Documente Academic
Documente Profesional
Documente Cultură
By Jitendra Garg
MS (Finance), CFA
Table of Contents
Overview ............................................................................................................................ 3
Overview
In the fall of 2008, the credit crunch, which had emerged a little more than a year before, began as
a bursting of the U.S. housing market bubble and a rise in foreclosures has ballooned into Wall
Street’s biggest crisis since the Great Depression. As hundreds of billion dollars in mortgage-
related investments went bad, some of the largest and most venerable banks, investment houses,
and insurance companies have either declared bankruptcy or have had to take enormous financial
hit.
In 2008, credit flows froze, lender confidence dropped, and one after another the economies of
countries around the world dipped into recession. The crisis exposed fundamental weaknesses in
financial systems worldwide, and it continues despite coordinated easing of monetary policy,
trillions of dollars in intervention by central banks of different countries, and several stimulus
packages by various governments. The crisis started in the US soon spread to Europe, and then to
Japan and emerging markets. Governments of most of countries have scrambled to prop up
banks, broadened guarantees for deposits and agreed on a coordinated response.
But the banks and other institutions that eventually sell the
CDOs were, at least until the recent crisis began to appear
in late summer 2007, not all that concerned about the
quality of such derivative-CDOs. Their ability to take risk
had gone up by buying insurance for the CDO in the form
of yet another derivative called a Credit Debt Swap or
(CDS). A CDS is a credit derivative contract between two
counter parties. The buyer makes periodic payments
(premium leg) to the seller, and in return receives a payoff
(protection or default leg) if an underlying financial
instrument defaults. Yet another means by which banks
attempted to insulate themselves from the shaky quality of
speculative investment has been their creation of Secured
Investment Vehicles (SIVs). These are in essence
electronic shadow banks set up by investment and commercial banks to offload potentially risky
CDOs from the banks' balance sheets. And indeed, the volume of CDS has exploded with nuclear
force, nearly doubling every year since 2001 to reach a recent peak of $62 trillion at the end of
2007, before receding to $54.6 trillion as of June 30, 2008 according to ISDA.
But why did banks and other financial institutions buy these dirty assets? Part of the reason lies in
rating agencies. These agencies are paid to rate the complex products of financial institutions for
their riskiness, nothing more than that. If they rate some securities favourably vis-a-vis the other,
that means there is little chance of losing money if someone invests in that particular security.
Apart from it, the bank’s SIVs make money from marking up and selling the CDOs as well as
from insuring them at an additional charge with credit debt swaps. It is therefore not surprising
that mainline investment and commercial banks experienced compound profit growth of more
than 20 percent per year collectively for each year from 2004 through 2006—i.e., roughly the
period of the most explosive growth of subprime mortgages bundled with CDOs.
industrial production & demand; oil prices after touching a height of US$147/b have come down
to US$42.95/b (as on 26 Feb. 09) and world trade has also decreased. Thus some of big
economies have registered negative growth & whole world including emerging nations are facing
slowdown in their GDP growth rate. Simultaneously, world stock markets have lost
approximately 40% of their value as on Jan. 2008 and in all, the slide from the height of the stock
markets had wiped out more than US$8 trillion in wealth.