GLOBAL FINANCIAL

CRISIS 2008

INTRODUCTION

Financial crises and accompanying economic recessions have occurred throughout history. Periodic crises appear to be part of financial systems of dominant or global powers.

The United States is the epicentre of the current financial crisis. Enjoying a unipolar moment following the collapse of the Soviet Union and the failure of Communism, the United States was confident that economic liberalization and the proliferation of computer and communications technologies would contribute to ever-increasing global economic growth and prosperity.

Globalization contributed to the extraordinary accumulation of wealth by a relatively few individuals and created greater inequality.

In an effort to reduce inequality in the United States, the government implemented policies that engendered the financial crisis.

Financial globalization contributed to the unprecedented growth and prosperity around the world.

China and India became significant economic powers, and the industrializedcountries grew even richer.

Closely integrated into the financial system are banks and investment firms. When the financial system is in crisis, banks reduce lending, companies often face bankruptcy, and unemployment rises. Ultimately, as we saw in the financial crisis of 2008–2009, many banks fail.

The financial crisis triggered a global economic recession that resulted in more than $4.1 trillion in losses, unemployment rates that climbed to more than 10 percent in the United States and higher elsewhere, and increased poverty. Stock markets around the world crashed.

Consumers reduced their spending, manufacturing declined, global trade diminished, and countries adopted protectionist measures, many turning their attention inward to focus on problems caused by the financial crisis. Given the central importance of finance to virtually all aspects of globalization, issues such as trade, the environment, crime, disease, inequality, migration, ethnic conflicts, human rights, and promoting democracy are affected.

Furthermore, the financial crisis weakened some countries more than others, thereby engendering significant shifts of power among countries, especially between the United States and China.

American investors lost roughly 40 percent of the value of their savings.

REASONS FOR THE CRISIS

Housing price increase during 2000-2005, followed by a levelling off and price decline.

Increase in the default and foreclosure rates beginning in the second half of 2006 due to the Fed’s manipulation of interest rates during 2002-2006

Collapse of major investment banks in 2008.Collapse of stock prices in 2008.

HOUSE PRICE CHANGE Housing prices were relatively stable during the 1990s, but they

began to rise toward the end of the decade. Between January 2002 and mid-year 2006, housing prices

increased by a whopping 87 percent. The boom had turned to a bust, and the housing price declines

continued throughout 2007 and 2008. By the third quarter of 2008, housing prices were approximately

25 percent below their 2006 peak.

INCREASE IN INTEREST RATE

Fed's prolonged Low-Interest Rate Policy of 2002-2004 increased demand for, and price of, housing.

The Fed injected additional reserves and kept short-term interest rates at 2% or less throughout 2002-2004

Due to rising inflation in 2005, the Fed pushed interest rates upward. Interest rates on adjustable rate mortgages rose and the default rate

began to increase rapidly. Default rate reached 5.2 percent during the third quarter of 2008. Starting in 2006, there was a sharp increase in the foreclosure rate.

COLLAPSE OF INVESTMENT BANK

An SEC Rule change adopted in April 2004 led to highly leverage lending practices by investment banks and their quick demise when default rates increased.

The rule favoured lending for residential housing. Based on historical default rates, mortgage loans for residential housing

were thought to be safe. But this was no longer true because regulations had seriously eroded the lending standards and the low interest rates of 2002-2004 had increased the share of ARM loans with little or no down payment.

When default rates increased in 2006 and 2007, the highly leveraged investment banks soon collapsed.

COLLAPSE OF STOCK PRICES

As of mid-December of 2008, stock returns were down by 37 percent since the beginning of the year.

This is nearly twice the magnitude of any year since 1950. This collapse eroded the wealth and endangered the retirement savings of many

Americans.

IMPACT ON MARKETSThe global financial crisis affected virtually all areas, including

the process of globalization. Housing prices crashed; foreclosures becamecommonplace; unemployment reached 10 percent in the United States and higher

levels in Europe and elsewhere; manufacturing declined sharply, especially in theautomotive industry; students were faced with higher costs as colleges suffered

financial losses; finding jobs after college became more challenging; and a globalrecession created widespread hardships. On the other hand, many developing

countries that took a prudent approach to finance and saved money were not as

badly damaged. In fact, countries that did not fully embrace financial liberalizationwere less affected than those that gave in to American pressure to fully engage

in financial globalization. We also saw a global power shift, with the United Stateslosing ground to China, India, Brazil, and other developing countries.

