Global Meltdown: Impact on U.K.

,
Turnaround & Learning
Presenters:
Deepak Bhardwaj
Geeta Fatwani
Presented To:
Prof. Rohit Rai Tondon Jitendra Mandloi
Pooja Bansal
Dt . 25 th October 2010 Prateek Samtani
Facts about UK Economy

Ø 6th largest economy in the world by

nominal GDP & also by purchasing power
parity(PPP),
Ø 2nd largest financial economy in the World after
US
Ø UK GDP by Industrial sector: Services-76.2%,
Industry and Manufacturing-22.8% and
Agriculture-0.9%
Ø GDP (PPP) : $2.128 trillion
Ø Exports: $357.3 billion, Imports: $486 billion
Ø Inflation rate (CPI): 3.1% in Aug’10, touched 5.2%
in sept’08
Ø Unemployment rate: 7.8% by July-end
Ø FTSE 100: Share index of highly capitalized UK
companies listed on London stock exchange
Global Meltdown: Introduction

Ø In 2002-03, US govt. pushed interest rate down (3-

4%) for mortgage loans, reached 1% to expand
economy
Ø In 2002-03, U.K. economy also had a downturn
Ø Increasing subprime loan market
Ø Boost to infrastructure sector in US by the govt.
resulting to more infrastructure
Ø Everyone thought the property rates would continue
to go up (both lenders and borrowers)
Ø Quick gains on property in both US & UK(200%)
Ø Less documentations & no creditability cross check
Ø
Ø
 Central bank Actions
Liquidity Crunch for Businesses

Excess Housing Inventory Bank Failures Fiscal Stimulus Package

Bank Assets Levels depleted

ousing Prices decline Home Owner Assistanc

bility to refinance Mortgage Bank Losses Systematic rescue

Mortgage Cash flow declines

age Delinquency & Foreclosure
Adjustable R ate M ortgage ( ARM )
Ø An adjustable-rate mortgage (ARM) is a mortgage
loan where the interest rate on the note is
periodically adjusted based on a variety of indices
Ø To ensure a steady margin for the lender
Ø Agencies providing such indices are, Thomson
Reuters and the London Interbank Offered
Rate (LIBOR)
Ø E.g. 2/28 mortgage's initial interest rate is fixed for a
period of two years and then resets to a floating
rate for the remaining 28 years of the mortgage
Ø LIBOR for August: 0.943 on 1 Year, Bank rate at 0.50
S e cu ritiza tio n
Ø Securitization is a structured finance process that
distributes risk by aggregating assets in a pool
(often by selling assets to a special purpose entity),
then issuing new securities backed by the assets
and their cash flows. The securities are sold to
investors who share the risk and reward from those
assets
Ø A way of diversifying risk and allowing the banks to
make more loans (thus earn more fees)
Ø Mortgage Backed Securities (MBS), Collateralized
Debt Obligations (CDO) or Asset Backed Securities
(ABS)
ECURITIZATION PROCESS BORROWER

Supply Payments & Mortgage

LENDER

Cash Assign Receivables

LIQUIDITY SUPPORT SPECIAL PURPOSE VEHICLE CREDIT ENHANCEMENT

Cash Issue Securities

INVESTORS
Reasons for Meltdown in U.K.
Ø Govt. window dressing (Low rate of interest)
Ø Low Savings rate
Ø More exposure to subprime mortgage
Ø Lax Effect
Ø Trading Securitized securities
Ø Housing bubble burst in US & UK
Ø Increasing subprime mortgage defaults
Ø Inaccurate credit ratings by Experian, Equifax,
and Call Credit
Ø Loss of confidence among banks & investors
Ø Mark to market (made Liabilities>Assets)
Ø Increase in energy prices fueled recession
Ø
Impact on U.K. Economy

Ø Decreased lending & high cost of borrowing

Ø Recession, a record 6 consecutive quarters of
negative growth
(Cont.) Impact

Ø Nationalization of private financial institutions

Ø High unemployment rate(~8%)
•
(Cont.) Impact

Ø High household debt

•
(Cont.) Impact

Ø Heavy govt. borrowing to control the situation


(Cont.) Impact

Ø Inflation in the Euro zone fell to 1.6%; 3.1% in UK

Ø Realty prices fell down remarkably although will
catch soon


Ø
Corrective Measures

Ø UK government has announced a package of £400

billion aimed at rescuing banking system
Ø Banks were asked to increase their capital by at
least 25 billion pound & borrow from government
Ø 200 billion pound was available from Bank of
England for short term borrowing to provide
liquidity to banks
Ø Injected money through nationalization of Northern
Rock,  Bradford & Bingley
Ø Bought 70% of the Royal Bank of Scotland (RBS)
and Lloyds equity shares each
Ø
Ø
(Cont.) Corrective Measures

