest priority in terms of debt repayment. The defaults are confined not only to the underlying securities. These subprime MBS are then divided into AAA tranche (70%). mezzanine tranche (20%). It was not only banks throughout the world that bought these CDOs. it can be assumed that in an extreme case of default. The volume of CDOs issued tripled between 2004 and 2006 from $125 billion to $350 billion per year (Bloomberg).
Capital is usually in the form of subordinated debt. The SIV funds these purchases with short-term asset backed commercial paper (ABCP). The aim is to generate a 9 spread between the yield on the asset portfolio and the cost of funding by managing the credit. market and liquidity risks.Fig01: Graph of houses purchased with prime and sub-prime mortgages A special.rating) until the vehicle is wind-down for any reason. sometimes tranched and often rated. General descriptions of the methodologies employed for SIVs by the agencies are publicly available on their web sites. 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. bankrupt remote. AAA/A. The level of capital is set to achieve this AAA type of rating. investment vehicle (SIV) is a limited purpose. company that purchases mainly highly rated medium and long term assets. or structured. (for example. 8 . The basic approach is to determine whether the senior debt of the vehicle will retain the highest level of credit worthiness. and medium term notes (MTNs) and capital.
Monolines carry enough capital to earn a triple-A rating and this prevents them from posting collateral. the portfolio is gradually liquidated. The two largest monolines. much of their growth has come in structured products such as asset backed bonds and CDOs. have been able to inject enough new capital to keep their sterling credit rating. monolines insured US$127 billion of CDOs that relied.5 trillion (Bloomberg). MBIA and AMBAC. or at least with an AAA level of certainty.6 trillion. before the vehicle ceases to exist. The size of the market is approximately US$2. Given the low risk of the bonds and the perceived low risk of the structured transactions insured by monolines. No debt will be further rolled over or issued and the cash generated by the sale of assets is used to payoff senior liabilities. on repayments on subprime home loans and face potential losses of US$19 billion . Since the end of 2007 monolines have been struggling to keep their triple-A rating. MBIA and AMBAC. Monoline insurers provide insurance to investors that they will receive payment when investing in different types of assets. According to S&P. Winddown occurs if the resources are becoming insufficient to repay senior debt. 9 . municipalities. In recent years. If a trigger event occurs and the SIV is wind-down by its manger (defeasance) or the trustee (enforcement).with capital being used to make up possible short falls. 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. at least partly. The total outstanding amount of bonds and structured financing insured by monolines is around US$2. both started out in the 1970s as insurers of municipal bonds and debt issued by hospitals and nonprofits groups.S. and a few others less exposed to subprime mortgages such as Financial Security Assurance (FSA) and Assured Guaranty. they have a very high leverage. Only the two major ones. with outstanding guarantees amounting to close to 150 times capital. with more than half of municipal bonds being insured by monolines (Bloomberg).
because of increased risk.huge liquidity in stock markets. are categorised as sub-prime loans.S Subprime Crisis : What is a sub-prime loan? In the US.b) U. 1. Now the intial topic CDS (credit debt secutirties )comes into picture. Typically. Concept :The prime guidelines of US regulation to give a simple loan with rules of minimum. repackages the loans as mortgagebacked securities and this mortgage backed securities (MBS) is a type CDS. 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 .The US Clinton govt. The banks started granting these loans.let us see how ? Fannie Mae buys loans from mortgage originators. The era when US economy is going with a very good time. interest rate charged by US central bank with a mortgage of security.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. who functions as an intermediary in the U.or as 'sub-prime'.usually not all default occur at one time but this time it does happened.S by purchasing and securitizing mortgages. And in this era. it is the poor and the young who form the bulk of sub-prime borrowers. 1993. interest rates are going down. with a objective of giving a house to every poor and young people at US.development rate was very high. till now everything is going in a simple way but Freddie Mac and Fannie Mae the 2 govt subsidary companies made whole situation complicated. And the loan given by violation of these prime guidelines is known as sub prime loans.indicating that they have a good credit rating based on their track record . something banks would normally be reluctant to do. 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. Loans given to sub-prime borrowers. meaning their track record in repaying loans has been below par. 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..no inflation. borrowers are rated either as 'prime' .
The remaining two converted to commercial bank models. 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. creating instability in the global financial system. 11 . The financial sector began to feel the consequences of this crisis. Fannie Mae and Freddie Mac provide banks and other financial institutions with fresh money to make new loans. The top five US investment banks each significantly increased their financial leverage during the 2004–2007 time period.2%. 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. inflationary pressure started coming on america's economy.S.S.Subprime borrowing was a major contributor to an increase in home ownership rates and the demand for housing.1 trillion in debt for fiscal year 2007. 3. August 15. Also.and all stock market gone down. Almost all the public companies have MBS and CDS are in their portfolio in huge amount. All the MBS or CDS are become worthless because the people whose loans are made as gurantee for them are no more. There was huge increase in subprime loans and The overall U. govt. American home prices increased by 124%. Biggest result of these crises came when the Dow dropped below 13.P. This demand helped fuel housing price increases and consumer spending. started increasing lending rates and there is too much supply of homes upto that time. subjecting themselves to much tighter regulation like J.By purchasing the mortgages.000. a figure roughly 30% the size of the U. The biggest 5 investment banks reported over $4. Immediate impacts 1.Morgan. Sept 2007. Many financial institutions borrowed enormous sums of money during 2004–2007 and made investments in mortgage-backed securities. 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. Jan 2007. economy.FII become impatient and started putting out their money from all over the world stock market.through to the investor in a timely manner. which increased their vulnerability to the MBS losses. 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. in February 2007 with the $10. 2007. Fannie Mae may hold the purchased mortgages for its own portfolio.5 billion writedown of HSBC which was the first major CDO or MBO related loss to be reported 2.
