Global Recession 07-09

8/8/2019 Global Recession 07-09

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Introduction:

The global financial system literally went into a cardiac arrest after the Lehman

Brothers Holdings Inc. collapse and a meltdown was barely avoided through very

aggressive policy responses. The entire global economy will contract in a severe and

protracted U-shaped global recession that started a year ago. The recession in the

US market and the global meltdown termed as Global recession have engulfed

complete world economy with a varying degree of recessional impact. World over the

impact has diversified and can be observed from the very fact of falling Stock

market, recession in jobs availability and companies following downsizing in the

existing available staff and cutting down of the perks and salary corrections. The

global financial crisis started to show its effects in the middle of 2007 and into 2008.

It contributed to the failure of key businesses, declines in consumer wealth

estimated in the trillions of U.S. dollars, substantial financial commitments incurred

by government. Around the world stock markets have fallen, large financial

institutions have collapsed or been bought out.

What is Recession?

Recession or crisis is

the part of the

normal cycle of

business. It is

certain that they will

sooner or later

occur. Recessions

are the result of

reduction in the

demand of productsin the global market.

Recession can also

be associated with

falling prices known

as deflation due to lack of demand of products. According to the National Bureau of

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Economic Research (NBER), recession is defined as a significant decline in economic

activity spread across the economy, lasting more than a few months, normally visible

in real gross domestic product (GDP), real income, employment, industrial

production and wholesale-retail sales.

A recession is characterized by:

Rising unemployment: It takes time for unemployment to rise, but, even

when the economy is recovering; it takes time for unemployment to fall.

Rising Government Borrowing: A recession is bad news for the

government budget. A recession leads to lower tax revenues and higher

government spending on unemployment benefits. The UK is forecast to

borrow 60 billion; a recession could make this borrowing even worse in

2009. This borrowing means higher taxes and higher interest payments in the

future.

Falling Share Prices Generally a recession leads to lower profitability and

lower dividends. Therefore, shares are less attractive. Note share prices often

fall in anticipation of a recession. E.g. the recent falls in share prices are

largely because the market expects a recession soon. During the actual

recession, share prices often increase in anticipation of the economy

recovering.

Lower Inflation: Typically a recession reduces demand and wage inflation.

This should result in a lower inflation rate. However, this recession is

complicated because of rising oil prices. Therefore, the forthcoming recession

may actually occur simultaneously with higher inflation - a term known as

stagflation. But, a recession will definitely reduce demand pull inflation

pressures and encourages price wars on the high street as firms seek to

retain consumers.

Falling investment: Investment is much more volatile than economicgrowth. Even a slowdown in the growth rate can lead to a significant fall in

investment.

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Global Recession:

A global recession is a period of global economic slowdown. The International

Monetary Fund (IMF) takes many factors into account when defining a global

recession, but it states that global economic growth of 3 percent or less is

"equivalent to a global recession". Defining a global recession is more difficult,

because developing nations are expected to have a higher GDP growth than

developed nations.

Origins of the Global Recession

The global financial system has suffered a severe and virtually unprecedented blow,

leading to the failure of a number of major financial institutions in developed

countries and a worldwide economic slowdown with its accompanying job losses,

erosion in consumer and business confidence, and a tightening of credit. It all started

in the US; the boom in the housing sector was taking the economy to a new level. A

combination of low interest rates and large inflows of foreign funds the world became

awash with liquidity, with funds chasing any opportunity for good returns. In the

USA, low-income earners were encouraged to buy homes with little or no equity and

the banks moved to providing low-income mortgages. As more and more people took

home loans, the demands for property increased and fueled the home prices further.

As there was enough money to lend to potential borrowers, the loan agencies started

to widen their loan

disbursement reach and

relaxed the loan conditions.

As a result, many people withlow income & bad credit were

given housing loans in

disregard to all principles of

financial prudence. These types

of loans were known as sub-

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prime loans as those were are not part of prime loan market. With stock markets

booming and the system flush with liquidity, many big fund investors like hedge

funds and mutual funds saw subprime loan portfolios as attractive investment

opportunities. Hence, they bought such portfolios from the original lenders. Major

(American and European) investment banks and institutions heavily bought these

loans (known as Mortgage Backed Securities, MBS)

to diversify their investment portfolios. Owing to

heavy buying of Mortgage Backed Securities (MBS)

of subprime loans by major American and European

Banks, the problem, which was to remain within the

confines of US propagated into the word's financial

markets. As the home prices started declining in

the US, sub-prime borrowers found themselves in a

messy situation. Their house prices were decreasing

and the loan interest on these houses was soaring. As they could not manage a

second mortgage on their home, it became very difficult for them to pay the higher

interest rate. As a result many of them opted to default on their home loans and

vacated the house.

However, as the home prices were falling rapidly, the lending companies, which

were hoping to sell them and recover the loan amount, found them in a situation

where loan amount exceeded the total cost of the house. Eventually, there remained

no option but to write off losses on these loans.

The problem got worsened as the Mortgage Backed

Securities (MBS), which by that time had become

parts of CDOs of giant investments banks of US &

Europe, lost their value. Falling prices of CDOs

dented banks' investment portfolios and these

losses destroyed banks' capital.

Despite efforts by the US Federal Reserve to offer some financial assistance to the

beleaguered financial sector, it has led to the collapse of Bear Sterns, one of the

world's largest investment banks and securities trading firm. Bear Sterns was bought

out by JP Morgan Chase with some help from the US Federal Bank. The crisis has

A mortgage-backed

security (MBS) is an asset-

backed security or debt

obligation that represents

a claim on the cash flows

from mortgage loans,

most commonly on

residential property.

