Topic:The Financial Crisis
The Hottest Topic of the season and it would most surely be one of the favorites for the Group discussions and could well be asked in the interviews. Not only this we expect panels would also ask for your advice on this. So we have underlined certain pointers which would come in handy for you.
What is Financial Crisis?
It is a situation of crisis or liquidity crunch where markets ,the banks and the financial institutions loose a large part of their capital or their assets suddenly lose a large part of their value. As a result, all of these financial institutions panic, do not cooperate among themselves and as a result the whole economy goes to recession.
When a bank suffers a sudden rush of withdrawals by depositors, this is called a bank run. Since banks lend out most of the cash they receive in deposits , it is difficult for them to quickly pay back all deposits if these are suddenly demanded, so a run may leave the bank in bankruptcy, causing many depositors to lose their savings unless they are covered by deposit insurance. A situation in which bank runs are widespread is called a systemic banking crisis or just a banking panic. A situation without widespread bank runs, but in which banks are reluctant to lend, because they worry that they have insufficient funds available, is often called a credit crunch.
"The financial crisis of 2007-2009, initially referred to in the media as a "credit crunch" or "credit crisis", began in July 2007[1][2] when a loss of confidence by investors in the value of securitized mortgages in the United States resulted in a liquidity crisis that prompted a substantial injection of capital into financial markets by the United States Federal Reserve, Bank of England and the European Central Bank.[3][4] The TED spread, an indicator of perceived credit risk in the general economy, spiked up in July 2007, remained volatile for a year, then spiked even higher in September 2008,[5] reaching a record 4.65% on October 10, 2008. In September 2008, the crisis deepened, as stock markets world-wide crashed and entered a period of high volatility, and a considerable number of banks, mortgage lenders and insurance companies failed in the following weeks."
-source(Wikipedia)
How it began?(its difficult to explain in short but its just an attempt:Recommend to read articles in between)
It all began in last quarter of 2006, prior to this there was a housing bubble created where America's dream of providing each of its citizens with a house of their own led its government to use its two powerful agencies (Fannie Mae & Freddie MAC)that did the underwriting(verification) of 80% of all US mortgages.These agencies were powerful because they were exempted form normal regulations. These agencies encouraged people to buy houses and subsequently created a bubble as the house/land values increased in US. People started buying houses by taking loans and the land values increased,Banks encouraged this as if there were defaulters the rising prices ensured that they would have assets worth their loans.Now as the housing bubble was created banks tried to cash in more by giving NINJA(No income No Job or assets) loans this was fine till the land prices rose, then came a time when the number of defaulters increased and the number of buyers decreased. This resulted in decrease in land value ,ultimately banks started loosing their asset value heavily. Now the banks instead of assets&capital had CDOs Collateralized debt obligations) these were basically asset backed security (An asset with a debt to be paid with a maturity).These CDOs were already pointed out as risky for financial markets by many experts including IMF chief economist as these included debt and financial institution wanted to sell them, eventually banks thought they had assets but no one was willing to pay the debt in CDOs.
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Ultimately Several large mortgage lenders run into problems, beginning with HSBC's well-publicized exit from the business at a $10.6 billion loss. Creditors quit lending short-term money - the lifeline of non-bank mortgage companies - to mortgage companies. Without the ability to borrow money, and with loan repurchases increasing, the party comes to an abrupt end for many subprime lenders.This began with bankruptcy of major firms Lehman brothers and Meryll Lynch both history now.
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What effect does it have on India?
Since America is the hub for trade all over the world, this recession would affect all other countries in the world. India's is hit mostly at the IT serivces sector which is the biggest contributor (45%)to GDP(2.996 trillion) , as the services sector depends mostly on US and Europe for contracts. This means a slump in US and Europe economy is bound to appear in Indian economy as well .The IT companies have these investment banks as their clients. With the effect of financial crisis, IT companies are not able to enhance their business with these
investment banks, and, in turn, started retrenching their employees. Apart from the financial crisis, the employees’ turnover is creating turmoil in the market as well. Job security is the biggest fear among people.More over FDI outflow and other factors have had a serious impact on Indian Markets.
Banks: The ongoing crisis has an adverse impact on Indian banks. The large investment
banks originally from the US, had invested substantially in the stocks of Indian banks.
The banks, in turn, have invested in derivatives, which might have exposure to these
investment bankers. Public sector banks, which have exposure towards derivatives, are
the worst hit by the crisis.Real estate:The investment banks had given huge amounts of money to real estate companies for development projects. With the large investment banks going bankrupt, the projects have to be discontinued, leading to the slump in the real estate market as well.Fortunately India has a powerful lending structure and most of the Indian Banks are nationalized. Indian Exports: Indian handicraft was hit by 70% the worst.Total exports fell from 29% growth to 10% since major exporter clients US and UK are severely hit by the crisis.Rupee depreciation.
What are governments around the world doing about it?
This is a very vast topic as different governments are trying out different things.Mostly we can say while West has been a part of the problem India is not but yet affected by it , so there is a difference in the policies followed all over the world.America has largely been following on the recommendation of Sir John Maynard Keynes, who was an economist and gave a theory on how to cope with the depression period in 1936. His theory work is popularly known as Keynesian Economics. Keynesians advise moderately strong government intervention, especially in a recession where the standard recommendation is for increased government spending , especially on capital projects such as new schools, hospitals and infrastructure, so as to stimulate the economy. In a boom they often suggest measures to dampen demand such as raising taxes and interest rates, and throughout the business cycle they generally prefer moderately robust regulation of economic activity(that was in short the theory goes very long).Keynesians believe that wage control,interest rate and tax rate control are very essential tools which governments all around the world should use at this time of recession.Major supportors of the Keynesian economics now include President Barack Obama and Nobel laurate Paul krugman(read Hindu for his articles).Partly India has also been following on the same terms. Some of the measure taken by RBI include lowering of the CRR(Cash reserve ratio i.e the amount(%) of cash a bank needs to give in to RBI) were slashed from 9 to first 7.5 then to 6.5 .This move will provide banks with additional money or cash i.e inflow of liquidity into the market as banks would be able to give more loans and meet the current demands. More over the interest rate was decreased from 5.5 to 4% encouraging people to take loans and invest in the economy thereby driving the economy to safe harbours.
.......More to come its just an introduction!
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