That was not CDS instrument that made all went wrong. Prospective purchasers for the mortgage lender are still being looked for. II. Another instance in Germany.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. the French Bank was compelled to take some drastic steps. • First. Fannie Mae and Freddie Mac which resulted all of them into big bail out packages and US govt. any crisis affecting these investors sees a contagion effect through the world. Northern Rock. China and to a lesser extent India. BNP Paribas. particularly those with large reserves like Japan. but the wrong implementation of the security instrument. 2007. • c) IMF (International monetary Fund) The International monetary Fund works as :I. Promoting exchange rate stability. Thus. It stopped all withdrawals from a fund of USD$2. Increasing international monetary cooperation. since global equity markets are closely interlinked through institutional investors. III. there are two major ways in which the effect is felt across the globe. • Some of the instances which shows world is affected by subprime crises:• • • The oil prices which were gone upto 150 US$ per barrel is now came to less than 60 US $. subsidisation themselves and fall of whole world economy. 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. 12 . Also.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. Apart from the fact that banks based in other parts of the world also suffered losses from the subprime market.the preception of equating the sphosticated compliacted CDS with the simple life insurance of many finance company like AIG. Impact on world:1. Promoting the growth of trade. any crisis in the US has a direct bearing on other countries.2 billion pertaining to investment funds as the true value of the investment portfolios could not be ascertained. which implies the impact of US subprime crisis on Europe is when Germany 's IKB Deutsche Industrial bank accepted USD$11.
To control the inflation RBI made a cut in all its key lending and policy rates like CRR. FDI in banking is permitted up to 49%.Low demand. eliminating exchange restrictions which hamper the growth of world trade. AIG etc. and encouraging progress towards convertibility of member currencies. because the crisis starts only because. low revenue. Establishing a system of multilateral payments. 13 . energy and other knowledge industries such as pharmaceuticals and biotechnology. The Job Scenario :1.from the banks.But in this money pulling the real looser is not the FII but the small investor because FII pulled out their huge money in bull rally.08% share in FDI inflows to India. 3.Reverse Repo etc.even in some sectors out way to the non performer employees. Backing of FDI :.textile. 2. On investment front. low sales. which is open for private participants.and leave the small investor in the bear market with huge stock market fall. Increase in banking rates :. FII money pull out :-As I already explained how FII pulled out their money from India and other part of world stock market. low profits simply means to stand by in present scenario cost cutting is only way and this cost cutting converts into no new recruitment at all. which strengthen the liquidity crunch. 2. and American Express. Pakistan 9.SLR. USA covers almost every sector in India.all the big banks of world are facing problem.Building a reserve base. All the export oriented industries jewellery. Both government-to-government level and business-to-business level conduct regular interactions with each other to promote and strengthen the trade and economic interactions between the two countries. IMF has issued bail out packages of many countries slashing economy like Iceland US$ 6 billion. The job scenario changed drastically in last one year and all because of above financial muddle. US companies that have successfully entered this field in India include New York Life. Banking sector already gone with this mess. US Success stories in this sector include Citicorp.with.USA has 17.handicrafts and many more. The insurance sector in India is opened up for up to 26% FDI. In the current prices. The US investor community was sharing confidence in the future of the Indian economy.6 billion. V. Several areas like infrastructure.all suffering from liquidity crunch around the world. IT.Repo. India : The liquidity crunch :1 . Telecom sector. there are proposals to hike this limit to 49%. However. possess immense potential for progressing economic cooperation between India and the US.IV. GE Capital.
S. miscellaneous textile article. 4. resulting in the nationalizing of the troubled mortgage lender. Tecumseh Products (India) Limited. Export decrease :.1 billion. where in many US companies are reaping the advantages offered by India's IT sector. 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. Fish and seafood (frozen shrimp). It has affected investors in North America. transmission shafts. Europe. with losses since the start of 2007 at leading banks and brokerage houses topping US$250 billion. Textile floor coverings.S. exports to and imports from India in 2003. Microsoft. Knit apparel. metals (worked diamonds & gold jewellery).S. hedge funds have halted redemptions. Pepsi. The U. Woven apparel. totalled US $5. Oracle Corporation. by contagion.S. Australia and Asia and it is feared that write-offs of losses on securities linked to U. and special investment vehicles have been wound-down. 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. valves. etc). pistons. respectively. Financial institutions are expected to write off an additional US$80 billion in the first quarter of 2008 . goods and services. other segments of the credit markets. Organic chemicals and Machinery (taps.General Electric. 3M. It has brought the asset backed commercial paper market to a halt. Adobe Systems Inc. U. India offers a large pool of trained. Panicing environment :This is not that much fundamentals of liquidity crunch effect the market but the influencing panic environment all over the country. as of April 2008 (Bloomberg). Whirlpool Ford (India). gears. or have failed. could reach a trillion US dollars . Intel. 5. Iron/steel products.S. Treasury and Federal Reserve helped to broker 14 . India's main exports to US are precious stones.A very important aspect of US India economic relations comes with the emergence of Business Process Outsourcing. Sun Microsystems. which offers huge cost benefits to the US MNCs.0 billion and US $13. IBM Corporation.India's sizable population and growing middle and higher income class makes India a potentially large market for U. Proctor and Gamble (India). EDS. According to the figure from government sources. Agilent Technologies Inc. d) Economic context The credit crisis of 2007 started in the subprime mortgage market in the U. English speaking personnel. Texas Instruments. subprime mortgages and. Among the major multi national corporations of USA that are doing a profitable business in India are. Banks have suffered liquidity problems.
such as credit cards and car loans. In January 2008.S. causing a decline in lending to companies and consumers.S. concerned about the magnitude of future write downs and counterparty risk.5 points from the secondquarter growth . This alone represents one of the largest cuts in interest rates in U. The Fed lowered its benchmark interest rate 3. such as sovereign funds. from 600 bps at the start of the year. The Fed has also been offering ready sources of liquidity for financial institutions. while the U. by JP Morgan Chase during the week-end of March 17. Banks. have been charging each other much higher interest rates than normal in the inter bank loan markets.the rescue of Bear Stearns. based on data compiled by Bloomberg. The severity of the crisis on bank capital has been such that U. tighter credit conditions could directly subtract 1. 2008. The deepening crisis in the subprime mortgage market has affected investor confidence in multiple segments of the credit market. for capital infusions of more than US$230 billion. auctionrate securities. with problems for commercial mortgages unrelated to subprime. 15 . and has taken on mortgage debt as collateral for cash loans.25 percentage points to 2 4 percent between August 2007 and June 2008 in order to address the risk of a deep recession (Bloomberg). corporate credit markets. banks will cut off the flow of credit. 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. the fifth Wall Street investment bank. banks have had to cut dividends and call global investors. For example. The effects of the crisis have affected the general economy. and 2. the cost of insuring against default by European speculative bonds had risen by almost one-and-a-half percentage point over the previous month. According to some economists. to preserve their regulatory capital ratios. leverage buy-out loans (LBOs). including investment banks and primary dealers.S. as of May 2008.25 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. high-yield bond spread has reached 700 bps over Treasuries. history. from 340 basis points (bps. They have been wary of lending to one another and consequently. 100bps = 1%) to 490 bps. and parts of consumer credit. The biggest danger to the economy is that.S. 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.