Collateralized debt

obligations (CDOs) are a

type of structured asset-

backed security (ABS)

whose value and payments

are derived from a portfolio

of fixed-income underlying

assets.

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also seen Lehman Brothers - the fourth largest investment bank in the US and the

one which had survived every major upheaval for the past 158 years - file for

bankruptcy. And slowly this recession started to creep into other countries like a

contagious disease.

Causes of global financial recession

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There is little doubt that

this global

recession was

caused by the

financial meltdown in the United States and quick spread out to touch almost

every corner of the world. It appears to be a commonly accepted theoryamong economists that this US recession was a direct result of sudden

busting of house bubble, and the

house bubble was created by rapid

growing yet unregulated subprime

mortgages. The burst of United

States housing bubble were peaked

in approximately 20052006. High

default rates on "subprime lending"

and "adjustable rate mortgages"

began to increase quickly thereafter.

An increase in loan incentives such as easy initial terms and a long-term trend

of rising housing prices had encouraged borrowers to assume difficult

mortgages in the belief they would be able to quickly refinance at more

favorable terms. However, once interest rates began to rise and housing

prices started to drop moderately in 20062007 in many parts of the U.S.,

refinancing became more difficult. Defaults and foreclosure

activity increased dramatically as easy initial terms expired, home prices failed to go

up as anticipated, and adjustable rate mortgage(ARM) interest rates reset

higher.

The main cause of a recession is a fall in Aggregate Demand. In the US 2008

recession, the main causes of falling aggregate demand have been:

An adjustable rate mortgage

(ARM) is a mortgage

loan where the interest

rate on the note is

periodically adjusted

based on a variety ofindices.

Foreclosure is the legal and

professional proceeding in which a

mortgagee, or other lien holder,

usually a lender, obtains a court

ordered termination of

a mortgagor's equitable right

of redemption.

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Growth of the Housing Bubble:This reduces consumer wealth and

prevents equity withdrawal through re-mortgaging. Also when house prices

fall, people lose confidence in spending as their main asset is declining in

value. Between 1997 and 2006, the price of the typical American house

increased by 124%. During the two decades ending in 2001, the national

median home price ranged from 2.9 to 3.1 times median household income.

This ratio rose to 4.0 in 2004 and 4.6 in 2006. This housing bubble resulted in

quite a few homeowners refinancing their homes at lower interest rates, or

financing consumer spending by taking out second mortgages secured by the

price appreciation. In a Peabody Award winning program, NPR correspondents

argued that a "Giant Pool of Money" (represented by $70 trillion in worldwide

fixed income investments) sought higher yields than those offered by U.S.

Treasury bonds early in the decade. Further, this pool of money had roughly

doubled in size from 2000 to 2007, yet the supply of relatively safe, income

generating investments had not grown as fast. Investment banks on Wall

Street answered this demand with the MBS and CDO, which were assigned

safe ratings by the credit rating agencies. In effect, Wall Street connected this

pool of money to the mortgage market in the U.S., with enormous fees

accruing to those throughout the mortgage supply chain, from the mortgage

broker selling the loans, to small banks that funded the brokers, to the giant

investment banks behind them. By approximately 2003, the supply of

mortgages originated at traditional lending standards had been exhausted.

However, continued strong demand for MBS and CDO began to drive down

lending standards, as long as mortgages could still be sold along the supply

chain. Eventually, this speculative bubble proved unsustainable. The CDO in

particular enabled financial institutions to obtain investor funds to finance

subprime and other lending, extending or increasing the housing bubble and

generating large fees. A CDO essentially places cash payments from multiple

mortgages or other debt obligations into a single pool, from which the cash is

allocated to specific securities in a priority sequence. Those securities

obtaining cash first received investment-grade ratings from rating agencies.

Lower priority securities received cash thereafter, with lower credit ratings but

theoretically a higher rate of return on the amount invested. By September

2008, average U.S. housing prices had declined by over 20% from their mid-

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2006 peak. As prices declined, borrowers with adjustable-rate mortgages

could not refinance to avoid the higher payments associated with rising

interest rates and began to default. During 2007, lenders began foreclosure

proceedings on nearly 1.3 million properties, a 79% increase over 2006. This

increased to 2.3 million in 2008, an 81% increase vs. 2007. By August 2008,

9.2% of all U.S. mortgages outstanding were either delinquent or in

foreclosure By September 2009, this had risen to 14.4%.

Easy credit conditions: Lower interest rates encourage borrowing. From

2000 to 2003, the Federal Reserve lowered the federal funds rate target from

6.5% to 1.0%.This was done to soften the effects of the collapse of the dot-

com bubble and of the September 2001 terrorist attacks, and to combat the

perceived risk of deflation U.S current account or trade deficit. Additional

downward pressure on interest rates was created by the USA's high and rising

current account (trade) deficit, which peaked along with the housing bubble in

2006. Ben Bernanke explained how trade deficits required the U.S. to borrow

money from abroad, which bid up bond prices and lowered interest rates.

