Presentation Outline

Estimated Duration Bibek Khadgi Deepeka Shrestha Sishir KC Ritu Joshi Manisha Baral : : : : : : 20 minutes Introduction & Origin Root Causes Spillover Impact of Crisis Developing Markets and Crisis, Comparison with Great Depression & Solution.
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INTRODUCTION
It is also known as The Great Recession, Lesser Depression, the Long Recession, or the global recession of 2009. Global economic decline that began in Dec. 2007 and took a particularly sharp downward turn in Sept. 2008 Caused the values of securities tied to U.S. real estate pricing to plummet, damaging financial institutions globally. Stimulated Systemic imbalances and sparked the outbreak of the financial crisis of 20072008.
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Origin
From 1820 to 1970, every decade U.S. workers experienced a rising level of wages In the 1970s this came to an end; real wages stopped rising and they have never resumed since U.S. workers became more productive, but got paid the same; wages began to stagnate and decline The gap between labor and capital grew bigger
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Origin Contd

Origin Contd
The large corporations made huge profits and had much money at their disposal They bought other corporations (mergers and acquisitions) and they put their money into banks The banks loaned that money (with interest) to workers who didnt have money to consume This was done to raise their purchasing power because their wages werent enough to buy things 6

Origin Contd
Since employers no longer raised workers wages, the workers had to go into debt to survive Debt went up and up and things got out of control

The banks continued to loan money through new loans (secondary mortgages) at high interest rates, and this was a profit bonanza for the banks
As corporations increasingly began to invest abroad (outsourcing production and services)
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Origin Contd
U.S. workers lost their jobs, and this led to greater unemployment and underemployment Unemployed workers with a lot of debt were unable to make their mortgage and credit card payments, and this led to foreclosures and bankruptcies

This, in turn, led to the collapse of the banking system, necessitating a government bailout of the banks
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Origin Contd
It is only through the nearly trillion dollar stimulus funds that the U.S. government poured into the economy to save the banks from default.

Root Causes
Lower Interest rates caused by worldwide macroeconomic imbalances over the last decades Increased risk taking by banks (sub prime lending) contributing to high assets price i.e. asset price bubbles. Changing structure of financial sector and rapid pace of financial innovation (credit market derivatives, credit default swaps) Lax regulation or failure to adequately regulate highly leveraged financial institutions
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Root Cause: Deregulation

Among other, repeal of Glass Stegal Act 1933 is most damaging deregulation. Under this act, banks, brokerage firms, and insurance companies were effectively barred from entering each others industries. Investment banking and commercial banking were separated. Lifted all restraints on the operation of giant monopolies that dominate the financial system.
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Root Cause: Deregulation Contd

No restriction on the integration of banking, insurance and stock trading as imposed by GS act. This allowed banks to engage in certain securities activities without first registering as broker with SEC.

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Root Cause: Leverage

Failure to stop excess leverage which started the speculation with borrowed money. Typical leverage for a hedge fund and private equity was 30:1 For subprime mortgage company the leverage is infinite because there was no requirement of equity capital.
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Root Cause: Financial Innovation

New credit derivative like Credit Default Swap originated. CDS was sold as an insurance for mortgaged backed securities and used to persuade the investors to buy the securities in declining market. When securities failed, the investors tried cash into the insurance which made run on the banks inadequate reserves resulting in collapse of the investment firms like Lehman Brothers, Merill Lynch 14 and AIG.

Subprime Increase and Decrease in Home Ownership

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Trend of House Prices

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Spillover: How it Spread?

