SUBPRIME CRISIS 2008

Housing Bubble: USA

Group 2: TYBBA A
Abhilasha Mohan Ram A003
Mayank Beria A025
MihirMandrekar A026
Monil Shah A027
Rohan Negi A035
ZoyaKazi A053

Meaning of Subprime :

The word means subordinate to primary

It is the loan given to people with a bad credit
rating who are not eligible for Prime loan
( normal loans )
Characterized by higher interest rates, poor
quality collateral, and less favorable terms in
order to compensate for higher credit risk
Sub-prime lending may be utilized for sub-prime
mortgages, sub-prime car loans, sub-prime
credit cards etc.

Why are Subprime loans issued ?

For banks to earn more money by tapping the

defaulting customers

For young people who do not have enough money

for down payment

For people having financial problems

For people who are discriminated against

Subprime Crisis in Brief

The US subprime mortgage crisis was a set of events and conditions that led to a
financial crisis and subsequent recession that began in 2008

Characterized by a rise in the inability to pay housing mortgages resulting in the

decline of securities backed by mortgages

These mortgage-backed securities (MBS) initially offered attractive rates of return

However, the lower credit quality ultimately caused massive defaults

The money was sucked out of several banks, financial institutions and the economy
as a whole in September 2008

Several European and developing countries had invested heavily in American banks

The subsequent loss of funds resulted in the Global Recession of 2008

 2000-2005

Very low interest rates, property prices were on a

rising trend and the sub prime borrowers were
able to meet their obligations by selling the
properties or getting the properties refinanced

This created what is called The Housing Bubble

2005-2006 :

The housing bubble burst during this time,

triggering the crisis
There was a steep fall in housing prices
The interest rates on subprime loans however
were high and were rising
The subprime borrowers were not able to meet
their liabilities leading to meltdown of the US
subprime industry

2006-2008 :

More subprime borrowers failed to pay their debts

Securities held by mortgages lost value globally
Global investors also drastically reduced
purchases of mortgage-backed debt and other
securities

The global recession of 2008-2009 :

Concerns about the soundness of U.S. credit and

financial markets led to tightening credit around
the world and slowing economic growth in the
U.S. and Europe
The U.S. entered a deep recession, with nearly 9
million jobs lost during 2008 and 2009
This recession was second to only The Great
Depression of the 1920s resulting in huge losses

WHEN DID IT ALL

START?

The American Dream

Owning a home is part of the 'American Dream'. It allows

people to take pride in a property and engage in a
community for the long term.
However, homes are expensive and most people need to
borrow money to get one.
The conditions were right for people to achieve that
dream. In the early 2000s, mortgage interest rates were
low, which allow you to borrow more money with a lower
monthly payment. In addition, home prices increased
dramatically, so buying a home seemed like a sure bet.
Lenders understood that homes make good collateral so
they were willing to participate.
The mortgage crisis was triggered as this situation built
momentum.

 DOT

COM COLLAPSE 2000

SEPTEMBER

11 TERRORIST ATTACK

Low interest rates

Increase in loan incentives

Easy credit conditions

 Principle of demand and Supply

2001

2004

Increase in Sub prime

borrowers
1994
1996
1999
2006

-5%
-9%
13%
20%

2005
The housing bubble began to burst in late
2005
Since the end of 2005, default rates on
subprime mortgages have soared from
6.5% to 17%, while foreclosure rates have
jumped from 2.5% to 9%.

2006
When

house prices ceased rising in mid

2006 and then started falling, subprime
mortgage defaults began accelerating.
Effects
Sub prime borrowers
Financial institutions
Banks

2008

On December 1, 2008, the National Bureau of

Economic Research announced that the economy had
entered into a recession in December of 2007. Real
GDP increased by only 0.4 percent for the year 2008,
and it decreased at annual rates of 5.4 percent in the
4th quarter of 2008 and 6.4 percent in the 1st quarter
of 2009. The unemployment rate increased from 4.9
percent in December of 2007 to 9.5 percent in June of
2009.

The total real estate equity in The United States was

valued at $13 trillion during the 2006 peak, had fallen
to $8.8 trillion by mid 2008.

