financial crisis11111
TRANSCRIPT
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Introduction
Financial Crisis: A situation in which the economy of a country experiences a
sudden downturn brought on by a financial crisis. An economy facing an economic crisis
will most likely experience a falling GDP, a drying up of liquidity and
rising/falling prices due to inflation/deflation. An economic crisis can take the form of
a recession or a depression. Also called real economic crisis.
The term financial crisis is applied broadly to a variety of situations in which some
financial institutions or assets suddenly lose a large part of their value. In the 19th and
early 20th centuries, many financial crises were associated with banking panics, and
many recessions coincided with these panics. Other situations that are often called financial
crises include stock market crashes and the bursting of other financial bubbles, currency
crises, and sovereign defaults
Impact of global financial crisis on the economy of Bangladesh: Since the
collapse of the United States subprime 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. Despite this the Bangladesh government has formed a
high-level technical committee and taskforce to monitor and advise 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 effects 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). In
February 2009, the Finance Minister AMA Muhith admitted that the global financial crisis
was having an impact on trade in Bangladesh. In April the Government announced their
stimulus package with 65 million dollars directed to assist exports. This though falls short of
the 877 million dollars needed according to industry experts (Yahoo news, 2009).
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During 2008, 57% of Bangladeshs economy was involved in the global economy and this is
increasing. This indicates that the country might be progressively more affected should the
crisis continue for an extended period. Trade, migration and remittance are the most likely
sectors to be impacted as 43.3% of Bangladeshs openness is related to trade and 10 % to
remittance. Overseas Development Assistance (ODA) and Foreign Direct Investment (FDI)
may also be vulnerable in the longer term but to a lesser extent due to only 3.2% integration
with the global economy (CPD and ILO, 2009).
Whilst the longer term nature of FDI commitments has kept the net inflow of investment
relatively stable, the sluggish growth of rich countries may eventually slow it down. Aid
receipts (excluding dollars) are providing less in local currency due to unfavorable exchange
rates and future aid commitments from donors may be in jeopardy if the downturn continues.
Chapter-1
The Origins of financial crisis: The financial crisis that has been wreaking havoc in
markets in the U.S. and across the world since August 2007 had its origins in an asset price
bubble that interacted with new kinds of financial innovations that masked risk; with
companies that failed to follow their own risk management procedures; and with regulators
and supervisors that failed to restrain excessive risk taking.
A bubble formed in the housing markets as home prices across the country increased each
year from the mid-1990s to 2006, moving out of line with fundamentals like household
income. Like traditional asset price bubbles, expectations of future price increases developed
and were a significant factor in inflating house prices. As individuals witnessed rising prices
in their neighborhood and across the country, they began to expect those prices to continue to
rise, even in the late years of the bubble when it had nearly peaked. The rapid rise of lending
to subprime borrowers helped inflate the housing price bubble. Before 2000, subprime
lending was virtually non-existent, but thereafter it took off exponentially. The sustained rise
in house prices, along with new financial innovations, suddenly made subprime borrowers
previously shut out of the mortgage markets attractive customers for mortgage lenders.
Lenders devised innovative Adjustable Rate Mortgages (ARMs) with low "teaser rates,"
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no down-payments, and some even allowing the borrower to postpone some of the interest
due each month and add it to the principal of the loan which were predicated on the
expectation that home prices would continue to rise.
But innovation in mortgage design alone would not have enabled so many subprime
borrowers to access credit without other innovations in the so-called process of "securitizing"
mortgagesor the pooling of mortgages into packages and then selling securities backed by
those packages to investors who receive pro rata payments of principal and interest by the
borrowers. The two main government-sponsored enterprises devoted to mortgage lending,
Fannie Mae and Freddie Mac, developed this financing technique in the 1970s, adding their
guarantees to these "mortgage-backed securities" (MBS) to ensure their marketability. For
roughly three decades, Fannie and Freddie confined their guarantees to "prime" borrowers
who took out "conforming" loans, or loans with a principal below a certain dollar threshold
and to borrowers with a credit score above a certain limit. Along the way, the private sector
developed MBS backed by non-conforming loans that had other means of "credit
enhancement," but this market stayed relatively small until the late 1990s. In this fashion,
Wall Street investors effectively financed homebuyers on Main Street. Banks, thrifts, and a
new industry of mortgage brokers originated the loans but did not keep them, which was the
"old" way of financing home ownership.
