GOOD MORNING

Salomon v A Salomon and Co Ltd [1897]

Harshad Mehta

Recession and Depression

The Recession was the biggest after “The Great Depression”

Economist’s JOKE JOAK :Recession is when your neighbour is not having a JOB and Depression is when you too are not having any JOB.

ICELAND

POPULATION 320,000

GDP: $13 BILLION

BANK LOSSES: $100 BILLION

WHERE DID IT ALL START…???

• After The Great Depression, economies were stable for more than 30 years.

• In the late 90’s BANKS were promoting internet companies they knew were going to fail.

• It was known as the DOT COM BUBBLE.• In December 2002 the 10 big banks paid $1.4 Billions

and settled the case.• The internet stock bubble followed by the attack of

9/11 cost $5 trillion in investment losses.

THE SECURITIZATION

FOOD CHAIN

CONTRACT

ASSET

STOCKSBONDS CURRENCIES

INTEREST RATESCOMMODITIES

DERIVATIVES

PARTY ‘A’ PARTY ‘B’

DERIVATIVES(MADE MARKET SAFE OF UNSAFE…???)

• The bankers could gamble on anything.• RISE OR FALL IN OIL PRICES, BANKRUPTCY OF A

FIRM OR EVEN WEATHER.• By late 90’s derivative were a $15 trillion

unregulated market.

• By 2001 the US financial sector was more profitable, concentrated and powerful then ever before.

• Dominating the industry were five Investment Banks:1. GOLDMAN SACHS2. MORGAN STANLEY3. LEHMAN BROTHERS4. MERRILL LYNCH5. BEAR STEARNS

• Two conglomerates:1. CITI GROUP 2. JP MORGAN

• Three securities insurance companies:1. AIG2. MBIA3. AMBAC

• Three rating agencies:1. MOODY’S2. STANDARD & POOR’S3. FITCH

CDO: COLLATERALIZED DEBT OBLIGATION

EARLIER SCENARIO

BUYER LENDER

MORTGAGE PAYMENT

THE SCENARIO LATER

BUYER LENDER INVESTMENT BANKS INVESTORS

HOME LOAN

CAR LOAN

COMMERCIAL DEBT

EDUCATION LOAN

CREDIT CARD DEBT

CDO

MORTGAGE PAYMENT

BANKS PAID THESE RATING FIRMSTO GIVE THEM HIGHER RATINGS

RATING AGENCIESINVESTMENT BANKS

AAABBB

CCC

Effects…

• This system was a ticking time bomb.• Lenders didn’t care anymore if a borrower could

repay.• They started making riskier loans.• The Investment Banks didn’t care either.• The more CDO’s sold, the most profit they make.• And the rating agencies didn’t have any liabilities

if CDO’s proved wrong.

Subprime Mortgages

• Subprime is a classification of loans offered at rates greater than the prime rate to individuals who are unable qualify for prime rate loans.

Loan Rate Monthly payment

First two years $200,000 7% $1,330.60

Third year $200,000 11% $1,922.96

Economic Bubble• An economic cycle characterized by rapid expansion

followed by a contraction.

• Goldman Sachs started to bet against the TOXIC CDO’s they were selling.

• Bought at least $22 Billion worth of CDS from AIG.

• In 2007 they sold CDO’s specifically made that more money their customers lost the more they get paid.

CDS: CREDIT DEFAULT SWAPS

orIndividual Company

BondsThese BONDS carry risk

Insurance Company

The RISE and RISE…

• The rating agencies gave more and more AAA ratings to the CDO’s.

• The more higher ratings they gave, the more their profits.

• They said the ratings that they gave to the CDO’s were mere their “OPINIONS”.

• The real estate property rates rose to almost 200% from 1996-2007.

• The amount of subprime loans were highest in 2005-2006, almost about 20%.

• The mortgage loans being made per year were quadrupled between 2000-2003.

• The Investment Banks preferred Subprime Loans as they contain higher interest rates.

• Since anyone could get a mortgage, the property rates SKYROCKETED.

• It was becoming the biggest FINANCIAL BUBBLE ever.

• The amount of Subprime mortgages rose from $30 Billion a year to nearly $600 Billion a year.

• The Financial Personnel were earning Millions of dollars as bonuses.

• The amount of borrowed money and Bank’s own money is called LEVERAGE.

• The more banks borrowed, the higher their leverage.