The modern financial system rests on 3 pillars: 1. f) Fixed income toolbox Fixed income refers to any type of investment that yields a regular return. Liquidity 3.5 trillion US $. The most basic tool in fixed income is the bond. Confidence :-Falling confidence has damaged inter-bank lending and made depositors jittery. This money hardly earned any return. All of them under attack. 16 . At UBS Investment bank. or corporate bank debt. 1994. This brainstorming on ways to obviate the risk of default in financial securities and free up the reserve money for investment. preferred stock is also considered to be fixed income. the bankers of J. Confidence Currently.e) Credit Default Swaps The monster that ate US economy. (Credit Default Swaps).Unprecedented losses have depleted financial institution's capital faster than their ability to raise new capital.P. People who invest in fixed income securities are typically looking for constant and secure return on their investment. The total estimated fianacial damage till now is 1. 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. such as stocks. hard core drinks and music. Liquidity:-Illiquid capital markets have made it hard for them to finanace their own debt. Such securities can be contrasted with variable return securities. Capital :. Capital 2. Somewhere in Florida -The sea beach with sexy gals. Morgan met for an offsite weekend. lavishing food. All that brain storming led to the birth of a new concept-CDS.
fixed income securities are traded on the open market. To complicate matters a bit. This tool will be one of the foci of this thesis.S.Interest rates change over time. From this. 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). The TED-spread is also a fixed income tool that is directly linked to interest rates on bonds. The yield of a bond is inversely related to its price today: if the price of a bond falls. we derive the yield curve. Otherwise investors would buy government bonds which are considered to be 100% secure. it is obvious the most important aspects within fixed income are the interest rates. Based on the above. The interest rate will directly affect the yield of a bond. along with the TED-spread. bonds). which is the relation between the interest rate and the time to maturity of the debt for a given borrower in a given currency. particularly the rates set by the Federal Reserve (regarding U. just like stocks. base on a variety of factors. 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. and viceversa. its yield goes up. 17 . When a company is issuing a bond. The term yield refers to the percentage that measures the cash returns to the owners of a security.
Ben Bernanke. stated. The chain reaction from the described problem can be summarized as in the figure below: At the end of spring 2007.3. Chairman of the Federal Reserve. 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. 18 . At the start of August. 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” . IMPACTS ON U. “We do not expect significant spillovers from the subprime market to the rest of the economy or the financial system”.S.
Poole’s comments did not reflect Fed policy. Traditionally. stated that they have substantial liquidity and have the capacity to borrow 19 . Louis Federal Reserve publicly argued against a rate cut (August 16).In the second week of August.7 billion) into the banking system. The European Central Bank has pumped money into Europe’s overnight money markets. Bank of America and Wachovia.1 billion (US$1. Also during this period.3% against the Euro. JP Morgan. a flight to quality occurred. 18 prime corporate names used the CP market to finance short term cash needs.3% and Standard Chartered fell 7.6%. Citigroup. During the same week. The yield on the three month T-bill fell from approximately 4% to as low as 3. 10. causing the yen to increase 4% against the dollar. Four banks. However. Further unwinding occurred two days later. 5. each borrowed US$500 million from the Fed . The FTSE 100 index declined by 4.13 trillion over the last week. with financial companies being the hardest hit.8% against the pound. The Fed took the unusual step of issuing a public statement that Mr.5% against the Australian dollar. Foreign investors had started to flee the ruble debt market. 5. Fed has done similar in the US. The Unwinding of carry trades caused a sudden 2% increase in the yen/dollar exchange rate. In a statement. causing a liquidity squeeze. JP Morgan. The Russian Central Bank injected Rbs 43. 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. The current lack of demand for CP made it very difficult for borrowers to rollover debt. Bank of America and Wachovia.1%. with investors buying Treasuries. Man Group fell 8.3% against the New Zealand dollar and 11. with hedge funds and institutional investors unwinding carry trades. 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. William Poole. the Fed reported that the total commercial paper (CP) outstanding fell more than US$90 billion to US$2.4%. President of the St.
money elsewhere on more favourable terms. it fell to 2. Among other things the securities pledged by dealers must have market prices and “investment grade” credit ratings . Institutional investors switch from commercial paper to Treasuries. during the day. Today. The volatility in the foreign exchange market caused some hedge funds to close their yen carry trade positions. More recently.5 billion in senior unsecured notes. it closed at 3. They were trying to encourage other banks to take advantage of the lower discount rate at the Fed window. other parts of fixed incomes markets continued to function. and by the end of day. with investment grade companies issuing debt: Comcast Corp sold US$3 billion 19 in notes. Indeed. in April 2008. The table below summarizes the top 15 announced losses per bank. yet. and inflation as well as economic downturn in the industrial sector are only starting to point their noses . the flight to quality continued. There was a rare high yield issuing by SABIC Innovative Plastics. called the Primary Dealer Credit Facility (PDCF). During the third week of August.04%. the more worrying aspect. Bank of America sold US$1.5 billion in notes and Citigroup US$1 billion in notes. Between August 16th and 22nd. the losses incurred by this crisis are enormous. for investment banks and securities dealers that give them the possibility to borrow against a wide range of securities as collateral for cash loans. At the start of trading in New York. the Fed took the unprecedented measure of introducing a new lending facility. 20 . the yield on the 3 month T-bill was 3. as of July 2008. 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 .90%. It sold US$1. investors poured US$42 billion into money market funds.51%. The consequences have not fully revealed themselves. the key word being announced. However.