Ø Imposed a ban on short-selling financial stock

temporarily
Ø Allowed banks to insure against extreme losses and
guarantee their debts
Ø Interest rate fell down to record, 1.5% to encourage
lending & borrowing
Ø To stabilize the economy, the govt. introduced a lot
of reforms like Government Recapitalization
Scheme, Credit Guarantee Scheme (CGS),
Asset Backed Securities Guarantee Scheme
(ABSGS), Special Liquidity Scheme
Ø
Ø
Ø
(Cont.) Corrective Measures

Ø Government Recapitalization Scheme

ü Enables the Govt. to make capital investments of
up to an aggregate of £50 billion in “Eligible
Institutions”, to strengthen their finances
ü “Eligible Institutions” mean UK incorporated banks
(including UK subsidiaries of foreign banks) that
have a substantial business in the UK
ü To support the Govt. with schemes to help
struggling mortgage borrowers stay in their
homes
ü Eligible Institutions published by HMT(Her
Majesty's Treasury) include HBOS, RBS, Lloyds
TSB, Barclays, Nationwide, Standard Chartered,
Abbey National, and HSBC
Ø
(Cont.) Corrective Measures

Ø Credit Guarantee Scheme (CGS)

ü To support UK banks in the face of the global
banking crisis
ü Under the CGS, HMT will guarantee, in return
for a fee & subject to certain conditions,
ü new issuances of short-term or medium-term debt
securities by Eligible Institutions, in order to help
refinance their funding obligations
ü The initial uptake of this scheme by eligible
banks has been estimated to amount to £250
billion
ü Brought amendments reduced the fee payable
to the Govt. & extended the maximum term
of guarantee to 5 years
(Cont.) Corrective Measures

Ø Asset Backed Securities Guarantee Scheme

(ABSGS)
ü Govt. announced a new guarantee scheme
ü commencing in April 2009 under which Eligible
Institutions under the CGS may issue new
asset backed securities (ABS) guarantee
ü HMT will, in consultation with issuers and
investors, provide full or partial guarantees for
eligible triple-A rated ABS, including
mortgages and corporate and consumer debts
ü Supporting lending to the wider economy
(particularly mortgage lending)
(Cont.) Corrective Measures

Ø Banking (Special Provisions) Act 2008

ü Enable the UK government to nationalize high-
street banks under emergency circumstances
by legislation
ü The Act was introduced in order to nationalize
the failing bank Northern Rock after the bank
was supported by Bank of England credit
ü The Bill was also sufficiently widely drawn to
allow the nationalization of any financial
institution, leading to the concern that other
banks may be in financial difficulty
(Cont.) Corrective Measures

Ø Special Liquidity Scheme

ü Improve the liquidity position of the banking system
ü by allowing banks and building societies to swap
their high quality mortgage-backed and other
securities for UK Treasury Bills for up to three
years.
ü The Scheme was designed to finance part of the
overhang of illiquid assets on banks' balance
sheets by exchanging them temporarily for more
easily tradable assets
ü The banks swapped assets worth £185bn in the
scheme & scheme has been closed for new
exchanges
UK Rescue Plan

Ø
Ø
Ø
Learning from the Crisis
ØBetter analysis of macro-prudential problems – problems which lie
Ø between macro-economic policy and financial system regulation is
in
Ø
vital
ØA large UK current account deficit, rapid credit extension and house
Ø
price rises are not in favor of long term growth
ØNeed to do more sectoral analysis and be more willing to make
judgments about the sustainability of whole business models
ØSecuritized Credit Model, is good up to a certain level and it cannot
replace or over rule Originate & Distribute Model
ØLarge systemically important banking institutions should be
restricted in undertaking proprietary activities that present particularly
high risks
ØTransparency, long term focus and simple financial products to be
promoted to safeguard investors & economy from such crisis
Current Updates
Ø The BoE now expects GDP to grow about 2.5% next
year — down from its forecast of 3.4%, currently at
1.2%
Ø Credit conditions hadn't eased up as much as
anticipated
Ø Households may be less inclined to spend because
they are worried about public sector cuts
Ø Inflation is at same level, 3.1%, expected to ease
down
Ø Massive cuts in public-sector spending
Ø Budget deficit stands at 12% of GDP in 2010; and is
expected to increase in the coming years
Ø UK housing market has shown signs of uncertainty.
House prices rose in 2009 and 2010, but in late
2010 and 2011, a further fall in prices is expected