Professional Documents
Culture Documents
Crises
The Worst Economic Crisis that Spread
like epidemic.
Ahmed Faizan
Table of Contents
Core Report
Introduction................................................................................................................ 3
Part I: How We Got Here............................................................................................. 5
Part II: The Bubble.................................................................................................... 12
The origins of the housing bubble.........................................................................13
The second phase of the housing bubble..............................................................13
The access of housing bubble...............................................................................14
The Financial Contributor of the Bubble................................................................16
Part III: The Crisis...................................................................................................... 21
Declines Begin....................................................................................................... 21
The Landslide Begins- Time Line...........................................................................22
The Way Forward................................................................................................... 24
Effect on Pakistan.................................................................................................. 26
Supplementary Reading:
Synopsis
Part I: How We Got Here
Part II: The Bubble
Part III: The Crisis
Important Terminologies Discussed
Bubble Economy:
Sub-prime mortgages:
Foreclosure:
Collateralized Debt Obligation (CDO):
How It Works/Example:
Hedge funds:
Mortgage-Backed Securities:
Adjustable-Rate Mortgage ARM:
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Introduction
The financial crisis of 20072008, also known as the Global
Financial Crisis and 2008 financial crisis, is considered by
many economists to be the worst financial crisis since the Great
Depression of the 1930s. It resulted in the threat of total collapse
of large financial institutions, the bailout of banks by national
governments, and downturns in stock markets around the world.
In many areas, the housing market also suffered, resulting in
evictions, foreclosures and prolonged unemployment. The crisis
played a significant role in the failure of key businesses, declines
in consumer wealth estimated in trillions of US dollars, and a
downturn in economic activity leading to the 20082012 global
recession and contributing to the European sovereign-debt crisis.
The bursting of the U.S. housing bubble, which peaked in 2006,
caused the values of securities tied to U.S. real estate pricing to
plummet, damaging financial institutions globally. The financial
crisis was triggered by a complex interplay of policies that
encouraged home ownership, providing easier access to loans for
subprime borrowers, overvaluation of bundled sub-prime
mortgages based on the theory that housing prices would
continue to escalate, questionable trading practices on behalf of
both buyers and sellers, compensation structures that prioritize
short-term deal flow over long-term value creation, and a lack of
adequate capital holdings from banks and insurance companies to
back the financial commitments they were making.
The United States housing bubble is an economic bubble
affecting many parts of the United States housing market in over
half of American states. Housing prices peaked in early 2006,
started to decline in 2006 and 2007, and reached new lows in
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This made CDOs popular with retirement funds, which could only
purchase high level securities.
This system in essence was a ticking time bomb as lenders didnt
care anymore whether a borrower could repay the loan, so they
started making riskier loans. The investment banks didnt care
either the more CDOs they sold the higher their profits. The
rating agencies which were paid by the investment banks had no
liability if their ratings of CDOs were proved wrong.
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Between the years 2000 and 2003, the number of mortgage loans
made each year had nearly quadrupled.
While in the early 2000s there was a huge increase in the riskiest
loans, called subprime loans.
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If the CDO went bad, AIG promised to pay the investor for their
losses.
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Goldman could bet against CDOs it didn't own, and get paid when
the CDOs failed.
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Begin
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Current Scenario
Six years after the first tremors in 2007, the world looks rather
different. Interest rates are much lower. Risk pricing is much more
sharply differentiated. The threat of deflation is now real for
several countries, and inflation is very low for others. In most
advanced countries since the crisis, real per capita GDP growth
has been insipid at best. Although weak banks appear to be much
less of a problem in Australasia, impaired bank balance sheets in
the Northern Hemisphere are casting a long economic shadow.
The new environment creates some structural and strategic
challenges for the global financial industry. Much-reduced
financial engineering and weaker financial institutions are likely to
see some retrenchment of certain banking activities. Also, with
very low yields, financial institutions subject to obligations or
strong expectations to pay fixed returns (such as pension funds)
face pressure to increase holdings of risky assets, so they can
support these returns. A renewed search for yield for these
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Supplementary Reading
Report At a Glance
This report would try to explain the financial crises in a three part
scenario as follows:
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Important
Terminologies
Discussed
Bubble Economy:
A surge in the market caused by speculation regarding a
commodity which results in an explosion of activity in that market
segment causing vastly overinflated prices. The prices are not
sustainable and the bubble is usually followed by a crash in prices
in the affected sector.
Sub-prime mortgages:
A type of mortgage that is normally made out to borrowers with
lower credit ratings. As a result of the borrower's lowered credit
rating, a conventional mortgage is not offered because the lender
views the borrower as having a larger-than-average risk of
defaulting on the loan. Lending institutions often charge interest
on subprime mortgages at a rate that is higher than a
conventional mortgage in order to compensate them for carrying
more
risk.
Foreclosure:
The process of taking possession of a mortgaged property as a
result of someone's failure to keep up mortgage payments.
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Hedge funds:
Hedge funds are private, actively managed investment funds.
They invest in a diverse range of markets, investment
instruments, and strategies and are subject to the regulatory
restrictions of their country.
Mortgage-Backed Securities:
A type of asset-backed security that is secured by a mortgage or
collection of mortgages. These securities must also be grouped in
one of the top two ratings as determined by a accredited credit
rating agency, and usually pay periodic payments that are similar
to coupon payments. Furthermore, the mortgage must have
originated from a regulated and authorized financial institution.
Also known as a "mortgage-related security" or a "mortgage pass
through."
When you invest in a mortgage-backed security you are
essentially lending money to a home buyer or business. An MBS is
a way for a smaller regional bank to lend mortgages to its
customers without having to worry about whether the customers
have the assets to cover the loan. Instead, the bank acts as a
middleman between the home buyer and the investment markets.
This type of security is also commonly used to redirect the
interest and principal payments from the pool of mortgages to
shareholders. These payments can be further broken down into
different classes of securities, depending on the riskiness of
different mortgages as they are classified under the MBS.
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