S.Since the beginning of this year. Ben Bernanke. But top of the list. The hangover's duration will depend on many things. if at all.6% a year earlier and non-farm payrolls have declined 6 months in a row. from the strength of foreign economies to the degree to which American firms cut jobs and investment. The labour market figures point to a shrinking economy: As of June 2008. over the first half of 2008 and could even contract slightly”. are the fate of 21 . Although not official yet. On April 2nd told a congressional committee that output was unlikely to “grow much. given the recession's origins in the property bust and the credit crunch.5% from 4. economists and government officials have had great concerns over a recession taking place in the U. chairman of the Federal Reserve. losing 438’000 jobs since January 2008. it is becoming increasingly obvious that the American economy has slipped into recession. there has been a jump in the unemployment rate to 5.
Americans' second-largest household asset. which was valued at $13 trillion at its peak in 2006.S. written in 2003. America's economy will be weighed down. savings and investment assets (apart from retirement savings) lost $1. By early November 2008. it seems unlikely.2 trillion and pension assets lost $1. Total home equity in the United States. from $10. the odds are against catastrophe but on a lasting headache. Economies end up 8% smaller on average than they would have been had they carried on growing at pre-crunch rates . dropped by 22 percent. On both counts.3 trillion. stock index. Total retirement assets. Taken together.3 trillion in 2006 to $8 trillion in mid-2008. a broad U. Between June 2007 and November 2008. 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. During the same period. or for how long.the housing market and the resilience of consumer spending. 22 . and the hangover will soon be gone. suggests that crashes typically last about four years and are often accompanied by banking crises. No one knows by how much. An analysis by the fund of post-war housing busts in rich countries. these losses total a staggering $8. Perhaps this time will be different.3 trillion. The IMF's gloom is based in part on its reading of history . had dropped to $8. with futures markets signaling a 30-35% potential drop. Americans lost more than a quarter of their net worth. was down 45 percent from its 2007 high. the S&P 500. Housing prices had dropped 20% from their 2006 peak.
insured depository institutions earned approximately $100 billion. 2007: FDIC Graph . at least 100 mortgage companies either shut down.5 billion. Mortgage defaults and provisions for future defaults caused profits at the 8533 USA depository institutions insured by the FDIC to decline from $35. Bank & Thrift Profitability By Quarter The crisis began to affect the financial sector in February 2007. Profits declined from $35.U. Top management has not escaped unscathed. the world's largest (2008) bank. the first major subprime related loss to be reported." Financial speculators seeking quick returns have removed trillions of dollars from equities and mortgage bonds. as the CEOs of Merrill Lynchand Citigroup resigned within a week of each other in late 2007.a) Financial market impacts. In all of 2007.6 billion in 2007 Q1 to $19. During 2007. or announced that they were negotiating seeking merger partners. 23 . suspended operations or were sold. As the crisis deepened. some of which has been invested into food and raw materials. 2007 Q4 saw the worst bank and thrift quarterly performance since 1990.S. more and more financial firms either merged. 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. During 2007.2 billion in 2006 Q4 billion to $646 million in the same quarter a year later. when HSBC. a decline of 46% . a decline of 98%.3 billion in 2008 Q1. wrote down its holdings of subprime-related MBS by $10. 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.
5 trillion of their holdings of subprime MBSs. $150 billion were withdrawn from USA money market funds. About $750 billion in such losses had been recognized as of November 2008. the European Central Bank.5 trillion of government debt and troubled private assets from banks. quadrupled shortly after the Lehman failure. The governments of European nations and the USA also raised the capital of their national banking systems by $1. the money market was subject to a bank run. This was the largest liquidity injection into the credit market. the crisis hit a key point. and other central banks was immediate and dramatic.5 trillion. The money market had been a key source of credit for banks (CDs) and nonfinancial firms (commercial paper). 24 . 2008: As of August 2008.b) Financial market impacts. financial firms around the globe have written down their holdings of subprime related securities by US$501 billion. During the last quarter of 2008. When Lehman Brothers and other important financial institutions failed in September 2008. The response of the USA Federal Reserve. During a two day period in September 2008. by purchasing newly issued preferred stock in their major banks. 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. and the largest monetary policy action. The TED spread(see graph above). a measure of the risk of interbank lending. these central banks purchased US$2. 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 average two day outflow had been $5 billion. The IMF estimates that financial institutions around the globe will eventually have to write off $1. Thus the massive reduction in bank capital just described has reduced the credit available to businesses and households . in world history.
The impact of which. foreign funds (through debt and equity) will be available at huge premium and would be limited to blue-chip companies. The debate. Indian companies which had access to cheap foreign currency funds for financing their import and export will be the worst hit.4. but fresh investment flows into India are in doubt. demand for India investment and cost thereof and decreased consumer demand affecting Indian exports. 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. again. therefore. The impact will be felt both in the trade and capital account. 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). we need to analyse the impact based on three critical factors: Availability of global liquidity. a)ON IMPORT-EXPORT While the global financial system takes time to “nurse its wounds” leading to low demand for investments in emerging markets. will be three-fold: Reduced capacity expansion leading to 25 . correction in the asset prices which were hitherto pushed by foreign investors and demand for domestic liquidity putting pressure on interest rates. the impact will be on the cost and related risk premium. Also. 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. 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.
other income from cross-border business flows and distribution of investment products will take a hit. limited domestic appetite due to liquidity pressure and pressure on corporate earnings. once again. leading to lower demand for Indian goods and services. while RBI would inject liquidity through CRR/SLR cuts. Consumer demand in developed economies is certain to be hurt by the present crisis. 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. 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. 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. thus affecting the Indian exports. increased demand for rupee loans and reduced statutory reserves will lead to improved NIM while.supply side pressure. increased interest expenses to affect corporate profitability and increased demand for domestic liquidity putting pressure on the interest rates. while the inflation would stay under control. The impact of which. Given the dependence on foreign funds and off-shore consumer demand for the India growth story. on the other hand. Overall. India cannot wish away from the negative impact of the present global 26 . increased demand for domestic liquidity will push interest rates higher and we are likely to witness gradual rupee depreciation and depleted currency reserves. will be three-fold: Export-oriented units will be the worst hit impacting employment. maintaining growth beyond 7% will be a struggle. The banking sector will have the least impact as high interest rates.
their capability to raise funds in their country is doubtful. The financial crisis in the global market will affect the availability of fund for the domestic realty sector. 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 forced to borrow from the high net worth individuals at high interest rates at around 20%. As RBI has already put restriction on Indian banks to finance real estate companies in the country. they are depended on foreign funds through FDI route for their fund requirements. now as the fate of these investment banks is uncertain. This will put severe constraint on availability of funds in India. But. A large player in the sector said that as the availability of funds from banking sector is restricted for the realty sector. besides restricting the fund flow in it. many of the private equity funds are returning back to their mother countries. 27 .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. a senior consultant said following the development in US. But. 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.