Bernanke explained that between 1996 and 2004, the USA current account

deficit increased by $650 billion, from 1.5% to 5.8% of GDP. Financing these

deficits required the USA to borrow large sums from abroad, much of it from

countries running trade surpluses, mainly the emerging economies in Asia

and oil-exporting nations. The balance of payments identity requires that a

country (such as the USA) running a current account deficit also have a

capital account (investment) surplus of the same amount. Hence large and

growing amounts of foreign funds (capital) flowed into the USA to finance its

imports. This created demand for various types of financial assets, raising the

prices of those assets while lowering interest rates. Foreign investors had

these funds to lend, either because they had very high personal savings rates

(as high as 40% in China), or because of high oil prices. Bernanke referred to

this as a "saving glut." A "flood" of funds (capital or liquidity) reached the

USA financial markets. Foreign governments supplied funds by purchasing

USA Treasury bonds and thus avoided much of the direct impact of the crisis.

USA households, on the other hand, used funds borrowed from foreigners to

finance consumption or to bid up the prices of housing and financial assets.

Financial institutions invested foreign funds in mortgage-backed securities.

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The Fed then raised the Fed funds rate significantly between July 2004 and

July 2006.This contributed to an increase in 1-year and 5-year adjustable-

rate mortgage (ARM) rates, making ARM interest rate resets more expensive

for homeowners. This may have also contributed to the deflating of the

housing bubble, as asset prices generally move inversely to interest rates and

it became riskier to speculate in housing. USA housing and financial assets

dramatically declined in value after the housing bubble burst.

Subprime Mortgage/Lending: U.S. subprime lending expanded

dramatically 2004-2006.The value of U.S. subprime mortgages was estimated

at $1.3 trillion as of March 2007,with over 7.5 million first-lien subprime

mortgages outstanding.In addition to easy credit conditions, there is evidence

that both government and competitive pressures contributed to an increase in

the amount of subprime lending during the years preceding the crisis. Major

U.S. investment banks and government sponsored enterprises like Fannie

Mae played an important role in the expansion of higher-risk lending.

Subprime mortgages remained below 10% of all mortgage originations until

2004, when they spiked to nearly 20% and remained there through the 2005-

2006 peak of the United States housing bubble. A proximate event to this

increase was the April 2004 decision by the U.S. Securities and Exchange

Commission (SEC) to relax the net capital rule, which permitted the largest

five investment banks to dramatically increase their financial leverage and

aggressively expand their issuance of mortgage-backed securities. This

applied additional competitive pressure to Fannie Mae and Freddie Mac, which

further expanded their riskier lending. Subprime mortgage payment

delinquency rates remained in the 10-15% range from 1998 to 2006,[48]

then began to increase rapidly, rising to 25% by early 2008.Some, like

American Enterprise Institute fellow Peter J. Wallison believe the roots of the

crisis can be traced directly to sub-prime lending by Fannie Mae and Freddie

Mac, which are government sponsored entities. On 30 September 1999, The

New York Times reported that the Clinton Administration pushed for sub-

prime lending. Fannie Mae, the nation's biggest underwriter of home

mortgages, has been under increasing pressure from the Clinton

Administration to expand mortgage loans among low and moderate income

people... In moving, even tentatively, into this new area of lending, Fannie

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Mae is taking on significantly more risk, which may not pose any difficulties

during flush economic times. But the government-subsidized corporation may

run into trouble in an economic downturn, prompting a government rescue

similar to that of the savings and loan industry in the 1980s.A 2000 United

States Department of the Treasury study of lending trends for 305 cities from

1993 to 1998 showed that $467 billion of mortgage credit poured out of

Community Reinvestment Act (CRA)-covered lenders into low and mid level

income borrowers and neighborhoods. Nevertheless, only 25% of all sub-

prime lending occurred at CRA-covered institutions, and a full 50% of sub-

prime loans originated at institutions exempt from CRA. While the number of

CRA sub-prime loans originated were less than non-CRA sub-prime loans

originated, it is important to note that the CRA sub-prime loans were the

more "vulnerable during the downturn, to the detriment of both borrowers

and lenders. For example, lending done under Community Reinvestment Act

criteria, according to a quarterly report in October of 2008, constituted only 7

percent of the total mortgage lending by the Bank of America, but constituted

29 percent of its losses on mortgages. "Others have pointed out that there

were not enough of these loans made to cause a crisis of this magnitude. In

an article in Portfolio Magazine, Michael Lewis spoke with one trader who

noted that "There werent enough Americans with [bad] credit taking out [bad

loans] to satisfy investors appetite for the end product." Essentially,

investment banks and hedge funds used financial innovation to enable large

wagers to be made, far beyond the actual value of the underlying mortgage

loans, using derivatives called credit default swaps and synthetic CDO. As

long as derivative buyers could be matched with sellers, the theoretical

amount that could be wagered was infinite. "They were creating [synthetic

loans] out of whole cloth. One hundred times over! Thats why the losses are

so much greater than the loans. "Economist Paul Krugman argued in January

2010 that the simultaneous growth of the residential and commercial real

estate pricing bubbles undermines the case made by those who argue that

Fannie Mae, Freddie Mac, CRA or predatory lending were primary causes of

the crisis. In other words, bubbles in both markets developed even though

only the residential market was affected by these potential causes.