The Main Players

The people who contributed to the deadly chain
of events that sent the entire world economy
into recession.

The Federal Reserve

Continued
Reduction in Fed
Rates
Sudden increase in
Money supply
Rates remained
low till 2005
High Liquidity

Commercial Banks
Lowered to lending rates to increase loan off
take
As the prime market was nearing
saturation, began lending to subprime
borrowers
Aggressively sold MBS, CDO
Additional funds raised by securitization was
re-deployed in the same manner

Non-traditional mortgages
MBS ratings influenced using parental
linkages as well as rating shopping

Homebuyer
Buying property well beyond their means
Buying for price arbitrage
Non-traditional mortgages leveraged their
borrowing capacity further
2yrs fixed rate, then floating rates: EMIs
rose exuberantly, house value fell
Thus making foreclosure a viable option
Accelerated downward spiral

Investment Banks
Increased use of Secondary mortgage
market
Lenders sold their mortgages in the
secondary market
Pooled mortgages into securities like CDOs
and MBS

Investors:
Investors were the ones willing to purchase
these CDOs at ridiculously low premiums
over Treasury bonds.
These enticingly low rates are what
ultimately led to such huge demand for
subprime loans.

Source: Hammond Associates

Hedge Funds
Fuelled volatility through credit arbitrage
Credit Default Swaps
Influenced banks to bring out more MBS &
CDOs as it was a good avenue to invest in

The worst hit economies

Denotes the real GDP Growth during 2009.
(Countries in brown represent those in recession)

Source: Wikipedia

Subprime Crisis and

India

Indias export growth rate

Year

Growth (US$ Bn)

2006-07

22.6

2007-08

29.0

2008-09

13.7

2009-10

-3.6

2010-11

29.5

15 per cent of total export in 2006-07 was directed toward

USA.
Official statistics released on the first day of the New Year,
showed that exports had dropped to $1.5 billion in
November 2008, (Sivaraman, 2008) from $12.7 billion a
year ago.
Manufacturing sectors like leather, textile, gems and
jewellery got hit hard.

Indias GDP growth rate

Year

Growth Rate

2005-06

9.5

2006-07

9.6

2007-08

9.3

2008-09

6.8

2009-10

8.0

2010-11

8.6

Source:
http://planningcommission.nic.in/data/datatable/1705/final_1.p

Impact on Indian Stock

Market

BSE SENSEX PERFORMANCE IN 2008

Month

Open

High

Low

Close

January

20325.27

21,206.77

15,332.42

17468.71

February

17820.67

18,895.34

16,457.74

17578.72

March

17227.56

17,227.56

14,677.24

15644.44

April

15771.72

17,480.74

15,297.96

17287.31

May

17560.15

17,735.70

16,196.02

16415.57

June

16591.46

16,632.72

13,405.54

13461.60

July

13480.02

15,130.09

12,514.02

14355.75

August

14064.26

15,579.78

14,002.43

14564.53

September

14412.99

15,107.01

12,153.55

12860.43

October

13006.72

13,203.86

7,697.39

9788.06

November

10209.37

10,945.41

8,316.39

9092.72

December

9162.94

10,188.54

8,467.43

9647.31

Source: http://www.bseindia.com/indices/indexarchivedata.aspx

Reason for fall in index

Against a net inflow of US$20.3 billion in

FY20072008, there was a net outflow of US$15
billion from Indian markets during FY20082009
as foreign portfolio investors sought safety and
mobilized resources to strengthen the balance sheet
of their parent companies.
With Indian stocks melting under the heat of a global
crisis, overseas investors pulled out three dollars
in 2008 from every four pumped in the previous
year.
A major chunk of FII of over $3 billion had taken
place in October 2008 alone, which saw the Sensex
going to its lowest level in the last three years.