Hence. This should keep the potential for liquidity constraints in banks minimal. The overall stimulus package adds up to around US$8 billion that is less than one percent of the GDP. Even though measures like further tax cuts is unlikely to be announced. It is in this background that the Government of India came out with two stimulus packages. felt the aftermath of the financial crisis emanating from the US rather quickly. 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. the plan will include recapitalisation of public sector banks with an app. textiles. 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 .5. which was widely believed to be less integrated with the global economy. Amongst other proposals. many Indian corporate firms turned to the domestic market for their credit needs thus compounding the problem. 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. Sectors which were exposed to the global market to a high degree such as civil aviation. 3-5%) which is a concern to many stakeholders. 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. There is some concern that these measures would lead to an increase in the fiscal deficit significantly (approx. This in turn led to a credit crunch giving rise to soaring interest rates especially in the money market. leather. b) improve access to credit and liquidity for enterprises and c) to boost local demand for selected goods and services. Government is finalising Plan and Non-plan expenditure that will be required for the next financial year to maintain the same momentum. These stimulus packages were intended to rebuild confidence in the economy basically to a)support most affected sectors. Official circles talked about a 7 percent growth rate while independent estimates came out with predictions that were less than this rate. First the crisis appeared as a crash in the stock market following the steady withdrawal of funds by the Foreign Institutional Investors. amount of another 20’000 Crore for the next 2 years. MEASURES TAKEN BY INDIAN GOVERNMENT a)BACKGROUND: The Indian economy. given the already growing fiscal deficit of India. Suddenly it was realized that the economy was not going to realize its expected growth rate of 9 percent.
100 billion through tax-free bonds . The other embers of this high powered committee are the Ministers of Commerce and Industry. cut in excise duties. 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. . the package will.chairmanship to monitor and coordinate the government’s response to the crisis.000.Lock-in period for loans to small firms under credit guarantee scheme reduced .Full refund of service tax paid by exporters to foreign agents . This included enhanced credit for exports. According to the Deputy Chairman of the Planning Commission Mr.Norms for government departments to replace vehicles relaxed . 5 November 2008). billion (Rs. Danske Bank: 8 December 2008) . Deputy Chairman.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 . India’s central bank (The Hindu. Montek Singh Ahluwalia.Export duty on iron ore fines eliminated .5 percent.India Infrastructure Finance Co allowed to raise Rs.000 crore) (the Indian News: 7 December 2008) The first fiscal package. the rate at which it borrows overnight to 5. Planning Commission and the Governor of the Reserve Bank of India.Limits under the credit guarantee scheme for small enterprises doubled .0 percent. relief to the dooming housing sector and SMEs. 20. b)FISCAL AND MONETARY POLICY PACKAGES: i) Stimulus Package I Amount : First Package US 4.Import duty on naphtha for use by the power sector is being reduced to zero . “minimize the impact of weak global economy on the Indian economy” and help achieve a 7% growth rate. Finance.500. the rate at which it lends to commercial banks -to 6.2 million . was intended to keep the domestic demand high as well as to provide incentives to some selected export sectors.Additional allocations for export incentive schemes .Interest subvention of two percent on export credit for labour intensive sectors . Monetary /Fiscal A cut in interest rates by India’s central bank: The Reserve Bank of India reduced its repo rate. and up to Rs. a modest one. and its reverse repo rate . (Flash Comment.Incentives for loans on housing for up to Rs.
The government announced a cut in Centrally-imposed Value Added Tax by 4% to increase spending across-the-board . In the light of the decline in exports by 12%. To boost housing sector. National Rural Employment Guarantee Scheme.000 crores through tax free bonds. the government authorized a recently created India Infrastructure Finance Co. Jawaharlal Nehru National Urban Renewal Mission. ii) Stimulus Package II Amount: US $ 4. 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. Ltd to raise Rs. India Awas Yojana.1 billion The second stimulus package liberalized overseas borrowing norms. leather.000 core to the highway sector. 100. 10.In addition: To boost exports. 30 .000 crore in the current year mainly for critical rural infrastructure and social security schemes such as Pradhan Mantri Gram Sadak Yojana. 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. public sector banks were urged to announce attractive home loan packages. restored benefits to exporters. Accelerated Irrigation Benefit Programme and National Social Assistance Programme. Concession is subject to a minimum rate of interest. govt. The government decided to seek authorization for additional plan expenditure of upto Rs. announced extra allocation of 70 million dollars. The government also announced that initiatives are being taken to support Public Private Partnership programme of Rs. 20. marine products and SME sector. 5 Jan 2009) . 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. To boost infrastructure spending.
25. The scale of liquidity potentially available through this window is Rs.An arrangement will be worked out with leading Public Sector Banks to provide line of credit to NBFCs specifically for purchase of commercial vehicles. . Details will be announced separately. and c) Non-Banking Finance Companies (NBFCs). 5 lakh. (b) To facilitate access to funds for the housing sector.1. 5 January 2009).09 announced a set of measures. To Enhance Credit Flows . would be permitted to access ECB from multilateral or bilateral financial institutions. 31 . In addition. 50 lakhs to Rs. . 2. it has been decided to increase the guarantee cover extended by Credit Guarantee Fund Trust to 85% for credit facility up to Rs.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.Recently.Additional steps are being taken on the monetary. 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. as second fiscal stimulus package. the guarantee cover under Credit Guarantee Scheme for MSME on loans was extended from Rs.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.000 crores (6 billion USD) .financial express. 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. In order to enhance flow of credit to micro enterprises. under the approval route of RBI: for particular industries. 1 with a guarantee cover of 50%.com. dealing exclusively with infrastructure financing. The RBI has on 2. Ease Access to Overseas Loans and investments . under the approval route of RBI: (www.Monetary/Fiscal 1. under the approval route of RBI.
