The so-called "Sub Prime crisis"
The current financial turmoil is rooted to the "Sub Prime crisis". During boom years, mortgage brokers enticed by the lure of big commissions, talked buyers with poor credit into accepting housing mortgages with little or no down payment and without credit checks.
Banks and financial institutions often repackaged these debts with other high-risk debts and sold them to world-wide investors creating financial instruments called CDOs or Collateralised Debt Obligations. The serious sub prime mortgage crisis began in June of 2007 when two Bear Stearns hedge funds collapsed.
Federal Reserve Bank and European Central Bank dumped $100-billion in liquidity into the system that calmed the market down for a short period. However the sub prime crisis continued to be solid as long as the housing market continued to escalate and interest rates didn’t go up.
BOUNCED CHEQUES
Lehman Brothers
Lehman’s slow collapse began as the mortgage market crisis unfolded during the summer of 2007. Its stock began a steady fall from a peak of $82 a share. The fears were based on the fact that the firm was a major player in the market for sub prime and prime mortgages.
Lehman managed to avoid the fate of Bear Stearns, the other of Wall Street’s small fries, which was bought by JP Morgan Chase at a bargain basement price under the threat of bankruptcy.
Lehman and Bear Stearns had a number of similarities. Both had relatively small balance sheets, they were heavily dependent on the mortgage market, and they relied heavily on the “repo” or repurchase market, most often used as a short-term financing tool.
On June 9, 2008, Lehman announced a second-quarter loss of $2.8 billion, far higher than analysts had expected. The situation became worse after the government on announced on September 8 a take-over of Fannie Mae and Freddie Mac. Lehman’s stock plunged as the markets wondered whether the move to save those mortgage giants made it less likely that Lehman might be bailed out.
Treasury Secretary Henry M. Paulson Jr. and Federal Reserve officials did encourage other financial institutions to buy Lehman, but by the end of the weekend the two main suitors, Barclay’s and Bank of American, had both said no. Lehman had reached the end of the line.
AIG Investment banking is an intrinsically cyclical business, but Wall Street’s greedy-and-aggressive top management forgot about that as they chased profits and bonuses during a stretch in which money was always easy to obtain.
AIG shouldn’t have had problems as it’s primarily an insurance company. However, when you look at AIG’s balance sheet, it has also made a speciality of speculative trading in derivatives. That was an attractive business for many years but like other businesses has recently run into trouble, it also followed suit.
Merrill Lynch Shortly after Lehman Brothers filed for bankruptcy, Merrill Lynch complained of suffering from a similar disease, and before the effects could become devastating, it cut a deal with the Bank of America for $50b, far below its value.
IMPACT IN INDIA
IT Cos: With nearly half of their revenues coming from banking and financial services segments, India’s top software exporters are closely monitoring the financial crisis spreading across markets.
The IT giants which had all these investment banks as their clients are TCS, Wipro, Satyam and Infosys Technologies. HCL seems to have escaped the loss as neither Lehman nor ML were their clients.
Banks: The government is worried the ongoing crisis would have an adverse impact on Indian banks. Lehman Brothers and Merrill Lynch had invested substantially in the stocks of Indian banks. The banks, in turn, have invested in derivatives, which might have exposure to these investment bankers.
PSU banks like Bank of India, Bank of Baroda have exposure towards derivatives. ICICI bank is the worst hit as of now. With Lehman Brothers filing for bankruptcy in the US, the country’s largest private bank ICICI Bank is expected to lose approximately $80 million (Rs 375 cr), invested in Lehman’s bonds through the bank’s UK subsidiary. The meltdown is also expected to hit Axis bank but the impact is not clear yet.
Real estate: Lehman Brothers Real Estate Partners had given Rs 740 crore to Unitech Ltd, for its mixed-use development project in Santa Cruz. Lehman had also signed a MoU with Peninsula Land Ltd-a Ashok Piramal real estate company-to fund the latter’s projects to the tune of Rs 576 crore. Another major real estate organisation whose valuations are affected by this meltdown is DLF Assets in which it had invested $200 million.
Bailout Package
The White House gave a package of over $700 bn which came as a lifeline to sinking equity markets around the world. US President George W Bush said the administration’s new rescue plan to revive the credit markets and restore market liquidity will ease pressure on the balance sheets of banks and other financial institutions. He said that America’s economy was facing unprecedented challenges, and they were responding with unprecedented action.
Meanwhile in India, finance minister P Chidambaram assured that PSU banks had virtually no exposure to Lehman Brothers. Although the credit crunch globally will impact credit availability in the Indian market, there is no cause for any alarm that any Indian bank is vulnerable, the FM said.