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Predatory lending. Predatory lending refers to the practice of unscrupulous

lenders, to enter into "unsafe" or "unsound" secured loans for inappropriate

purposes. A classic bait-and-switch method was used by Countrywide,

advertising low interest rates for home refinancing. Such loans were written

into extensively detailed contracts, and swapped for more expensive loan

products on the day of closing. Whereas the advertisement might state that

1% or 1.5% interest would be charged, the consumer would be put into an

adjustable rate mortgage (ARM) in which the interest charged would be

greater than the amount of interest paid. This created negative amortization,

which the credit consumer might not notice until long after the loan

transaction had been consummated. Countrywide, sued by California Attorney

General Jerry Brown for "Unfair Business Practices" and "False Advertising"

was making high cost mortgages "to homeowners with weak credit,

adjustable rate mortgages (ARMs) that allowed homeowners to make

interest-only payments.". When housing prices decreased, homeowners in

ARMs then had little incentive to pay their monthly payments, since their

home equity had disappeared. This caused Countrywide's financial condition

to deteriorate, ultimately resulting in a decision by the Office of Thrift

Supervision to seize the lender. Former employees from Ameriquest, which

was United Statess leading wholesale lender, described a system in which

they were pushed to falsify mortgage documents and then sell the mortgages

to Wall Street banks eager to make fast profits. There is growing evidence

that such mortgage frauds may be a cause of the crisis.

Increased debt burden or over-leveraging. Leverage ratios of investment

banks increased significantly 2003-2007. U.S households and financial

institutions became increasingly indebted or overleveraged during the years

preceding the crisis. This increased their vulnerability to the collapse of the

housing bubble and worsened the ensuing economic downturn. Key statistics

include: (1)Free cash used by consumers from home equity extraction

doubled from $627 billion in 2001 to $1,428 billion in 2005 as the housing

bubble built, a total of nearly $5 trillion dollars over the period, contributing

to economic growth worldwide. U.S. home mortgage debt relative to GDP

increased from an average of 46% during the 1990s to 73% during 2008,

reaching $10.5 trillion. (2)USA household debt as a percentage of annual

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disposable personal income was 127% at the end of 2007, versus 77% in

1990.(3) In 1981, U.S. private debt was 123% of GDP; by the third quarter of

2008, it was 290%.(4) From 2004-07, the top five U.S. investment banks

each significantly increased their financial leverage , which increased their

vulnerability to a financial shock. These five institutions reported over $4.1

trillion in debt for fiscal year 2007, about 30% of USA nominal GDP for 2007.

Lehman Brothers was liquidated, Bear Stearns and Merrill Lynch were sold at

fire-sale prices, and Goldman Sachs and Morgan Stanley became commercial

banks, subjecting themselves to more stringent regulation. With the

exception of Lehman, these companies required or received government

support.(5) Fannie Mae and Freddie Mac, two U.S. Government sponsored

enterprises, owned or guaranteed nearly $5 trillion in mortgage obligations at

the time they were placed into conservatorship by the U.S. government in

September 2008.

Financial innovation and complexity. The term financial innovation refers

to the ongoing development of financial products designed to achieve

particular client objectives, such as offsetting a particular risk exposure (such

as the default of a borrower) or to assist with obtaining financing. Examples

pertinent to this crisis included: the adjustable-rate mortgage; the bundling of

subprime mortgages into mortgage-backed securities (MBS) or collateralized

debt obligations (CDO) for sale to investors, a type of securitization; and a

form of credit insurance called credit default swaps (CDS). The usage of these

products expanded dramatically in the years leading up to the crisis. These

products vary in complexity and the ease with which they can be valued on

the books of financial institutions. As described in the section on subprime

lending, the CDS and portfolio of CDS called synthetic CDO enabled a

theoretically infinite amount to be wagered on the finite value of housing

loans outstanding, provided that buyers and sellers of the derivatives could be

found. For example, selling a CDS to insure a CDO ended up giving the seller

the same risk as if they owned the CDO, when those CDO's became

worthless. Certain financial innovation may also have the effect of

circumventing regulations, such as off-balance sheet financing that affects the

leverage or capital cushion reported by major banks. For example, Martin

Wolf wrote in June 2009: "...an enormous part of what banks did in the early

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part of this decade the off-balance-sheet vehicles, the derivatives and the

'shadow banking system' itself was to find a way round regulation.

Incorrect pricing of risk. The pricing of risk refers to the incremental

compensation required by investors for taking on additional risk, which may

be measured by interest rates or fees. For a variety of reasons, market

participants did not accurately measure the risk inherent with financial

innovation such as MBS and CDO's or understand its impact on the overall

stability of the financial system. For example, the pricing model for CDOs

clearly did not reflect the level of risk they introduced into the system. Banks

estimated that $450bn of CDO were sold between "late 2005 to the middle of

2007"; among the $102bn of those that had been liquidated, JPMorgan

estimated that the average recovery rate for "high quality" CDOs was

approximately 32 cents on the dollar, while the recovery rate for mezzanine

CDO was approximately five cents for every dollar. Another example relates

to AIG, which insured obligations of various financial institutions through the

usage of credit default swaps. The basic CDS transaction involved AIG

receiving a premium in exchange for a promise to pay money to party A in

the event party B defaulted. However, AIG did not have the financial strength

to support its many CDS commitments as the crisis progressed and was taken

over by the government in September 2008. U.S. taxpayers provided over

$180 billion in government support to AIG during 2008 and early 2009,

through which the money flowed to various counterparties to CDS

transactions, including many large global financial institutions. The 'shadow

banking system' itself was to find a way round regulation.