4. agricultural hand tools and specified categories of yarn are being enhanced with retrospective effect from September 1 2008. 5000 crore and will provide pre-shipment and post-shipment credit in rupees of dollars to Indian exports at competitive rates.12. 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. For Infrastructure Capex o States will be allowed to raise in the current financial year add. In order to provide predictability and stability of regime in the short term for future contracts. Arrangement to be worked out with leading government-owned banks to provide credit to NBFCs specifically to buy commercial vehicles. bicycles.09. For Exports Exporters are especially hit by the recessionary conditions globally.Duty drawback benefits on certain items including knitted fabrics. 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.Taking into account the fact that the rupee has appreciated nearly 4% against the dollar since November 2008. the DEFB scheme would be extended till 31.3. 75000 Crore at competitive rates over the next 18 months.000 Crore for capital expenditure.5% of Gross State Domestic Product) amounting to about 30. a number of steps have been taken: . it has been decided to restore DEPB rates to those prevailing prior to November 2008.EXIM Bank has obtained from RBI a line of credit of Rs. For Commercial Vehicles States. . To support exports. as a one time measure up to June 30 2009. 32 . 5. . Market borrowings of .
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.f. Full exemption from basic customs duty for zinc and ferroalloys. STCL 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. Surat in Gujarat. 325 crores would be provided for leather. textiles. 1/4/2009. 33 • . Diamond India Limited. Handmade carpets and Dried vegetables.6. is being withdrawn. 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. etc for exports w. in a financial year subject to RBI and customs guidelines. MSTC Limited and STCL Limited have now been added under the list of nominated agencies notified under para 4 A. While a full year policy for 2009-10 will be unveiled in due course by the next Government. incentives of Rs. The Export Promotion Council for Gems and Jewellery and Star Trading Houses (in the Gems and Jewellery sector). 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. MSTC Limited. Other Measures Exemption from Counter veiling duties (CVD) on particular construction materials/cement which were given to contain inflation is being withdrawn. Export incentives have been provided for certain items like Technical textiles. which is home to thousands of diamond units with lakhs of diamond workers has been recognized as “Town of Export Excellence”. Minister of Commerce and Industry on Thursday.e. In addition.4 of foreign trade policy for the purpose of import of precious metals. besides Diamond India Limited. which was also provided to contain inflation. Stapling machine.4 of Foreign Trade Policy for the purpose of import of precious metals.
Export obligation period against advance authorizations extended up to 36 months in view of the present global economic slowdown.f. for export by ultimate exporter. has been allowed. the provisions in Foreign Trade Policy have been aligned with the relevant Custom Notifications.10.4. At present. Export through Krishnapatnam seaport has been included for the purpose of Export Promotion Scheme. Supply of an Intermediate product by the domestic supplier directly from their factory to the Port against Advance Intermediate Authorisation. in case of payment of duty by incentive scheme scrips such as VKGUY.000 crores in the previous three years and the current year taken together. Value cap applicable under DEPB have been revised for two products.• • • • • • • • • • • • • • • • • Import restrictions on worked corals have been removed to address the grievance of gem and jewellery exporters. Bhilwara in Rajasthan and Surat in Gujarat have been recognized as Towns of Export Excellence. the export obligation for all exporters of that product(s) is to be reduced proportionately.2002. in case of decline in exports of a product(s) by more than 5%.e. recognizes Premier Trading Houses based on an export turnover of Rs. Electronic Message Transfer facility for Advance Authorisation and EPCG Scheme established for shipments from EDI ports w. An independent office of DGFT at Srinagar. In case of Advance Authorisation for Annual Requirement where Standard InputOutput Norms are not fixed. Export of blood samples is now permitted without license after obtaining ‘no objection certificate’ from Director General of Health Services (DGHS). 34 . for exports during 2008-09. 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. the requirement of MODVAT/CENVAT certificate dispensed with in case the Customs Notification itself prescribed for payment of CVD. Govt. The utilization is now extended for payment of duty for import of restricted items also. for textiles and diamonds respectively. Re-credit of 4% SAD. has now been allowed.2009.7500 crores. 1. For Advance Licenses issued prior to 1. Under EPCG scheme. Requirement of hard copy of Shipping Bills dispensed with thereafter for Export Obligation discharge. In view of the prevailing global slowdown. At present. FPS and FMS. DEPB/Duty Credit Scrip can be used for payment of duty only on items which are under free category. This will help in closure of a number of pending advance licences. the threshold limit for recognition as Premier Trading Houses is now been reduced to Rs. The procedural formalities for claiming duty drawback refund and for getting refund of Terminal Excise Duty for deemed exports is further simplified.4. This provision has been extended for the year 2009-10.
It was decided to relax these restrictions for a period of 15 days effective October 14.• Re-imbursement of additional duty of excise levied on fuel would also be admissible for EOUs. Under the Agricultural Debt Waiver and Debt Relief Scheme Government had agreed to provide to commercial banks. 2008. RRBs and co-operative credit institutions a sum of Rs.25. whichever is higher. finance ministry relaxed norms to allow companies in the mining. 1Nov. banks permitted to avail of additional liquidity support under the LAF to the extent of up to 1 per cent of their NDTL. 1. 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. RBI agreed to provide the sum to the lending institutions immediately. only in respect of the CDs held by mutual funds.5 per cent of their NDTL. 35 .5 per cent. Nov. At the request of the Government. 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 0.000 crore as the first instalment. respectively. 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. Under the existing guidelines. into system. Increased interest rates on Non-Resident deposit schemes by 50 basis points. Again both repo cut made a liquidity of 40000crore Rs. they are also not permitted to buy-back their own CDs before maturity. c) RBI Measures • • • • • • • • • • • • • To improve liquidity and check depreciation of rupee. banks and FIs are not permitted to grant loans against certificates of deposits (CDs). CRR cut by 350 basis points to 5. To reduce the repo rate or its main short-term lending rate by 50 basis points to 7. 2008. This measure will release additional liquidity into the system of the order of Rs 48. as against the existing limit of 25 per cent.5 percent.5 percent. 20 Oct 2008 (RBI) slashed its key lending rate by 100 basis points to 7.5 per cent As a temporary measure. 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. Special 14 days repo to be conducted every day upto a cumulative amount of Rs. Purely as a temporary measure. The earlier limit was $50 million.000 crore..000 crore with a view to enabling banks to meet the liquidity requirements of Mutual Funds.20. exploration and refineries sectors to bring in up to $500 million in external commercial borrowing (ECB) to the country for rupee expenditure. Furthermore. or 0. 2008.