Primary Market (IPO-NSE)

Year

No. of
IPOs

Amt
Raised
(in Rs.
Cr)

Issue
Issue
Succeed Failed
ed

2007

108

33,946.2
2

104

04

2008

39

18,339.9
2

36

03

2009

22

19,306.5
8

21

01

2010

66

36,362.1
8

64

02

IPO Report - Year Vs. Money raised through IPOs

FDI & ECBs

FDI

ECBs

Year

Inflow

2004-05

US$6Bn

2007-08

US$34.3Bn

2004-05

US$9Bn

2007-08

US$30.3Bn

only US$18 billion raised in FY20082009 as commercial credit

from the overseas market=41% less than the amount raised in the
previous year.
ECB approvals declined from US$3 billion in September 2008 to
less than US$0.5 billion in February 2009.
For the first time in last six years, FDI inflows witnessed a negative
growth of 2% in FY20082009.

Fall of INR
Jan 1st : 1USD =39INR

Dec 30th : 1USD =48INR

Dec 1st : 1USD=50INR

WHERE AND HOW IT DID NOT

HURT INDIA ON A LARGE SCALE ??

WHY THIS DIFFERENCE!!

Indias Real estate market was very similar
to that of the U.S in 2008.
Housing developments were sprouting up
everywhere.
Plenty of money flowing into India, mainly
from private equity and hedge funds, to fuel
the commercial real estate bubble in
particular.
Carlyle, Blackstone, Citibank they were
all here, throwing money at developers

Banking Sector
70% of the banking system in India is
nationalized, so RBIs role as a strong
regulator is critical.
Indian banks were not levered like American
banks.
Capital ratios here are 12% and 13%,
instead of 7% or 8% of the Americans.

Banks
Federal Bank
Oriental Bank of
Commerce
Barclays Bank
Corporation bank
Kotak Mahindra Bank
Allahabad Bank
Bank of India
ICICI bank
Citi Bank
Axis Bank
Indian Overseas Bank
HFDC bank

Capital Adequacy
Ratio during
2007-08
22.5%
12.1%
21.1%
12.1%
18.7%
12.0%
12.0%
14.0%
12.0%
13.7%
12.0%
13.6%

Positives of the Indian Banking

sector
Indian banks dont do interest-only or
subprime loans.
Never gave more money to a borrower
because the value of the house had gone up.
Non performing loans are less than 1 %.
Mortgage loans tend to have down payments
in India that are 1/3rd of the purchase price.
Lets not talk about those prevailing in the
United states!

ONE MAN ARMY of Dr. Y.V.

Reddy!
He started sensing that real
estate, in particular, had
entered bubble territory before
the crisis.
One of the first moves he made
was to ban the use of bank
loans for the purchase of raw
land.
Only when the developer was
about to commence building
could the bank get involved
and then only to make
construction loans.

Reddy pushed interest rates up to more

than 20 percent, which of course dampened
the housing frenzy.

He made banks put aside extra capital for

every loan they made.

In effect, Mr. Reddy was creating liquidity

even before there was a global liquidity
crisis.

INDIAN IT SECTOR
India's trade theory is changing a lot as it is
turning out to be more of a manufacturing
export oriented country.
The net trade of services done by India
accounts to about just 22% .
The trade practices of India with US has
decreased .
BUT on the other hand has relatively
increased with China reflecting out that the
risk of US recession has been deflected.

However on a short term it will have its effect

on the IT companies and also on its revenues in
their future quarter results.
The growth in the employment in the IT sector
in the year 2008 was 44 % up till August 08
which will drop to about 28% net growth for this
financial year.

BLACK MONEY

For both commercial and residential real-estate,

the proportion of black to white money may
vary from 20 to 40 % depending on various
factors.

However, the borrowing from banks is based

only on the white portion as it should be.

Thus the value of the asset is substantially

higher than what is shown in the book due to
financing of the asset partly by black income.

The presence of black

money or what one may
call the hidden net worth
of India has tremendous
advantages in times of
asset based lending and
borrowing since only a
part of the price of asset
is seen, like the tip of the
iceberg.
The other portion of the
asset finance by the
borrower from black fund
makes it imperative for
him to protect his
position by meeting the
obligations.

The amounts in the form of black money are

large and mostly invested in real-estate and
gold, two major areas of passion for the
Indian middle-class. As long as a good
portion of our economy and asset financing
is by black income we need not worry about
sub-prime

THANK YOU!