• In 2004 Government of USA removed the limit of leverage allowing the banks to increase their borrowings.

• People were buying more and more houses, as much they can.

The Meltdown

• Early in 2004, FBI was warning about an EPIDEMIC of Mortgage Fraud.

• In 2005, Raghuram Rajan, IMF’s Chief Economist, warned that dangerous incentives could lead to crisis.

• Followed by many other economists who warned the government about the Bubble.

• They described how the BUBBLE would unravel.

• By 2008, home foreclosures were skyrocketing and SECURITIZATION FOOD CHAIN imploded.

• Lenders could no longer sell their loans to Investment Banks.

• And since loans went bad, dozens of lenders failed.

• The market for CDO’s collapsed, leaving the Banks holding Hundreds of Billions of Dollars in Loans.

• On March 16th, 2008, the Investment Bank Bear Stearns ran out of cash and acquired by JP Morgan Chase for $2 a share.

• Bear Stearns were rate AAA a month before it went Bankrupt.

• On September 7th,2008; the government took over Fannie Mae and Freddie Mac.

• By September 12th, Lehmann Brothers ran out of cash.

• Lehmann wasn’t alone, Merrill Lynch, another major Investment Bank was on the brink of failure.

• On September 14th, it was acquired by Bank of America.

• Lehmann Brothers filed for BANKRUPTCY on September 15th.

• It was clear that the Global Economy is going to take a hit.

• The same week AIG owed $13 Billion to holders of Credit Default Swaps (CDS) and they didn’t have the money.

• On September 17th AIG was taken over by the Government.

• A day later Paulson and Bernanke asked the government for $700 Billion to bailout the Banks.

• The alternative would have been a catastrophic financial collapse.

• Every part of financial and credit system froze up, nobody could borrow money.

• After AIG bailout, Goldman Sachs were paid $61 Billion for its CDS.

• AIG paid 100 cents on a Dollar to its CDS holders.

• AIG bailout cost Taxpayers $150 Billion.

• AIG were not allowed to SUE the BANKS for fraud.

• U.S. household wealth fell by about $16.4 trillion of net worth from its peak in spring 2007.

• Since 2009, only a little more than half of that lost wealth - $8.7 trillion is back on household balance sheets.

• That leaves American household wealth $7.7 trillion less than it was before the recession.

• 1 in every 54 households submitted foreclosure filings in 2008.

Fall in US House Prices

• By July 2010, 7.9 Million people lost their JOBS.

• The unemployment rate went to a high of 10.8%.

• Iceland, Ireland, Europe (The European Union), Russia, Japan, The Oil Countries of Middle East were hit the most.

• Global trade declined sharply by 13% between 2008-2009.

Rate of Unemployment During RECESSION

• Global GDP shrank by nearly $4 Trillion or 6%.

• Global Investment declined by 15%.

• Global Industrial Production in advanced economies dropped a 15%, causing unemployment to soar around the world.

• Global Governments spent an astonishing $17 Trillion to support the World Economy in the form of Bailouts, Guarantees and Equity Market Purchases.

• The production sector of USA took a hit.

• American Companies sent most of its jobs overseas to save money.

• As manufacturing declined, other industries rose.

• US leads the world in Information Technology.

• But such high paying jobs require an education.

• For average Americans college is out of reach.

• Tuition for public Universities rose from $650 in 1970 to over $10,000 in 2010.

• The tax policy shifted to favour the WEALTHY.

• Inequality in US is highest among developed nations.

• For the first time in history, average Americans have less education and are less prosperous than their parents.

Who FAILED..??

Who Did GAIN..?!?

Lehmann Brothers CEO, Richard Fuld, made$450 Million out of Lehmann Bankruptcy

JP Morgan Chase CEO, Jamie Dimon, made $23 Million as salary till 2011

Goldman Sachs CEO, Lloyd Blankfein, made $108.5 million during 2006-07

Morgan Stanley CEO, John J. Mack, made $41 million in 2006

CITI Group CEO, Vikram Pandit, made made $60 million as salary

Merrill Lynch CEO ,John Thain, was making a salary of $81 Million

For decades, the American financial system was stable and safe. Then the financial system

turned its back on the society and plunged the world economy into crisis. At enormous cost the

disaster has been avoided and the world is recovering. But the men and institution that

caused the crisis are still in power….

That needs to change….