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. like interest rates for home loans upto Rs. d) REACTIONS : Mixed reactions from the Industry. as fiscal incentives and monetary policies delay the process and further. This would amount to app. which is required to be a real booster. 200 billion (US$4 billion). The second stimulus package evoked disappointment in the textile sector as it doesn’t contain anything to stimulate the slugging exports in the sector. A leading industry lobby said. 3 million) be 7. 5 lakhs (Rs..5%. “The second stimulus package unveiled Friday is in the right direction but falls short of expectation that it would be around Rs. as against the Rs. 5 lakh be reduced to 6. 2 percentage as a proportion to the GDP. SIMA and TEA) have requested the government to have a re-look at the various proposals they made for relief and potential bailout. The ministry has demanded specific sops. there are concerns that stimulus packages are not sufficient to boost economic growth. Overall: The fiscal package in India does not have an explicit employment target.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. 1 trillion (US$20 bn). 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. CMAI. while loans between Rs. Major textile trade bodies 6 (Texprcil.5 percent annually – a senior official’s quote. it primarily focuses on measures to augment liquidity in the system in addition to providing some fiscal incentives especially to the export oriented sectors. 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. Further. 36 .
Case of Airlines in November 2008).). No particular measures have been taken to safeguard worker’s rights. The Unorganized Workers Social Security Bill. 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. f) MEASURES SAFEGUARDING WORKER’S RIGHTS Government is strong against lay offs and job cuts of the private sector. 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). However. Rashtriya Swasth Bhima Yogana for BPL families. One incidence has been particularly delicate which is mentioned below: 37 . 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. This has now been set in motion.”(Asia Pulse Date Source via COMTEX). there is a clear tendency in all the industries towards rationalization of employment and stop of further expansion of employment (no new hiring). and few selective incidences where the Government had to interfere (eg. NREGS. 2008. albeit in a limited form. Government intensified efforts for accelerated delivery and more efficient implementation of existing schemes and programmes (housing. 3rd Nov. RURAL INFRASTRUCTURE. RIT News). (Rediff News. Working groups have been established in Employers’ associations to seek alternatives to layoffs by taking rational decision and by cutting prices. About 14 states have initiated implementation of this scheme. most of the employment adjustments have been at the enterprise level. by way of legislation.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.
Ministry of Labour and Employment has constituted Industrial Tripartite Committees (ITCs). the expectation is that employment will be protected to some extent by these stimulus packages. 39 . special measures are called for to protect the informal workers.g) SOCIAL DIALOGUE End of December. Engineering. Electricity Generation and Distribution. There have been incidences of adjustments at enterprise/industry levels. export oriented industries and services felt the shock suddenly and in significant measure. 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. Although no direct measures have been taken to create additional domestic demand. one each for Cotton Textiles. Sugar and Plantation industry. Given the overwhelming presence of the informal sector in the Indian economy. 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. Road transport. Jute. the Indian economy felt the shocks of the financial and economic crisis in the developed countries rather quickly. h) CONCLUDING REMARKS Contrary to expectations. which were based on social dialogue but no particular incidences to solve employment retrenchment at a tripartite level till date. Not surprisingly. 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.
major instability in world financial markets increased awareness and attention to the crisis. guarentees. the Fed announced the $200 billion Term Asset-Backed Securities Loan Facility (TALF). the Fed expanded the collateral it will lend against to include commercial paper. along with other central banks. a) Federal Reserve responses to the subprime crisis: The central bank of the USA. This took place in six steps occurring between 18 September 2007 and 30 April 2008. and small businesses. In October 2008. the Fed announced a $600 billion program to purchase the MBS of the GSE. To date.6 trillion in loans to banks were made for various types of collateral by November 2008 . and direct spending .25% to 2%. In September 2008. began to take additional. The Fed increased the monthly amount of these auctions throughout the crisis. and the discount rate from 5.S. Finalized.4 trillion . These are effectively short-term loans to member banks collateralized by government securities. raising it to $300 billion by November 2008. out of a program limit of $1. In November 2008. as well as political officials. • • • • • 40 . 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. Central banks have also lowered the interest rates (called thediscount rate in the USA) they charge member banks for short-term loans . open market operations to ensure member banks remain liquid. in partnership with central banks around the world. Various agencies and regulators.6. GOVERNMENT Various actions have been taken since the crisis became apparent in August 2007. education. to help lower mortgage rates . new rules for mortgage lenders . up from $20 billion at inception.25%. various government agencies have committed or spent trillions of dollars in loans. This program supported the issuance of assetbacked securities (ABS) collateralized by loans related to autos. credit cards. This step was taken to offset liquidity concerns . the Fed had purchased $271 billion of such paper. A total of $1. more comprehensive steps to handle the crisis. ACTIONS TAKEN BY U. Used the Term Auction Facility (TAF) to provide short-term loans (liquidity) to banks. Undertaken. By November 2008. • • Lowered the target for the Federal funds rate from 5. In November 2008. Federal Reserve Chairman Ben Bernanke stated in early 2008: "Broadly. to help address continued liquidity concerns. the Federal Reserve. has taken several steps to address the crisis. asset purchases. in July 2008.75% to 2.
