1. Sub Prime Crisis &
Euro Zone Crisis
A Presentation by-
Siddhant Agarwal

2. Sub Prime Crisis…
… and its rippling effects on the global economy

3. Contents
$ About the Crisis
$ Impact on USA
$ Impact on the World
$ Impact on India
$ Conclusion: Is there light at the end of the tunnel?

4. About the crisis
$ Post 2001, the US government had encouraged
US banks to lend money to people, to
encourage spending & investing mainly for the
purpose of buying houses
$ These banks granted loans to large number of
borrowers despite having lower income levels,
unsure employment status, unscrupulous credit
history, etc.
$ Huge number of borrowers availed of bank
credit without evaluating their repayment
capacities. The economy was flush with
liquidity & stock markets were booming

5. The Bubble Burst
$ A silent storm brewed in international financial
markets with origins in the US housing market,
which witnessed an unprecedented boom since
2001
$ The boom was led by rising housing prices, low
interest rates & aggravated by financial
innovation viz. MBS, CDO and CDS
$ Housing prices in USA began to drop in 2006.
Rising interest rates & falling housing prices led
to rise in sub prime mortgage delinquencies &
resultant foreclosure
$ Result: The housing bubble burst in Aug 2006

6. Sequence of events

7. Impact of Sub Prime Crisis in USA
The chart above brings out the irony and shows that underlying sub prime
houses are only a small percentage of the total housing market and it was
the bubble formed due to financial instruments viz. MBS, CDO and CDS,
that caused the real problem

8. Impact of Sub Prime Crisis in USA
$ Initial impact was felt in March 2008, when
investment bank, Bear Stearns was acquired
by J.P. Morgan Chase, a commercial bank, for
US$1.2 billion
$ September 2008, witnessed major shakeouts in
the US financial sector. The drama began with
Lehman Brothers declaring bankruptcy on 15
September 2008, facing a refusal by the
federal government to bail it out
$ Washington Mutual is closed by the US
government in the largest failure of a US bank.
Its banking assets are sold to J.P. Morgan
Chase for US$1.9 billion
The problem with investment bank balance sheets was that on the left side
nothing was right and on the right side nothing was left!

9. Impact of Sub Prime Crisis in USA
$ US Federal Reserve provided an emergency loan
of US$85 billion to insurance major, American
International Group (AIG), which will be
repaid by selling off assets of AIG
$ Investment bank, Merill Lynch was acquired by
Bank of America in September 2008 for $50
billion
$ US Federal Reserve granted approval to
investment banks, Goldman Sachs and Morgan
Stanley to convert themselves into commercial
banks
$ US Treasury Department confirmed that both
Fannie Mae and Freddie Mac, would be placed
into conservatorship with the government taking
over their management

10. Impact of Sub Prime Crisis in USA
$ Wachovia Corp agrees to sell most of its assets
to Citigroup Inc in a deal brokered by regulators.
However, Wells Fargo, a commercial bank,
drafted an agreement to acquire assets of
Wachovia for US$15.1 blln
$ The deal forced Wachovia to backtrack from the
Citigroup deal worth US$2.2 billion which was
backed by the US Government
$ US Government releases a US$700 billion bailout
package for its financial industry
$ Dow Jones posts its largest point decline ever
while the S&P 500 had its worst day since 1987
with an 8.8% drop
What's the difference between a guy who just lost everything in Las Vegas and an
Investment Banker? A tie!

11. Domino Effect across the World
$ Northern Rock Bank had difficulty
finding finance to keep the business
going and was nationalised in February
2008
$ British bank Lloyds TSB Group Plc
agrees to buy rival HBOS Plc, (UK’s
largest mortgage lender) scooping up
Britain's biggest home loan lender in an
all-share deal which values HBOS at
over £12 billion (US$22.3 billion)
$ In September 2008, British bank
Bradford & Bingley was nationalised
by the UK government, which will take
control of the bank's £50bn mortgages
and loans, while its savings operations
and branches are to be sold to Spain's
Santander

12. Domino Effect across the World
$ The Dutch operations of Fortis, Europe's largest victim of the credit crisis,
have been nationalised in a €16.8 billion (£13 billion) deal aimed to calm
investors in the troubled banking and insurance group
$ Germany struggled to rescue lender Hypo Real Estate (Mortgage Giant),
underlining the challenge facing European leaders, who vowed to restore
stability in a banking system hit by the worst crisis since the 1930s
$ In October 2008, the Australian government announced that AU$4 billion was
to be raised to fund non-bank lenders that are unable to obtain funding to
finance new loans. After industry feedback this was increased to AU$8 billion
$ Japanese financial powerhouse, Nomura Holdings Inc. bought over Lehman's
franchise in Europe and Asia Pacific, including Japan and Australia

13. Domino Effect across the World
$ Stock markets tanked - Crisis caused panic in the
financial markets and investors sold out and
withdrew their money, resulting in sharp drop in
stock prices.
$ Many banks, mortgage lenders, real estate
investment trusts & hedge funds suffered
significant losses.
$ Credit got tighter - banks became extremely careful parting with
their capital and decreased lending activities either to business
houses, retail customers and even to each other.
$ Effect on jobs – Many employees lost their jobs, especially in
the financial sector.