Courtey: Economic Times, 21 Sep'08
The current financial turmoil is rooted to the "Sub Prime crisis". During boom years, mortgage brokers enticed by the lure of big commissions, talked buyers with poor credit into accepting housing mortgages with little or no down payment and without credit checks.
Banks and financial institutions often repackaged these debts with other high-risk debts and sold them to world-wide investors creating financial instruments called CDOs or Collateralised Debt Obligations. The serious sub prime mortgage crisis began in June of 2007 when two Bear Stearns hedge funds collapsed.
Federal Reserve Bank and European Central Bank dumped $100-billion in liquidity into the system that calmed the market down for a short period. However the sub prime crisis continued to be solid as long as the housing market continued to escalate and interest rates didn’t go up.
BOUNCED CHEQUES
Lehman Brothers
Lehman’s slow collapse began as the mortgage market crisis unfolded during the summer of 2007. Its stock began a steady fall from a peak of $82 a share. The fears were based on the fact that the firm was a major player in the market for sub prime and prime mortgages.
Lehman managed to avoid the fate of Bear Stearns, the other of Wall Street’s small fries, which was bought by JP Morgan Chase at a bargain basement price under the threat of bankruptcy.
Lehman and Bear Stearns had a number of similarities. Both had relatively small balance sheets, they were heavily dependent on the mortgage market, and they relied heavily on the “repo” or repurchase market, most often used as a short-term financing tool.
On June 9, 2008, Lehman announced a second-quarter loss of $2.8 billion, far higher than analysts had expected. The situation became worse after the government on announced on September 8 a take-over of Fannie Mae and Freddie Mac. Lehman’s stock plunged as the markets wondered whether the move to save those mortgage giants made it less likely that Lehman might be bailed out.
Treasury Secretary Henry M. Paulson Jr. and Federal Reserve officials did encourage other financial institutions to buy Lehman, but by the end of the weekend the two main suitors, Barclay’s and Bank of American, had both said no. Lehman had reached the end of the line.
AIG Investment banking is an intrinsically cyclical business, but Wall Street’s greedy-and-aggressive top management forgot about that as they chased profits and bonuses during a stretch in which money was always easy to obtain.
AIG shouldn’t have had problems as it’s primarily an insurance company. However, when you look at AIG’s balance sheet, it has also made a speciality of speculative trading in derivatives. That was an attractive business for many years but like other businesses has recently run into trouble, it also followed suit.
Merrill Lynch Shortly after Lehman Brothers filed for bankruptcy, Merrill Lynch complained of suffering from a similar disease, and before the effects could become devastating, it cut a deal with the Bank of America for $50b, far below its value.
IMPACT IN INDIA
IT Cos: With nearly half of their revenues coming from banking and financial services segments, India’s top software exporters are closely monitoring the financial crisis spreading across markets.
The IT giants which had all these investment banks as their clients are TCS, Wipro, Satyam and Infosys Technologies. HCL seems to have escaped the loss as neither Lehman nor ML were their clients.
Banks: The government is worried the ongoing crisis would have an adverse impact on Indian banks. Lehman Brothers and Merrill Lynch had invested substantially in the stocks of Indian banks. The banks, in turn, have invested in derivatives, which might have exposure to these investment bankers.
PSU banks like Bank of India, Bank of Baroda have exposure towards derivatives. ICICI bank is the worst hit as of now. With Lehman Brothers filing for bankruptcy in the US, the country’s largest private bank ICICI Bank is expected to lose approximately $80 million (Rs 375 cr), invested in Lehman’s bonds through the bank’s UK subsidiary. The meltdown is also expected to hit Axis bank but the impact is not clear yet.
Real estate: Lehman Brothers Real Estate Partners had given Rs 740 crore to Unitech Ltd, for its mixed-use development project in Santa Cruz. Lehman had also signed a MoU with Peninsula Land Ltd-a Ashok Piramal real estate company-to fund the latter’s projects to the tune of Rs 576 crore. Another major real estate organisation whose valuations are affected by this meltdown is DLF Assets in which it had invested $200 million.
Bailout Package
The White House gave a package of over $700 bn which came as a lifeline to sinking equity markets around the world. US President George W Bush said the administration’s new rescue plan to revive the credit markets and restore market liquidity will ease pressure on the balance sheets of banks and other financial institutions. He said that America’s economy was facing unprecedented challenges, and they were responding with unprecedented action.
Meanwhile in India, finance minister P Chidambaram assured that PSU banks had virtually no exposure to Lehman Brothers. Although the credit crunch globally will impact credit availability in the Indian market, there is no cause for any alarm that any Indian bank is vulnerable, the FM said.
Courtey: Economic Times, 21 Sep'08
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