Over the past decade, private sector commercial and investment banks developed new ways
of securitizing subprime mortgages: by packaging them into "Collateralized Debt
Obligations" (sometimes with other asset-backed securities), and then dividing the cash flows
into different "tranches" to appeal to different classes of investors with different tolerances
for risk. By ordering the rights to the cash flows, the developers of CDOs (and subsequently
other securities built on this model), were able to convince the credit rating agencies to assign
their highest ratings to the securities in the highest tranche, or risk class. In some cases, so-
called "monocline" bond insurers (which had previously concentrated on insuring municipal
bonds) sold protection insurance to CDO investors that would pay off in the event that loans
went into default. In other cases, especially more recently, insurance companies, investment
banks and other parties did the near equivalent by selling "credit default swaps" (CDS),
which were similar to monocline insurance in principle but different in risk, as CDS sellers
put up very little capital to back their transactions.
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These new innovations enabled Wall Street to do for subprime mortgages what it had already
done for conforming mortgages, and they facilitated the boom in subprime lending that
occurred after 2000. By channeling funds of institutional investors to support the origination
of subprime mortgages, many households previously unable to qualify for mortgage credit
became eligible for loans. This new group of eligible borrowers increased housing demand
and helped inflate home prices.
These new financial innovations thrived in an environment of easy monetary policy by the
Federal Reserve and poor regulatory oversight. With interest rates so low and with regulators
turning a blind eye, financial institutions borrowed more and more money (i.e. increased their
leverage) to finance their purchases of mortgage-related securities. Banks created off-balance
sheet affiliated entities such as Structured Investment Vehicles (SIVs) to purchase mortgage-
related assets that were not subject to regulatory capital requirements Financial institutions
also turned to short-term "collateralized borrowing" like repurchase agreements, so much so
that by 2006 investment banks were on average rolling over a quarter of their balance sheet
every night. During the years of rising asset prices, this short-term debt could be rolled over
like clockwork. This tenuous situation shut down once panic hit in 2007, however, as sudden
uncertainty over asset prices caused lenders to abruptly refuse to rollover their debts, and
over-leveraged banks found themselves exposed to falling asset prices with very little capital.
While ex post we can certainly say that the system-wide increase in borrowed money was
irresponsible and bound for catastrophe, it is not shocking that consumers, would-be
homeowners, and profit-maximizing banks will borrow more money when asset prices are
rising; indeed, it is quite intuitive. What is especially shocking, though, is how institutions
along each link of the securitization chain failed so grossly to perform adequate risk
assessment on the mortgage-related assets they held and traded. From the mortgage
originator, to the loan servicer, to the mortgage-backed security issuer, to the CDO issuer, to
the CDS protection seller, to the credit rating agencies, and to the holders of all those
securities, at no point did any institution stop the party or question the little-understood
computer risk models, or the blatantly unsustainable deterioration of the loan terms of the
underlying mortgages.
1.2 The Financial Crisis of the Great Depression: The Great Depression of
the 1930s was the economic event of the 20th century. The history of the depression is
fascinating because it is a reference point for economic misery and fear. When people make
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financial planning decisions and politicians set policy the depression experience is, or maybe
should be, in the back of everyone's mind as a worst case scenario.
The depression is also interesting because, in hindsight, the downturn could have been much
shall owner had policy makers not made certain mistakes. Some of these mistakes have beenvery well researched by economists over the years and are highlighted here. There are also
lessons to be had from the depression on human behavior and society in general. Lessons
such as how blind and greedy we become when swept away by delusions of grandeur, only to
flagellate ourselves when our dreams don't work out. And how our initial reaction to fear is to
create barriers between others and ourselves resulting in added misery for everyone.
If this was an article about how we recovered from the Great Depression there would also be
inspiring stories of leadership and daring generosity among all kinds of people. How facing
extreme difficulties put people in touch with a wealth that was beyond their empty bank
accounts.