14. Domino Effect across the World
The world market capitalisation has fallen by 20% since March 2007 and by 31%
since December 2007. Year to date, the Indian and Chinese markets have been the
worst performers amongst the larger indices

15. Domino Effect in India
$ FII investments increased in most of
2007 in a booming Indian economy,
as the Sensex was on its way to a
historic peak of over 20,000 points
$ Since the inflow of dollars in the
Indian economy increased, the
dollar exchange rate decreased
$ In 2008, however, due to the effect
of the sub prime crisis, FIIs
liquidated their equity investments
in a big way – leading to a crash in
the stock markets
$ Simultaneously commodity prices,
including oil prices, were on a rise
due increasing demand for these
commodities
$ The combined effect resulted in an
increase in the dollar exchange rate

16. Is there light at the end of the tunnel?
$ There are factors that indicate that there may be more trouble left in American
equity markets viz. USA has a low private savings rate and a negative
household savings rate, in addition to a large current account deficit and a
currency that needs to depreciate further to reduce this gap
$ There is also a severe financial crisis affecting all sectors of the economy. It
does not seem likely the trouble has ended just yet
$ However, Warren Buffett may have started to see some light and has invested
$5bn in thepreference shares (attached with equity warrants) of Goldman Sachs
and $3bn in the preference shares of General Electric
$ Commodity prices (and hence inflation) are falling sharply and this will bring
relief to the world and make a stronger case for lower interest rates. This also
mitigates the impact of higher interest rates warranted by rising fiscal deficits of
the governments being created to bail out/ takeover financial institutions

17. Is there light at the end of the tunnel?
$ After an extended debate the US legislators have thought it fit, probably even
profitable, to create a bailout fund of US$700bn. This has been widely
endorsed by most while some still feel the amount to be grossly inadequate
$ Central Banks around the world are putting up a concerted effort to provide
liquidity to the globe by extending lines and cutting rates. This cannot but have
a stemming effect
$ The world’s Wealth is estimated at US$150 trillion, a lot of which was built in
the last 3 years. Some of the current losses in stocks and wealth is of course
very painful but in the long term may prove to be just a bad dream that led to
some much needed reform and changes in global leadership, a nightmare which
looks like it shall last a while
$ Never before have housing, banks, hedge funds, insurance companies,
commodities and currencies got so badly intertwined. Untangling them will
take sometime. When done, this will create a new world order

18. Some quotes on the crisis
“We were at the brink of something that would have made anything that's
happened in financial history look pale. We were very, very close to a
system that was totally dysfunctional and would have not only gummed up
the financial markets but gummed up the economy in a way that would take
us years and years to repair” – Warren Buffet
“There could be a lot more bank closures in the coming months which could
create significant investment opportunities. As many as thousand banks
could go belly up” – Wilbur Ross
“It is quite likely that the current synchronized global economic boom and the
universal, all encompassing asset bubble will lead to a colossal bust” – Dr.
Marc Faber
“The money markets have completely broken down, with no trading taking
place at all. There is no market any more. Central banks are the only
providers of cash to the market, no one else is lending” – Christopher
Reiger (Dresdner Kleinwort)

19. Eurozone Debt Crisis
CAUSES, TIMELINE, EXTENT
OF THE CRISIS, HOW IT IS
BEING ADDRESSED AND
HOW IT’LL AFFECT US

20. How the crisis unfolded?
• Euro was born when European Union became a single
economic zone.
• EU comprised of strong (Germany, France) as well as weak
(Greece, Portugal) economies.
• Euro being the single currency in the union, there was no fear
of local inflation, so banks lent indiscriminately.
• World economy was in good shape, so direct correlation
between economic and repayment strength was not evident.
• Weaker economies of EU (PIIGS) overspent using borrowed
money.
• Now they are unable to pay back their debt