Commodities boom. Rapid increases in a number of commodity prices

followed the collapse in the housing bubble. The price of oil nearly tripled

from $50 to $147 from early 2007 to 2008, before plunging as the financial

crisis began to take hold in late 2008.Experts debate the causes, with some

attributing it to speculative flow of money from housing and otherinvestments into commodities, some to monetary policy, and some to the

increasing feeling of raw materials scarcity in a fast growing world, leading to

long positions taken on those markets, such as Chinese increasing presence

in Africa. An increase in oil prices tends to divert a larger share of consumer

spending into gasoline, which creates downward pressure on economic growth

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in oil importing countries, as wealth flows to oil-producing states self was to

find a way round regulation.

Systemic crisis. Another analysis, different from the mainstream

explanation, is that the financial crisis is merely a symptom of another,

deeper crisis, which is a systemic crisis of capitalism itself. According to Samir

Amin, an Egyptian Marxist economist, the constant decrease in GDP growth

rates in Western countries since the early 1970s created a growing surplus of

capital which did not have sufficient profitable investment outlets in the real

economy. The alternative was to place this surplus into the financial market,

which became more profitable than productive capital investment, especially

with subsequent deregulation. According to Samir Amin, this phenomenon

has led to recurrent financial bubbles (such as the internet bubble) and is the

deep cause of the financial crisis of 2007-2010. John Bellamy Foster, a

political economy analyst and editor of the Monthly Review, believes that the

decrease in GDP growth rates since the early 1970s is due to increasing

market saturation.

Role of economic forecasting. The financial crisis was not widely predicted

by mainstream economists, who instead spoke of The Great Moderation. A

number of heterodox economists predicted the crisis, with varying arguments.

Dirk Bezemer in his research[110] credits (with supporting argument and

estimates of timing) 12 economists with predicting the crisis: Dean Baker

(US), Wynne Godley (UK), Fred Harrison (UK), Michael Hudson (US), Eric

Janszen (US), Steve Keen (Australia), Jakob Brchner Madsen & Jens Kjaer

Srensen (Denmark), Kurt Richebcher (US), Nouriel Roubini (US), Peter

Schiff (US), and Robert Shiller (US).The Wharton School of the University of

Pennsylvania's online business journal examines why economists failed to

predict a major global financial crisis. Popular articles published in the mass

media have lead the general public to believe that the majority of economists

have failed in their obligation to predict the financial crisis.

Mortgage Defaults. Many homeowners were sold mortgage products that

became unaffordable when their introductory period ended and interest rates

increased. This lowered their disposable income and caused many to default

on their mortgage payments.

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Financial Crisis. The prospects of banks like Northern Rock and Bear Sterns

in the US going bankrupt have made people less confident about spending

and investing. Financial crisis caused an economic slowdown for US economy

decreased US demand for foreign goods + decline in demand due to fall in

dollar.

Credit Crunch / Difficulty of Borrowing Money. Because of high

mortgage defaults in US, many banks lost money. Therefore financial

institutions have become very reluctant to lend money; this has led to a

shortage of funds in the money markets. This has caused borrowing to be

more expensive and difficult to arrange leading to lower investment and

consumer spending.

Global contagion: The crisis rapidly developed and spread into a globaleconomic shock, resulting in a number of European bank failures, declines in

various stock indexes, and large reductions in the market value of equities

and commodities. Both MBS and CDO were purchased by corporate and

institutional investors globally. Derivatives such as credit default swaps also

increased the linkage between large financial institutions. Moreover, the de-

leveraging of financial institutions, as assets were sold to pay back obligations

that could not be refinanced in frozen credit markets, further accelerated the

solvency crisis and caused a decrease in international trade. World political

leaders, national ministers of finance and central bank directors coordinated

their efforts to reduce fears, but the crisis continued. At the end of October

2008 a currency crisis developed, with investors transferring vast capital

resources into stronger currencies such as the yen, the dollar and the Swiss

franc, leading many emergent economies to seek aid from the International

Monetary Fund. Failed in their obligation to predict the financial crisis.

Credit Default Swaps: Insurance obligations that were created to save

investment banks from loan defaults. This caused the insurance companies

get into trouble. Example AIG

Rising Costs. Rising oil, energy and food prices have caused an increase in

the cost of production. This causes the aggregate supply curve to shift to the

left; it leaves lower discretionary income for the average consumer.

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Stages of the Crisis:

The crisis has gone through

several stages.

First, during late

2007, over 100 mortgage

lending companies went

bankrupt as subprime

mortgage-backed securities

could no longer be sold to

investors to acquire funds.

Second, starting in Q4 2007 and in each quarter since then, financial

institutions have recognized massive losses as they adjust the value of their

mortgage backed securities to a fraction of their purchased prices. These

losses as the housing market continued to deteriorate meant that the banks

have a weaker capital base from which to lend.

Third, during Q1 2008, investment bank Bear Stearns was hastily

merged with bank JP Morgan with $30 billion in government guarantees, after

it was unable to continue borrowing to finance its operations.

Fourth, during September 2008, the system approached meltdown. In

early September Fannie Mae and Freddie Mac, representing $5 trillion in

mortgage obligations, were nationalized by the U.S. government as mortgage

losses increased.

Finally, investment bank Lehman Brothers filed for bankruptcy. In

addition, two large U.S. banks

(Washington Mutual and Wachovia)

became insolvent and were sold to

stronger banks. The world's largest

insurer, AIG, was 80% nationalized

by the U.S. government, due to

Currently, Fannie and Freddie

guarantee about 70% of all new

home loans. They are under

conservator-ship, and Treasury

Secretary Paulson is deferring

decisions regarding the mission

of the companies for the next

President and Congress.

