Prof. T.S.

Marwah

Financial Crisis in USA in 1929

The year 1929 is referred in financial world globally as

the year of Great Depression. Real estate bubble burst was the cause of this Great Depression in USA. Post 1929 in the year 1930 all major banks in USA declared bankruptcy , in other words all major banks were insolvent. There was no recapitalization of these banks in USA in the year 1930 by US Federal Reserve (Central Bank of USA) American bench mark stock market Index is known as Dow Jones industrial Average (^DJIA)

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^DJIA jumped six fold from just 64 in 1921 to about 380 in the year 1929 .
Then big crack emerged after the bank failures of 1930. ^DJIA crashed from a high of 380 pts to its bottom of only 41 in 1932- it had given up all the gain of 8 years of bull run and some more.

Financial Crisis - 2008

In Q2 2007 onwards, housing mortgage financing

companies in USA started lending money to potential home buyers who were not eligible as per standard credit norms in the US housing finance market. USA is the biggest economy in the world with a GDP approx. US $ 14.3 trillion. By January 2008 the total exposure of all housing mortgage finance companies reached at a dangerous level of approx US$ 14 trillion. This figure of US$ 14 trillion included mortgage payments to about 10% of borrowers who were not eligible as per standard credit norms These borrowers started defaulting on their monthly mortgage EMIs with banks and housing mortgage finance companies .

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The

defaulters were now called sub-prime borrowers in the US financial markets . This happened because of excess liquidity in the US financial market and easy monetary policy of the US Federal Reserve. Sub-prime crisis shocked the US financial market in January 2008, as the information came into public domain that about US$ 1.4 trillion was the exposure of lenders to sub-prime house mortgage borrowers.

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^DJIA corrected nearly 25-30% in January 2008 US Fed. started investigation into this sub-prime crisis

and by June 2008 the information was shocking banks and mortgage companies had lent money to home buyers in USA violating all important norms i.e., job profile , credit rating , repayment capacity etc. Even insurance companies in USA had financed banks and other home lenders to make quick profits . It is needless to mention that lending rates to sub-prime borrowers were few percentage points higher than prime borrowers. The prime rate was around 9% p.a. for standard 25 years home mortgage and subprime rates were charged 11-12% p.a.

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In

early September 2008 the large American investment banks in USA started reporting huge mark to market losses on account of their exposure to Derivatives linked to housing finance Mortgage Bonds. What happened was that from July to early September 2008 - the prices of listed and traded housing Mortgage Bonds crashed as a consequence Derivatives linked to these Bonds also crashed .

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The crisis which shocked the US financial markets

and the world was - M/s Lehman Bros. which filed for bankruptcy in mid September 2008. It was not build out by US Fed as it bailed out a medium sized i-Bank M/s. Bear Sterns Inc in USA in August 2008. This chain reaction led to series of bankruptcies i.e. Bank of America , Citi Bank , Merrill Lynch , Fannie May, Freddie Mac and AIG etc.

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US Fed had to intervene and not allow global

insurance giant AIG to file for bankruptcy as this would have led to a total collapse of US financial markets. US Fed bailed out AIG by giving them US $ 180 billion . This failure of Lehman Bros. and subsequent failure above said Banks and Housing mortgage finance companies shattered the US and global financial market .

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In the last week of September 2008, ^DJIA crashed in its single largest daily fall in its history fell 778 points to close at 10365 on 29th September 2008. Just for information in January 2008 - ^DJIA was trading at above 14500 levels.
^ DJIA tested low of 7883 on 10th October 2008 down more than 50% its yearly high . Other global

equity indices were also down in October 2008 between 45 to 75 % from their yearly highs.

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US Govt. moved in to revive the economy by getting US$ 780 billion funding program as stimulus package sanctioned by lawmakers. This program was called TARP and was used for recapitalizing insolvent banks and

housing mortgage companies. Other Governments in the world also approved stimuli packages for their respective economies to pull them out of recession. The total estimated global stimulus package was in the range of US$ 3 to 3.5 trillion with the second biggest stimulus package announced by Chinese Govt with the tune of US$ 600 billion.

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Global economy recovered from low of March 2009 to

August 2010 ( about 18 months) . ^ DJIA doubled from low March 2009 of around 6400 to around 13000+ in 18 months.

Current Financial Crisis

Current financial crisis started with Iceland - a small

economy in Europe which was bailed out IMF in December 2010. The issue was Debt to GDP ratio and the large banks in Iceland facing insolvency due to downgrade of Icelands Sovereign debt bonds. IMF build out Iceland with a US$ 50 billion package.

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Next country to default was Ireland which had problem on

two accounts Sovereign debt issues and solvency issues of four largest banks. The contagion spread to Greece and Portugal over the next six months and Greece was unable to service it Sovereign Debt . We repeat that Ireland , Greece , Portugal, Spain , Italy and off late France, have one common issue i.e. high Debt to GDP ratio. Greece was bailed out on 1st July 2010 jointly ECB and IMF by giving emergency aid of Euro 12 billion to avoid Sovereign Debt default . This means the Greek Govt. could not pay interest on Sovereign Debt as there are no money in their treasury .

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ECB and IMF in the last week of July 2011 bailed out

Greece with a package of Euro 150 billion. Just for information Debt to GDP ratio of Greece is more than 170%, with a debt of Euro 320 billion. Debt to GDP ratio of Spain is about 150% and that of Italy is around 78% . The market has perception that Spain, Italy and now France may not be able to service their Sovereign Debt. The second issue which caused the current financial crisis is the downgrade AAA rating of US Sovereign Debt to AA+ by American rating Agency M/S Standard and Poor on Friday 5th August 2011.

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This rattled the American financial markets as this is

for the first time that US Sovereign Debt has lost its AAA rating. This downgrade was announced after US Govt. raised their Debt ceiling limit by 2.1 trillion dollars on 2nd August 2011 to avoid Sovereign default. Current US Sovereign debt US$ 14.00 trillion. ^DJIA crashed 20% after this announcement of debt ceiling increase and downgrade by S&P. This led to global equity market crash.

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The fear is that US might also follow on the same path

of sovereign default as it may not be able to service its debt . Fears are USA headed for double dip recession and other recession like to 2008. Indian exports have shown a surge of more than 50 % in July 2011 and exports too have shown a surge of about 48 %. But the trade deficit for the month was US $ 11.50 billion. For the last fiscal Indian trade deficit was US $ 105.00 billion

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Commerce Secretary GoI informed media on

8/11/2011 that exports will show a dip in September 2011 onwards because of the financial crisis which has hit USA and EU countries in July and August 2011. We feel the sectors of the Indian economy which will be hit on the export front would be IT and ITes, Textile and other apparel, Gems & Jewellery, Automobiles and components. Pharma API and FMCG exports should do well.

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Imports will continue to surge due to a strong

domestic demand in India across all sectors . Coal and Fertilizer sectors should boom in India. Consumer electronics, smart mobile phones, lap-tops, golfing gear, high end sports goods, luxury life-style products and fashion apparel are other imported goods which will do well in India due to strong domestic demand. Wellness products is another niche area which will boom in India irrespective of global recession. Need less to mention BMWs, Audis, etc.

Cheers to the Indian Economy !

Thanks
8/11/2011