21. What did the PIIGS do?
• Ireland underwent a massive real estate bubble, and its banks sustained
giant losses. The Irish government wound up rescuing its banks, and now
the country is burdened under a huge debt load.
• Spain also experienced a huge housing bubble. The country didn't indulge
in excessive borrowing, rather, it ended up with high deficits because it
couldn't collect enough tax revenue to cover its expenses.
• Greece not only borrowed beyond its means, but exacerbated the problem
with lots of overspending, little economic production to make up the
difference, and some creative bookkeeping to prevent euro zone
authorities from realizing the true extent of the situation.
• Italy and Portugal have huge debt to GDP ratios, high unemployment and
are struggling with a weak economy

22. And now..
• Given the huge size of the PIIGS debt, investors are reluctant
to buy bonds from European countries, since many are in huge
debts and others may have to assume responsibility for the
black sheep.
• We could be looking at depression for Europe and recession
for rest of the world.
• Uncertainty prevails as
EU may break up
Some countries may pull out of the EU
Leading to a rash of ban failures

23. Timeline of the crisis
1999-2008
•Euro is introduced, more countries join in.
•In Dec ‘08 EU leaders agree on a 200bn-euro stimulus plan to
help boost European growth following the global financial crisis.
•2009
•Slovakia joins EU, Estonia, Denmark and others make
preparations to join.
•In April, the EU orders France, Spain, the Irish Republic and
Greece to reduce their budget deficits
•In December, Greece admits that its debts have reached 300bn
Euros; 113% of GDP, nearly double the EU limit of 60

24. Timeline of the crisis (cont.)
2010
• Severe irregularities are found in Greece’s accounting
procedures.
• Talks start over austerity measures, sparking riots and protests
• Euro continues to fall against Dollar and Pound.
• In May, EU members and IMF agree on a 110 bn Euro bail-
out package for Greece.
• Ireland, Portugal, Spain, Italy come under review.
• In November, the EU and IMF agree to a bailout package to
the Irish Republic totaling 85bn Euros.
• The Irish Republic soon passes the toughest budget in the
country's history.

25. Timeline of the crisis (cont.)
2011
• In February, eurozone finance ministers set up a permanent
bailout fund, called the European Stability Mechanism, worth
about 500bn euros.
• In April, Portugal admits it cannot deal with its finances itself,
leading to a 78bn-euro bailout.
• Greece approves fresh round of austerity measures, the EU
approves the latest tranche of the Greek loan, worth 12bn
euros.
• A second bailout of Greece is agreed upon, at 109 bn Euros

26. Timeline of the crisis (cont.)
2012
• S&P downgrades France and eight other euro zone
countries, blaming the failure of euro zone leaders to
deal with the debt crisis.
• Euro zone service sector shrinks, unemployment rates
hit all time high and European Commission predicts
that the euro zone economy will contract by 0.3% in
2012.
• Attention shifts to Spain and Italy, as they struggle to
avoid going the ‘Greece way’.

27. Extent of the Crisis: Debt as a % of GDP

28. Extent of the Crisis: Unemployment Rate

29. Extent of the Crisis: Projected GDP

30. Whose fault is it?
• “Irresponsible" countries who borrowed too much, taking advantage of the
low interest rates available to all euro member nations.
• The euro as a single currency cant meet the needs of 17 different economies.
• Typically, a country's central bank can adjust a nation's money supply to
encourage or inhibit growth as a way of dealing with economic turmoil.
However, the nations yoked together under the euro frequently haven't had
that option.
• If Spain and Germany hadn't both spent the last several years on the euro,
for example, then they wouldn't have been able to borrow at the same low
interest rates.
• If the PIIGS all still had their own individual currencies, they might be able
to export their way out of the mess they're in -- selling goods on the
international market until their respective situations were a little less dire
• The interconnectedness of the modern financial industry. Default by Italy or
a departure of the eurozone by a fed-up Germany , could reverberate around
the world.

31. What ‘s being done to avoid the crisis?
•Stronger economies are pushing for stringent spending
control guidelines, where a country’s spending will be
directly proportional to its economic strength.
•Several options are being discussed, such as, issuance
of Euro Bonds, backed by the entire EU.
•Restructuring of debt, with strict austerity measures
placed on countries at risk of default.
•Troubled eurozone countries are pledging to cut back
government spending to show they can be trusted

32. How does it affect the world?
• Stock market volatility.
• Financial institutions exposed to the debt will write it
down, affecting their bottom line.
• Borrowing will get costlier as interest rate will remain
high.
• As a result, spending will be less leading to a longer
recession.
• Weak consumption and spending in Europe spells
trouble for the rest of the world economy, that is
struggling to get out of the downturn.

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