At least in part, the Great Depression was caused by underlying weaknesses and imbalances
within the U.S. economy that had been obscured by the boom psychology and speculative
euphoria of the 1920s. The Depression exposed those weaknesses, as it did the inability of the
nation's political and financial institutions to cope with the vicious downward economic cycle
that had set in by 1930. Prior to the Great Depression, governments traditionally took little or
no action in times of business downturn, relying instead on impersonal market forces to
achieve the necessary economic correction. But market forces alone proved unable to achieve
the desired recovery in the early years of the Great Depression, and this painful discovery
eventually inspired some fundamental changes in the United States' economic structure. After
the Great Depression, government action, whether in the form of taxation, industrial
regulation, public works, social insurance, social-welfare services, or deficit spending, came
to assume a principal role in ensuring economic stability in most industrial nations with
market economies.
1.3 The Financial Crisis of 2007-2009: The ultimate point of origin of the great
financial crisis of 2007-2009 can be traced back to an extremely indebted US economy. The
collapse of the real estate market in 2006 was the close point of origin of the crisis.[12] The
failure rates of subprime mortgages were the first symptom of a credit boom tuned to bust
and of a real estate shock. But large default rates on subprime mortgages cannot account for
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the severity of the crisis. Rather, low-quality mortgages acted as an accelerant to the fire that
spread through the entire financial system. The latter had become fragile as a result of several
factors that are unique to this crisis: the transfer of assets from the balance sheets of banks to
the markets, the creation of complex and opaque assets, the failure of ratings agencies to
properly assess the risk of such assets, and the application of fair value accounting. To these
novel factors, one must add the now standard failure of regulators and supervisors in spotting
and correcting the emerging weaknesses. For many months before September 2008, many
business journals published commentaries warning about the financial stability and risk
management practices of leading U.S. and European investment banks, insurance firms and
mortgage banks consequent to the subprime mortgage crisis.
Beginning with failures caused by misapplication of risk controls for bad debts,
collateralization of debt insurance and fraud, large financial institutions in the United States
and Europe faced a credit crisis and a slowdown in economic activity. The crisis rapidly
developed and spread into a global economic 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. Moreover, the de-leveraging of financial institutions further
accelerated the liquidity crisis and caused a decrease in international trade. World political
leaders, national ministers of finance and central bank directors coordinated their efforts toreduce fears, but the crisis continued.
At the end of October 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.
1. Imprudent Mortgage Lending: Against a backdrop of abundant credit, low interest rates,
and rising house prices, lending standards were relaxed to the point that many people were
able to buy houses they couldnt afford. When prices began to fall and loans started going
bad, there was a severe shock to the financial system.
2. Housing Bubble: With its easy money policies, the Federal Reserve allowed housing
prices to rise to unsustainable levels. The crisis was triggered by the bubble bursting, as it
was bound to do.
3. Global Imbalances: Global financial flows have been characterized in recent years by an
unsustainable pattern: some countries (China, Japan, and Germany) run large surpluses every
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year, while others (like the U.S and UK) run deficits. The U.S. external deficits have been
mirrored by internal deficits in the household and government sectors. U.S. borrowing cannot
continue indefinitely; the resulting stress underlies current financial disruptions.
4. Securitization: Securitization fostered the originate-to-distribute model, which reduced
lenders incentives to be prudent, especially in the face of vast investor demand for subprime
loans packaged as AAA bonds. Ownership of mortgage-backed securities was widely
dispersed, causing repercussions throughout the global system when subprime loans went bad
in 2007.
5. Lack of Transparency and Accountability in Mortgage Finance: Throughout the
housing finance value chain, many participants contributed to the creation of bad mortgages
and the selling of bad securities, apparently feeling secure that they would not be held
accountable for their actions. A lender could sell exotic mortgages to home-owners,
apparently without fear of repercussions if those mortgages failed. Similarly, a trader could
sell toxic securities to investors, apparently without fear of personal responsibility if those
contracts failed. And so it was for brokers, realtors, individuals in rating agencies, and other
market participants, each maximizing his or her own gain and passing problems on down the
line until the system itself collapsed. Because of the lack of participant accountability, the
originate-to distribute model of mortgage finance, with its once great promise of managing
risk, became itself a massive generator of risk.