and preventing companies from becoming "too big to fail. banks had capital ratios of around 12% in December 2008 after the initial round of bailout funds. • • • • On 31 March 2008. UK regulators announced a temporary ban on shortselling the stock of financial firms . Many investment banks had limited capital to offset declines in their holdings of MBSs. Regulations or guidelines can influence the transparency and reporting required of lenders and the types of loans they choose to issue. bankruptcy protection.. investment banks and mortgage companies) are not subject to the same capital requirements as depository banks. that would expand its jurisdiction over nonblank financial institutions. and the licensing and qualifications of lenders. or to support their side of credit default insurance contracts . Nobel prize winner Joseph Stiglitz has recommended that the USA adopt regulations restricting leverage. Congressional committees are also conducting hearings to help identify solutions and apply pressure to the various parties involved . Alan Greenspan has called for banks to have a 14% capital ratio. The minimum capital ratio is regulated . Michael Spence have argued for an "early warning system" to help detect a confluence of events leading to systemic risk. each financial institution would pay an insurance premium to the government based on its systemic risk • • • • • • • 41 . Dr. based on an assessment by regulators.b) Regulatory responses to the subprime crisis: Regulators and legislators have contemplated taking action with respect to lending practices. credit counseling. 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 . affordable housing. 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 . tax policies. Further. Major U. Ram Charan has also argued for risk management early warning systems at the corporate board level . Responding to concerns that lending was not properly regulated. in an attempt to maintain competition in the mortgage market. rather than the historical 8-10%. and its authority to intervene in market crises . education. Economists Nouriel Roubini and Lasse Pederson recommended in January 2009 that capital requirements for financial institutions be proportional to the systemic risk they pose.g.S. the House and Senate are both considering bills to further regulate lending practices . On 18 September 2008. a sweeping expansion of the Fed's regulatory powers was proposed. However this is considered a drop in the ocean in regards to total lending . British Prime Minister Gordon Brown and Nobel laureate A. Nondepository banks (e. The Australian government will invest AU$4 billion in mortgage backed securities issued by nonbank lenders.
Lends money to mortgage bankers to help them refinance the mortgages of owner-occupants at risk of foreclosure. The lender reduces the amount of the mortgage (typically taking a significant loss).c) Economic Stimulus Act of 2008: On 13 February 2008. Requires that lenders disclose more information about the products they offer and the deals they close. Some Congressmen even contemplated a second round of tax rebates to ensure that the American economy would indeed be stimulated. The Act: Insures $300 billion in mortgages. • • • 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. mainly taking the form of income tax rebate checks mailed directly to taxpayers. or whether consumers would simply spend their rebates to cover higher food and fuel prices. However. 42 . that will assist an estimated 400. The refinancing must have fixed payments for a term of 30 years. Secretary of the TreasuryHenry Paulson strongly opposed such initiative . 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 . • Helps local governments buy and renovate foreclosed properties. This coincidence led some to wonder whether the stimulus package would have the intended effect. Raises the ceiling on the dollar value of the mortgages the government sponsored enterprises (GSEs) may purchase. Checks were mailed starting the week of 28 April 2008.000 borrowers. this rebate coincided with an unexpected jump in gasoline and food prices. in exchange for sharing in any future appreciation in the selling price of the house via the Federal Housing Administration. President Bush signed into law an economic stimulus package costing $168 billion.
The GSEs Fannie Mae and Freddie Mac were both placed in conservatorship in September 2008. the U. IndyMac Federal Bank. The UK government made this takeover possible by agreeing to waive its competition rules. As of 8 October 8 2008. Morgan Chase . America's leading Alt-A originator in 2006 with approximately $32 billion in deposits was placed into conservatorship by the FDIC on July 11. while its deposit and branch network are to be sold to Spain's Grupo Santander . encountering difficulty obtaining the credit it required to remain in business.2 billion. In October 2008.P. FSB. Scottish banking group HBOS agreed on 17 September 2008 to an emergency acquisition by its UK rival Lloyds TSB. was established under the control of the FDIC . after a major decline in HBOS's share price stemming from growing fears about its exposure to British and American MBSs. The sale was conditional on the Fed's lending Bear Sterns US$29 billion on a nonrecourse basis . British bank Bradford & Bingley was nationalised on 29 September 2008 by the UK government. the Australian government announced that it would make AU$4 billion available to nonbank lenders unable to issue new loans. Merrill Lynch was acquired by Bank of America in September 2008 for $50 billion. In exchange. Bear Stearns was acquired by J. citing liquidity concerns. Lehman Brothers declared bankruptcy on 15 September 2008. was nationalized on 17 February 2008. In November 2008. The preferred stock carries an 8% 43 . The two GSE's guarantee or hold mortgage backed securities(MBS).S. 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. Most of WaMu's untroubled assets were to be sold to J. AIG received an $85 billion emergency loan in September 2008 from the Federal Reserve. The government assumed control of the bank's £50 billion mortgage and loan portfolio. and warrants on 4. the Federal government acquired a 79. After discussion with the industry. mortgages and other debt with a Notional value of more than $5 trillion . which AIG is expected to repay by gradually selling off its assets. A bridge bank.5% of its common stock. United Kingdom taxpayer liability arising from this takeover had risen to £87 billion ($150 billion).e) Failures and government bailouts of financial firms: Northern Rock.9% equity stake in AIG . after the Secretary of the Treasury Henry Paulson. IndyMac Bank. refused to bail it out . government announced it was purchasing $27 billion of preferred stock in Citigroup. this amount was increased to AU$8 billion .P. 2008. citing moral hazard. Morgan Chase in March 2008 for $1.
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 . we came to the conclusions that: 44 . 7.dividend.
so according to us the government should have taken this thing seriously at that time and should have taken some serious measures. it was a serious mistake to lend money to people who could not afford it. Colin Campbell. It would be a chain reaction. it's probable we face the Second Great Depression. a geologist. and incompetence on the part of policymakers". The government and few financial institutions like Lehman Brothers never took it seriously. Due to the lack of this all these kind of trouble got bigger. industries will close…” . That speaks of a financial crisis. probably equaling the Great Depression of 1930. 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. one bank would fail. were already announced in as early as 2006 by Dr. So I think that the debt of the world is going bad.• • The current financial crisis was caused both by "dishonesty on the part of financial institutions. So yes. former Vice-President of Fina Oil Company and founder of the nowadays respected ASPO (Association for the Study of Peak Oil) . The current events that nobody saw coming. 45 . "Expansion becomes impossible without abundant cheap energy. unseen. The same was warned by few financial researches made by some institutions. and another one would fail.
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