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GLOBAL FINANCIAL CRISIS (2008 Sub-prime Crisis (Sequence of events…
GLOBAL FINANCIAL CRISIS
2008 Sub-prime Crisis
Sequence of events
Mortgage lenders started liberal home loans.
even to the "subprime" orrowers, wt10 even do not have the capacity to repay, since mid 1990s
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Mortgage lenders want more money to lend,
hence they sold these existing loans to banks, Freddie Mac & Fannie Mae
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Investment banks combined them and sold
these as Collateralized Debt Obligations (CDOs) ($ 634 n in 2007) and sold to worldwide
investors as Mortgage Backed Securities (MBSs).
Credit Rating Agencies gave good credit
rating to Inv. banks as U1ey were tl, eir clients. The returns to the investors
depends on the montt1ly payments on loans
Insurance companies came into picture
through Credit Default Swaps (CDS) to cover investors losses. if t1ome buyers
defaulted on loans.
-Housinf prices started falling by 2006
-Home buyers defaulted on loans
-Insurance companies could not honoUR cds
-Govt ofEurope and North America came to rescue
-Cost to US economy 6-14 trillion dollars
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Worries remain still!
S&P, Fitch and Moody's still
control 90% of the Credit Rating Market
Top 10 commercial banks still
account for more than half the assets held by 100 largest
commercial banks
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Main reasons
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Banks in advanced economies moved away from business of making loans to investing funds in complex assets called 'securitised assets"
-These securitised assets were fderived from sub prime loans
-This had enormous implications for banks, as housing prices fell and assets lost value
Unaddressed major issues
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Size of debt
The crucial aspect of financial crisis
was the build-up of private debt, that is, the debt of households and nonfinancial
firms.
As per some experts, the key driver
of the recession in the U.S was the rise in household debt and the
consequent drop in household consumption
The regulation must address growth in credit
as well as the flow of credit into sectors such as real estate
Private debt has fallen, but Government
debt and Corporate debt have risen
Total debt i.e., Government, Corporate,
and Household: as a percentage of GDP ia higher than ever before
For the global economy as a whole, the
overhang of debt poses serious challenges
FINANCIAL GLOBALISATION
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From time to time, the U.S. spreads a flood
of dollars at low rates
The World takes up the cheap finance then,
the U.S. raises interest rates.
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The U.S. can borrow to the hilt, but the dollar
will not depreciate, it may even appreciate.
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