A credit default swap (CDS) isa swap contract in which

the buyerof the CDS makes a

series of payments to

thesellerand, in exchange,

receives a payoff if a credit

instrument (typically a bond or

loan) goes into default16
http://en.wikipedia.org/wiki/Swap_(finance)http://en.wikipedia.org/wiki/Bond_(finance)http://en.wikipedia.org/wiki/Default_(finance)http://en.wikipedia.org/wiki/Swap_(finance)http://en.wikipedia.org/wiki/Bond_(finance)http://en.wikipedia.org/wiki/Default_(finance)


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concerns regarding its ability to honor its obligations via a form of financial

insurance called credit default swaps.

Impacts of global recession

Unemployment

ILO has projected that

because of the

ongoing economic

downturn, global job

loss was likely to be to

the tune of 18 to 51million by the end of

2009. A major setback

will be an additional

fall of 53 million

people below the

poverty line as a result

of the global crisis in 2009 alone. In the United States, 5.4 million jobs were lost

between July, 2008 and February, 2009; Spain lost 766 thousand jobs in the first

quarter of 2009 and unemployment jumped to 17.4 per cent. A substantial number

of job losses in developed economies along with possible reduction of various

workers benefits led to reduction of disposable income of low-income working people

and consequently had adversely affected demand for goods and services.

Business effects

The global recession affected the various business industries, such as lather,tourism, garment, etc.

Social effects

The living standards of people

dependent on wages and salaries are

more affected by recessions than those

who rely on fixed incomes or welfare

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benefits. The loss of a job is known to have a negative impact on the stability of

families, and individuals' health and well-being.

Stock market

The economy and the

stock market are

closely related as the

buoyancy of the

economy gets reflected

in the stock market.

Due to the impact of

global economic

recession, Indian stockmarket crashed from

the high of 20000 to a

low of around 8000

points.

FDI Flow in Developed and Developing Countries

Global FDI flow in 2008 has declined by 21 per cent compared to the previous year,

and reached US$1.4 trillion. Preliminary data issued by UNCTAD indicated that FDI

flow fell by 33.7 percent in EU and 5.5 per cent in USA during 2008, while in

developing and transition economies it was 4 per cent higher mainly because of

investment opportunities based on cheap asset prices and industry restructuring.

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Impact of global recession on Bangladesh

Since the collapse of the United States sub prime mortgage market and the

subsequent international global crisis, many developed and developing countries

have been plunged into deep recession. Bangladesh though has found itself in a

slightly different position. Its economy is not so dependent on international capital

and foreign investment, which has helped to lower the immediate impact of the

crisis.

Although it is now clear that the on going global crisis will have a significant impact

on Bangladesh, its impact is still expected to be less severe than in most other

economies. The reasons for this include:

Bangladeshs relatively limited exposure to the global economy, particularly in

export (about 18.0 percent of GDP)

Bangladesh largely exports garments which are mainly low priced products for

the lower end of the market, demand for which has been relatively recession

resistant

the continued importance of domestic agriculture as a driver of economic

growth, which performed relatively in a robust manner

the presence of a large informal sector that comprises of domestic trade and

commerce which creates some inbuilt resilience in the economy

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the positive impact of the plunge in commodity prices, particularly oil and

fertilizer, on costs of production

the minimal exposure of Bangladesh to international capital markets making

the economy less vulnerable to the withdrawal of foreign capital

the strong macroeconomic fundamentals underwritten by sustainable levels of

budget deficit and public debt

many garment orders are shifting from China to other countries (Vietnam,

Cambodia) including Bangladesh

Relatively low retrenchment of Bangladeshi workers in the Gulf and Middle

Eastern countries because Bangladeshi workers are engaged mainly in

unskilled low paid jobs, not affected by the recession.

The rescue programs

Governments in even the wealthiest nations have had to come up with rescue

packages to bail out their financial systems. Both market-based

and regulatory solutions have been implemented or are under consideration, while

significant risks remain for the world economy over the 20102011 periods.

Various Stimulus Packages Taken by Partner GovernmentsAs the global financial crisis started to strengthen its grip on the development

prospects of countries around the world, governments came up with strategic plans

to safeguard their economies by way of putting in place various initiatives to protect

the interest of domestic producers, exporters, workers and consumers. Currently a

number of global, regional and national initiatives have been set in motion to

stimulate economic recovery in the affected countries.

The USs US$700 billion bailout plan was the first among the many initiatives

followed by UAEs injection of US$19 billion into the economy, and Frances 10.5

billion rescue plan for six of its largest banks.

Among the developing countries, China announced a 4 trillion yuan (US$586 billion

equivalent to 7 per cent of GDP) domestic stimulus package for the remainder of

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2008, which would be continued till the end of 2010. Vietnam, on the other hand,

announced a stimulus package of US$1 billion focusing primarily on stimulating

domestic consumption among consumers. The Indonesian government has also

come up with a fiscal stimulus package worth about US$6.1 billion. The government

of Philippines has announced a US$6.9 billion stimulus package in order to create

about one million jobs; of this, about US$5.2 million would be used to support

retrenched overseas workers. India has so far announced three stimulus packages

with a total support of US$8 billion including various fiscal incentives to affected

industries such as textiles, leather, marine products,- particularly SMEs.

Stimulus packages taken by Bangladesh Govt.