6. Rating Agencies: The credit rating agencies gave AAA ratings to numerous issues of
subprime mortgage-backed securities, many of which were subsequently downgraded to junk
status. Critics cite poor economic models, conflicts of interest, and lack of effective
regulation as reasons for the rating agencies failure. Another factor is the markets excessive
reliance on ratings, which has been reinforced by numerous laws and regulations that use
ratings as a criterion for permissible investments or as a factor in required capital levels.
7. Government- Mandated Subprime Lending: Federal mandates to help low-income
borrowers (e.g., the Community Reinvestment Act (CRA) and Fannie Mae and Freddie
Macs affordable housing goals) forced banks to engage in imprudent mortgage lending.
8. Financial Innovation: New instruments in structured finance developed so rapidly that
market infrastructure and systems were not prepared when those instruments came under
stress. Some propose that markets in new instruments should be given time to mature before
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The market was not nearly as obsessed with ratings as were the regulators. Many rated
securities were not even traded in the market. Instead, banks obtained ratings for the sole
purpose of engaging in regulatory capital arbitrage, meaning that they were able to reduce
capital requirements for a given risk.
3: Policy makers relied too much on market discipline to regulate financial risk taking.
Many experts, including former Federal Reserve Board Chairman Alan Greenspan, have
voiced the complaint that the market proved less rational than expected in its management of
risk. The implication is that markets are too unreliable and that stronger regulation is the
answer.
It is certainly true that some financial executives made serious miscalculations. They
themselves greatly underestimated the risks of a housing market decline and overestimated
the insulation from risk that could be obtained by using sophisticated financial models and
structured finance.
However, the greater flaw was in the regulatory structure, and in particular the capital
regulations for banks, investment banks, and the mortgage agencies Freddie Mac and Fannie
Mae. There was an absence of market discipline at these firms in large part because such a
large share of the risk that they took was borne by taxpayers rather than by shareholders and
management.
4: The financial crisis was primarily a short-term panic.
The financial crisis has four components:
Bad bets, meaning unwise decisions by developers to build too many homes, by consumers
to purchase too many homes, by mortgage lenders to make unwise loans, and by financial
institutions that incurred too much exposure to credit risk in housing.
Excessive leverage, meaning that the debt-to-equity ratio was so high at some key firms,
such as Freddie Mac, Fannie Mae, and Bear Stearns, that only a small drop in asset values
could bankrupt the firms.
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Domino effects, meaning the ways at which problems at one firm could spill over to
another firm.
21st-century bank runs, in which institutions that were using mortgage securities as
collateral for short-term borrowing from other firms found that their counter-parties were
reluctant to extend their loans.
The first two components reflect fundamental problems that developed over a period of at
least a decade. The last two components reflect a financial panic that emerged abruptly in
2008.
Too many policy makers are focused only on the financial panic. For example, when
Bernanke, offering a retrospective on the crisis at a conference at Jackson Hole in August of
2009, used the word panic more than a dozen times, but the phrase house prices only
twice and the phrase mortgage defaults just once.
5: The only way to prevent this crisis would have been to have more vigorous
regulation.
There is a myth that financial firms were like teenagers who started a terrible fire because of
a lack of adult supervision. In fact, Congress and regulators were doing the equivalent of
handing out matches, gasoline, and newspapers.
Housing policy was obsessed with increasing home purchases. This was pushed to the point
where, given the lack of any down payment, the term home ownership is probably a
misnomer. If the goal was home ownership, then the actual result was speculation and
indebtedness.
The easiest way to have prevented the crisis would have been to discourage, rather than
encourage, the trend toward ever lower down payments on home purchases. Maintaining a
requirement for a reasonable down payment would have dampened the speculative mania that
drove house prices to unsustainable levels. It would have reduced the number of mortgage
defaults. Another way to have prevented the crisis would have been to rely on something
other than risk buckets and credit agency ratings to regulate bank capital. A better approach
would have been to use stress tests, in which regulators would specify hypothetical scenarios
for interest rates or home prices, with bank capital adequacy measured against such stress
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tests. Another approach, noted earlier, would have been to require financial firms to issue
unsecured debt. Such debt would help insulate deposit insurance funds from fluctuations in
asset prices. Moreover, if such debt is traded, then its price can be used as a market indicator
of risk, giving regulators an early-warning system for problems.