FORECLOSURES People could no longer afford to purchase homes, which meant that

homebuilders were forced to abandon construction projects. This resulted in a fall of demand of goods required in construction. All of the industries that produced these products generally

experienced declining sales.

DECLINE IN MANUFACTURING Manufacturing, already in decline, fell dramatically. This especially was the case in the automotive industry, with

General Motors and Chrysler declaring bankruptcy after closing many factories and dealerships, despite unprecedented financial support from the U.S. government.

GLOBAL POWER SHIFT Another major impact of the global financial crisis is

a global power shift. Although most countries were negatively affected by

the financial crisis and global recession, some emerged stronger than others.

Brazil, Russia, India, and China, also known as the BRIC countries, enhanced their power vis-à-vis the United States, Western Europe, and Japan.

HOW DID INDIA MAKE IT THROUGH?

In sharp contrast to the policies adopted by the U.S. Federal Reserve under Chairman Alan Greenspan, the Reserve Bank of India, led by Y . V. Reddy, rejected many financial innovations and limited the participation of foreign investors in India’s financial system.

Instead of believing that markets are self-regulating, as many Americans do, the Indian government favoured regulations and was quick to recognize financial bubbles.

Reddy restricted bank lending to real estate developers, increased the amount of money banks had to set aside as reserves, and blocked the use of some derivatives.

This conservative approach enabled India to largely avoid the global financial crisis.

EFFECTS OF ECONOMIC CRISIS

2008 ON THE GLOBAL ECONOMY

The historic meltdown of the global capital markets, and sharp economic downturn, is systemic in nature, and is conditioned by the contradictions, and vulnerabilities, of the current level of economic organization, with the world economy unable to develop further in the old manner. 

The global systemic crisis, which itself has built up over decades, will not be overcome until the vulnerabilities/ and contradictions that caused it are resolved effectively.

• While the crisis felt more acutely in some regions, it was a global systemic crisis.  The initial epicenter of the crisis was in the United States, but the crisis was a world crisis which affected the whole world system and disrupted the production process. The crisis was felt much stronger in the USA, and also in countries which are heavily integrated within the US economic and strategic sphere.

• The crisis was global in nature, and affected all countries that are part of the world economy, but not necessarily at the same time and to the same extent.  How and when it affected each country varied.  Collapse of several large international banks, corporate collapses and industrial shutdowns occured unevenly and at different times in various countries.

The crisis produced a handful of winners and help to reinforce global powerful monopolies controlling nearly all production, commerce and finance in the world economy. The importance of medium and small-size business declined still further.  The world economy became increasingly monopolized, and numerous corporate takeovers took place. Most small-size enterprises were unable to survive.

After contracting during the crisis, energy consumption resumed its growth. The global revival will need cheap energy, produced in greater quantities than before. 

There were already indications that the crisis will possibly encourage more internally centered economic growth in China, India, Russia and the rest of the emerging economies, strengthening domestic markets, but hence reducing their contribution to world trade during the crisis

As a result of the deepening of the global economic crisis, social inequality increased, but inequality of incomes between workers in the developed economies and the emerging economies lessened.

The crisis was destined to bring about fundamental changes in the world economic system. In order to develop further, the world economy needs qualitative changes.  There are limits to reform in the current global economic system, but at no other time in the last half-century have those limits seemed more flexible.

As a result of the serious collapse in global markets, and also because of the relative strength of their banking sector, it is quite possible that the emerging economies will increasingly shape the future of global finance just as they are already shaping the direction of global trade

IMPACT ON INDIAN

ECONOMY

IMPACT ON STOCK MARKET The immediate impact of the US financial crisis has

been felt when India’s stock market started falling. On 10 October, Rs. 250,000 crores was wiped out on a single day bourses of the India’s share market.

The Sensex lost 1000 points on that day before regaining 200 points, an intraday loss of 200 points. This huge withdrawal from the India’s stock market was mainly by Foreign Institutional Investors (FIIs), and participatory-notes.

IMPACT ON INDIA’S TRADEThe trade deficit is reaching at alarming proportions. Because of worker’s remittances. NRI deposits, FII investment and so on, the current deficit is at around $10 billion. But if the remittances dry up and FII takes flight, then we may head for another 1991 crisis like situation.