Despite this the Bangladesh government has formed a high-level technical

committee and taskforce to monitor and advice on the crisis, and ministries and

financial institutions have taken several precautionary measures. Importantly in

October 2008 Bangladesh Bank withdrew 90 % of its total investment from foreign

banks which has helped to further shield the economy, so that it is only now that the

affects of the crisis are being felt.

Additionally the Bank has taken measures to stabilize the exchange rate, provide

extra liquidity to the financial sector and raised the limit on private foreign

borrowing. It has also relaxed the conditions for opening fresh letters of credit

(L/Cs).

Stimulus Package: FY2008-09

In April, 2009, the Govt. announced the first stimulus package in view of global

financial crisis. The underlying objective of this stimulus package was to safeguard

Bangladeshs domestic economy from the negative impacts of the global recession by

way of maintaining robust export growth, buoyancy in revenue earnings from

imports, and resilience in remittance earnings. The special package was worth of

Tk.34.2 billion (US$495.22 million, 0.55 per cent of GDP of FY2008-09) which was

allocated to support domestic and export oriented industries and agriculture,

generation of electricity and providing social protection to workers during these times

of global crisis.

Stimulus Package of FY2009-10

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The national budget for FY2009-10 has announced a stimulus package to the tune of

Tk.50 billion (US$724 million).43 It would appear that disbursement of this fund for

FY2009-10 will be based on the guideline mentioned in the stimulus package of the

FY2008-09. These supports are expected to contribute towards boosting domestic

industries, and keeping the business of export-oriented industries running in view of

falling prices of export products. Such measures would at least indirectly contribute

to retention of jobs by workers.

What is Subprime loan?

Interestingly, the termsubprime does not have an exact meaning. For all

purposes, it refers to the practice of giving loans to people who wouldnot normally qualify for a loan.

Subprime loan is a type of loan that is offered at a rate above prime rate (The

interest that banks charge to their preferred customers, usually large

corporations, for short-term loans) to individuals who do not qualify for prime

rate loans. Quite often, subprime borrowers are often turned away from

traditional lenders because of their low credit ratings or other factors that

suggest that they have a reasonable chance of defaulting on the debt

repayment.

Subprime loan is a loan made to a borrower who does not qualify for the

lowest market interest rates due to credit problems or other underwriting

deficiencies. Because of the greater risk to the lender, the borrower is

charged a higher rate and/or greater fees.

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History of Subprime Lending

Subprime lending evolved with the realization of a demand in the marketplace for

loans to high-risk borrowers with imperfect credit. The first subprime was initiated in

1993. Many companies entered the market when the prime interest rate was low,

and real interest became negative allowing modest subprime rates to flourish;

negative interest rates are hand-outs, such that the more you borrow the more you

earn. In 1998, the Federal Trade Commission estimated that 10% of new-car

financing in the US was provided by subprime loans, and that $125 billion of $859billion total mortgage dollars were subprime.

Subprime lending of USA: a scenario

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The value of U.S. subprime mortgages was estimated at $1.3 trillion as of March

2007, with over 7.5 million first-

lien

subprime mortgages outstanding.

There is evidence that both

government and competitive

pressures contributed to an

increase in the amount of

subprime lending during the

years preceding the crisis. Major

U.S. investment banks and

government sponsored

enterprises like Fannie Mae

played an important role in the

expansion of higher-risk

lending.

Subprime mortgages remained below

10% of all mortgage originations until

2004, when they spiked to nearly 20% and remained there through the 2005-2006

peak of the United States housing

bubble. This applied additional

competitive pressure to Fannie Mae and

Freddie Mac, which further expanded

their riskier lending. Subprime mortgage

payment delinquency rates remained in

the 10-15% range from 1998 to 2006,

then began to increase rapidly, rising to

25% by early 2008.

In law, a lien is a form

of security

interest granted over an

item of property to secure

the payment of a debt or

performance of some

other obligation. The

owner of the property,

who grants the lien, is

referred to as

the lienorand the person

who has the benefit of the

lien is referred to as

the lienee.

By 2007, subprime loans

accounted for 29% of total

home loans. The vast majority

of the subprime loans causing

todays massive foreclosures

were issued by institutions and

independent mortgage brokers

not covered by the CRA.

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Objective of the Report

Broad Objectives

To know about the present financial condition of the world as well as

Bangladesh economy

Specific Objectives

To assess the likely impact of the global economic crisis on the Bangladesh

economy, particularly its impacts in terms of employment, labour market.

To know the economic condition of Bangladesh

To know what safety steps govt. are taking about the recession

To make some policy implications and conclusion to avoid the financial

recession

Methodology of the Study

Data requirements:

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In fact, our aim was to collect as much information as it can be possible to make a

clear idea about the present economic condition of the world as well as Bangladesh.

Of course we had to collect enough information so that we can make an analysis of

the global financial crisis and the rescue programs of the govt. of various countries.

Sources of data:

This report was made based on the secondary information source only. The data

were collected from the different websites, as well as different articles, which were

published in internet.

Secondary data sources:

Different Websites

Articles about the recession from the internet

Limitations

The study has suffered from a number of barriers

Unavailability of Primary Data.

The analysis of the data couldnt be done effectively.

We had to depend on the non-statistical graph.

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Report Review

The global recession started in USA due to the boom in the housing sector was

taking the economy to a new level. A combination of low interest rates and large

inflows of foreign funds the world became awash with liquidity, with funds chasingany opportunity for good returns. In the USA, low-income earners were encouraged

to buy homes with little or no equity and the banks moved to providing low-income

mortgages. As a result, many people with low income & bad credit were given

housing loans in disregard to all principles of financial prudence. These types of loans

were known as sub-prime loans as those were are not part of prime loan market.