By the time, investors (usually banks) could understand the risk, the crisis was into systemic spillover. Banks that lend to sub prime borrower securitized the loans and sold it to other financial institutions within and out of US. The money collected from securitized loans were again used to lend to subprime borrower
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Spillover: How it Spread? Contd

Underlying assets price fell drastically and Borrower defaulted on their loans Liquidity of the banks and market dried up

Inter bank borrowing dwindled due to lack of trust

As a result, default of sub prime borrower led to default of the lenders and in turn default of other buyers and insurers of the loan causing systemic spill over the world.
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Spillover: How it Spread? Contd

Through trade, financial, and commodity price linkages in our interconnected global economy. The International Monetary Fund (IMF), which failed to warn against the US housing bubble and the subsequent global financial crisis

The export based countries suffered due to lower demand from the US and other European countries.
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Spillover: How it Spread? Contd

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Spillover: How it Spread? Contd

Various countries failed to identify the nature and effect of the crisis which delayed the policy responses

By the time, governments put their efforts, the crisis already was turned into sovereign debt crisis.

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Impact
The current economic crisis has been deep and widespread on a global basis, especially in the U.S. In the epicenter of the crisis, in the United States, unemployment increased from 7 million in December 2007 to 16 million in October 2010 Counting the discouraged and part-time workers, the unemployment rate reached 18% in 2010 Foreclosures have been running over 1 million a year & Poverty is on the rise (now 44 million Americans 1 in 7 live at or below the poverty line) 22

Impact contd
Loss of manufacturing sector and more Finances

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 Private debt crisis into a sovereign debt crisis when the rating agency, S&P, waited for Wall Street announcing that America's debt would no longer be classed as top-notch triple A. May 2010 marked the point at which the focus of concern switched from the private sector to the public sector.

Impact Contd

Policymakers are confronted with a slowing global economy and a systemic crisis in one of its component parts, Europe.
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Impact Contd
By the time the IMF and the EU announced they would provide financial help to Greece, the issue was no longer the solvency of banks but the solvency of governments. Budget deficits had ballooned during the recession, as a result of lower tax receipts and higher nondiscretionary welfare spending Austerity became the new watchword, affecting policy decisions in the UK, the Euro zone and, most in the US, the country that stuck with expansionary fiscal policy the longest.
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Impact Contd
Greece had unique problems as it covered up the dire state of its public finances and had difficulties in collecting taxes To the extent that they are united, they are united in stupidity, wedded to blanket austerity that will make matters worse not better. And they have yet to tackle the issue that lay behind the 2007 crisis in the first place, the imbalances between the big creditor nations such as China and Germany, and big debtors like the US.
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Global Crisis : Euro Debt Crisis

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Developing Markets and Crisis

China Export driven economy of china dwindled due to decrease in the exports Importing countries, imported less from the China due to their crisis ridden financial condition. India The most immediate effect of that crisis on India has been an outflow of foreign institutional investment from the equity market. As Foreign institutional investment pull out their money from the stock market, the large corporate 28 undoubtedly affected

Developing Markets and Crisis Contd

The worst affected are likely to be the exports and small and marginal enterprises that contribute significantly to employment generation.

Nepal Has no direct linkage Job Loss in foreign countries by Nepalese workers Decreased remittance Decreased exports to some European countries
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Great Depression and Global Crisis

Both started from the United States Both characterized by stock market crash Both episodes were preceded by rapid credit expansion and financial innovation that led to high leverage. However, while the 1920s credit boom was largely US-specific, the 2004-07 boom was global. The problems arose from the erosion of the deposit base of US banks in the absence of deposit insurance in the Great depression.
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Great Depression and Global Crisis Contd

Funding problems have arisen for financial intermediaries relying on wholesale funding, particularly those issuing or holding (directly and indirectly) US mortgage-related securities whose value was hit by increasing mortgage defaults in recent crisis. Despite the stunning contraction of industrial production and trade across the globe in the second half of 2008, the global economy is still a far cry away from the calamities of the Great Depression.
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Which Way Out of the Crisis?

Changes that are required to revitalize the economy and turn things around point to a redistribution of wealth and income to increase mass consumption This would increase demand for consumer goods, hence increase production, and create jobs for the unemployed, as well as raising revenue for the state through corporate and individual income taxes Lending regulations and effective policy measures.
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Which Way Out of the Crisis? Contd

Raise economic and financial literacy Limit financial leverage Regulate derivatives majorly the credit derivative markets Balanced budget to cope with sovereign debt crisis Establish a new and more effective ratings agencies
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