IMPACT ON INDIA’S EXPORTSWith the US and several European countries slipping under the full blown recession, Indian exports have run into difficult times, since October. Manufacturing sectors like leather, textile, gems and jewellery have been hit hard because of the slump in the demand in the US and Europe. Indian exports fell by 9.9 per cent in November 2008, when the impact of declining consumer demand in the US and other major global market, with negative growth for the second month, running and widening monthly trade deficit over $10 billions

. IMPACT ON INDIA’S HANDLOOM SECTOR, JEWELRY EXPORT AND TOURISM

Again reduction in demand in the OECD countries affected the Indian gems and jewellery industry, handloom and tourism sectors.

Around 50,000 artisans employed in jewellery industry have lost their jobs as a result of the global economic meltdown.

Further, the crisis had affected the Rs. 3000 crores handloom industry and volume of handloom exports dropped by 4.6 per cent in 2007-08, creating widespread unemployment in this sector .

EXCHANGE RATE DEPRECIATION With the outflow of FIIs, India’s rupee depreciated approximately by 20

per cent against US dollar and stood at Rs. 49 per dollar at some point, creating panic among the importers.

IT-BPO sectorThe overall Indian IT-BPO revenue aggregate is expected to grow by over 33 per cent and reach $64 billion by the end of current fiscal year (FY200). Over the same period, direct employment to reach nearly 2 million, an increase of about 375000 professionals over the previous year. IT sectors derives about 75 percent of their revenues from US and IT-ITES (Information Technology Enabled Services) contributes about 5.5 percent towards India’s total export. So the meltdown in the US will definitely impact IT sector. Further, if Fortune 500 companies slash their IT budgets, Indian firms could adversely be affected.

FII and FDIThe contagious financial meltdown eroded a large chunk of money from the Indian stock market, which will definitely impact the Indian corporate sector. Due to global recession, FIIs made withdrawal of $5.5 billion, whereas the inflow of foreign direct investment (FDI) doubled from $7.5biilion in 2007-08 to $19.3 billion in 2008 (April-September).

GOVERNMENT RESPONSE

The FEDERAL RESERVE (Fed) has been extremely active in making sure that the financial system continues to function properly during the credit crisis. 

The Fed lowered its key federal fund rates to provide additional liquidity to the financial system, expanded the range of collateral it would willing to accept in return for loans, and provided direct lines of credit to a broader variety of financial institutions

When Bear Stearns was on the verge of bankruptcy the Fed also guaranteed a large portion of Bear Stearns' liabilities in order to facilitate a takeover by JPMorgan. 

THE FEDERAL RESERVE 

The executive branch of the government has also been closely involved in maintaining stability in the financial system. 

the Federal Housing Finance Agency (FHFA,) in conjunction with the Treasury Department, placed Fannie Mae and Freddie Mac under conservatorship as part of a four-part plan to strengthen the housing agencies.

Following the rescue of Fannie Mae and Freddie Mac, the government chose not to rescue Lehman Brothers, instead allowing it to file for bankruptcy on September 15.

THE GOVERNMENT RESCUES PROMINENT FINANCIAL FIRMS

Faced with the possibility of a systemic collapse of the financial system, the Treasury proposed a $700 billion plan that would involve the government's purchase of impaired assets from the balance sheets of banks

Initially refused,The Treasury subsequently revised its proposal, and spurred by rapidly worsening financial market conditions, the House voted to pass the bill on October 3, 2008

Similar plans have been implemented globally as part of efforts to stabilize financial systems and stimulate economic activity. 

THE "BAILOUT PLAN"

Following the stock market crash of 1929, policy makers committed a trio of errors. They tightened monetary policy, restricted fiscal spending and failed to enhance confidence in the banking system.

It is widely believed that these mistakes exacerbated the effects of the depression that followed. 

Policymakers have learned from these mistakes, and those lessons were put to good use during the credit crisis of 2008, during which the Fed provided enormous amounts of liquidity to the financial system.

HOW EFFECTIVE WERE THESE MEASURES

The government also increased its spending, thereby providing fiscal stimulus to the economy. 

Finally, the government took extraordinary measures to secure confidence in the financial system through a variety of guarantees, insurance programs, loans and direct investments. 

CONTD.

THANK YOU!