Major investment banks and institutions heavily bought these loans to diversify their

investment portfolios. Owing to heavy buying of Mortgage Backed Securities (MBS)

of subprime loans by major American and European Banks, the problem, which was

to remain within the confines of US propagated into the word's financial markets. As

the home prices started declining in the US, sub-prime borrowers found themselves

in a messy situation. Their house prices were decreasing and the loan interest on

these houses was soaring. As they could not manage a second mortgage on their

home, it became very difficult for them to pay the higher interest rate. As a result

many of them opted to default on their home loans and vacated the house.

However, as the home prices were falling rapidly, the lending companies, which werehoping to sell them and recover the loan amount, found them in a situation where

loan amount exceeded the total cost of the house. Eventually, there remained nooption but to write off losses on these loans.

The causes works behind the recession are falling housing prices, subprime

mortgage loans, subprime mortgage backed securities, high rate of defaults, etc.

As a result of the recession the number of unemployment were increased rapidly.

global job loss was likely to be to the tune of 18 to 51 million by the end of 2009. Italso affected the various business industries, such as lather, tourism, garment, etc.

The living standards of people dependent on wages and salaries are more affected byrecessions than those who rely on fixed incomes. The economy and the stock market

are closely related as the buoyancy of the economy gets reflected in the stockmarket. Due to the impact of global economic recession, Indian stock market

crashed from the high of 20000 to a low of around 8000 points.Bangladesh though has found itself in a slightly different position. Its economy is not

so dependent on international capital and foreign investment, which has helped tolower the immediate impact of the crisis.

Govt. of different countries including wealthy countries, like USA, France comes out

with rescue packages. The largest package was US $700 billion bailout. Bangladesh

govt. announced a special package of TK. 34.2 billion.

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REFERENCES

Wikipedia

http://en.wikipedia.org/wiki/Main_Page

Financial_crisis_of_20072010.htm

Ministry of Finance, Bangladesh

http://www.mof.gov.bd/en/

J.D. Foster, October 22 2009

http://www.heritage.org/Research/Economy/bg2331es.cfm

2008 Financial Crisis & Global Recession

http://2008financialcrisis.umwblogs.org

Bangladesh online research network

http://www.bdresearch.org/home/index.php?

option=com_content&view=article&id=54:impact-of-global-financial-crisis-on-

the-economy-of-bangladesh&catid=46:protifolon&Itemid=60

Economic Help(07.07.208):The Impact of A Recession

http://www.economicshelp.org/2008/07/impact-of-recession.html

Sify Business, 18.11.2008: Top government bailouts

http://sify.com/finance/top-government-bailouts-news-investments-jegvtldfbcd.html

Articlebase.com

Google.com

CPD report, Impact of the Global Financial and Economic Crisis onBangladesh A RAPID ASSESSMENT

www.ilo.org/asia/whatwedo/events/lang--en/.../index.htm
http://en.wikipedia.org/wiki/Main_Pagehttp://www.mof.gov.bd/en/http://www.heritage.org/about/staff/JDFoster.cfmhttp://www.heritage.org/Research/Economy/bg2331es.cfmhttp://2008financialcrisis.umwblogs.org/http://www.bdresearch.org/home/index.php?option=com_content&view=article&id=54:impact-of-global-financial-crisis-on-the-economy-of-bangladesh&catid=46:protifolon&Itemid=60http://www.bdresearch.org/home/index.php?option=com_content&view=article&id=54:impact-of-global-financial-crisis-on-the-economy-of-bangladesh&catid=46:protifolon&Itemid=60http://www.bdresearch.org/home/index.php?option=com_content&view=article&id=54:impact-of-global-financial-crisis-on-the-economy-of-bangladesh&catid=46:protifolon&Itemid=60http://www.economicshelp.org/2008/07/impact-of-recession.htmlhttp://sify.com/finance/top-government-bailouts-news-investments-jegvtldfbcd.htmlhttp://sify.com/finance/top-government-bailouts-news-investments-jegvtldfbcd.htmlhttp://www.ilo.org/asia/whatwedo/events/lang--en/.../index.htmhttp://en.wikipedia.org/wiki/Main_Pagehttp://www.mof.gov.bd/en/http://www.heritage.org/about/staff/JDFoster.cfmhttp://www.heritage.org/Research/Economy/bg2331es.cfmhttp://2008financialcrisis.umwblogs.org/http://www.bdresearch.org/home/index.php?option=com_content&view=article&id=54:impact-of-global-financial-crisis-on-the-economy-of-bangladesh&catid=46:protifolon&Itemid=60http://www.bdresearch.org/home/index.php?option=com_content&view=article&id=54:impact-of-global-financial-crisis-on-the-economy-of-bangladesh&catid=46:protifolon&Itemid=60http://www.bdresearch.org/home/index.php?option=com_content&view=article&id=54:impact-of-global-financial-crisis-on-the-economy-of-bangladesh&catid=46:protifolon&Itemid=60http://www.economicshelp.org/2008/07/impact-of-recession.htmlhttp://sify.com/finance/top-government-bailouts-news-investments-jegvtldfbcd.htmlhttp://sify.com/finance/top-government-bailouts-news-investments-jegvtldfbcd.htmlhttp://www.ilo.org/asia/whatwedo/events/lang--en/.../index.htm

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Global Recession 07-09