Chapter 2
2.1 Impact of Financial Turmoil (2007-2009) on Bangladeshi
Economy:
Since the collapse of the United States subprime 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. 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
effects 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).
In February 2009, the Finance Minister AMA Munity admitted that the global financial crisis
was having an impact on trade in Bangladesh. In April the Government announced their
stimulus package with 65 million dollars directed to assist exports. This though falls short of
the 877 million dollars needed according to industry experts (Yahoo news, 2009). During
2008, 57% of Bangladeshs economy was involved in the global economy and this is
increasing. This indicates that the country might be progressively more affected should the
crisis continue for an extended period. Trade, migration and remittance are the most likely
sectors to be impacted as 43.3% of Bangladeshs openness is related to trade and 10 % to
remittance. Overseas Development Assistance (ODA) and Foreign Direct Investment (FDI)
may also be vulnerable in the longer term but to a lesser extent due to only 3.2% integration
with the global economy (CPD and ILO, 2009).
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Bangladesh is captive to what transpires in international markets and economies of leading
countries. Against the background, Bangladesh cannot be immune from the global
economic slowdown and is most likely to be adversely affected sooner or later.
Why this crisis? To put it simply, it has been argued the whole meltdown of the financial
system was Made In America for having relaxed rules of providing loans to jobless
people with no income for buying houses, called sub-prime housing loans or now known
as toxic loans or assets amounting to about $2.1 trillion dollars.
Banks and financial institutions that bought security-paper have lost money. In its latest
calculations, the IMF reckons that worldwide losses on toxic assets originated in
America will reach $1.4 trillion and so far $760 billion has been written down by banks
and financial institutions.
Normally the banks and financial institutions lend and borrow money and the money market
works well. During the crisis, money markets ceased to function as investors and banks who
ordinarily arrange foreign exchange swaps among themselves for a set time period are
nervous about the risk that their counter-party will go bust because of liability of toxic
assets while the swap is being put into place and so have shied away from such deals. Thus
the global money market was closed and a severe credit-crunch was felt across the world.
Conclusion
Financial Crisis: A situation in which the economy of a country experiences a
sudden downturn brought on by a financial crisis. An economy facing an economic crisis
will most likely experience a falling GDP, a drying up of liquidity andrising/falling prices due to inflation/deflation. An economic crisis can take the form of
a recession or a depression. Also called real economic crisis.
The term financial crisis is applied broadly to a variety of situations in which some
financial institutions or assets suddenly lose a large part of their value. In the 19th and
early 20th centuries, many financial crises were associated with banking panics, and
many recessions coincided with these panics. Other situations that are often called financial
crises include stock market crashes and the bursting of other financial bubbles, currency
crises, and sovereign defaults
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Impact of global financial crisis on the economy of Bangladesh
Since the collapse of the United States sub prime mortgage market and the subsequentinternational 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.
Despite this the Bangladesh government has formed a high-level technical committee and
taskforce to monitor and advise 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 effects 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).
In February 2009, the Finance Minister AMA Muhith admitted that the global financial crisiswas having an impact on trade in Bangladesh. In April the Government announced their
stimulus package with 65 million dollars directed to assist exports. This though falls short of
the 877 million dollars needed according to industry experts (Yahoo news, 2009).
During 2008, 57% of Bangladeshs economy was involved in the global economy and this is
increasing. This indicates that the country might be progressively more affected should the
crisis continue for an extended period. Trade, migration and remittance are the most likely
sectors to be impacted as 43.3% of Bangladeshs openness is related to trade and 10 % to
remittance. Overseas Development Assistance (ODA) and Foreign Direct Investment (FDI)
may also be vulnerable in the longer term but to a lesser extent due to only 3.2% integration
with the global economy (CPD and ILO, 2009).
Whilst the longer term nature of FDI commitments has kept the net inflow of investment
relatively stable, the sluggish growth of rich countries may eventually slow it down. Aid
receipts (excluding dollars) are providing less in local currency due to unfavorable exchange
rates and future aid commitments from donors may be in jeopardy if the downturn continues.
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