The World this Week June 18 - June 22 2012

The world this week june 18 - june 22 2012

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How did the sub-prime crisis become such a huge global crisis?

The Sub-prime crisis is a 2007 financial crisis that started in the United States of America from the high number of defaulting borrowers with sub-prime mortgages.

During the high demand period for housing loans in the US, when the real estate sector was booming, people with a bad credit history, and a higher chance of defaulting on their payments, were providedloans at higher-than-normal interest rates (sub-prime rates). Problems in the sub-prime market began to arise as these sub-prime borrowers that did not have the capacity to repay the loan.

The elevated risks that financial institutions were taking with sub-prime mortgages in the USA began to create problems towards the end of 2006. Borrowers began to default on their loans in higher numbers,which created a global credit crisis. Central banks were forced to inject money into financial markets, more than one hundred sub-prime lenders in the United States collapsed, leading to decline in US economic activity and global economic growth was expected to slow.

A decline in economic activity in theUS resulted in lower disposable incomes and hence a decline in demand. People who were not able to pay back their Loans, lost their homes to financial institutions,which were not able to sell it in the Open markets to recover the amount lended, as the property rates had fallen tremendously due to an oversupply. This triggered the sub-prime crisis.

The world was hit by the heat of the US sub-prime crisis. It was initially thought by some that other major world economies would not be significantly affected. While the sub-prime mortgage meltdown was mostly an American problem, financial markets around the world have been affected by it either directly or indirectly, on account of US being the largest economy.

Source : Multiple

Fannie Mae & Freddie Mac Fallout

With the Economies booming post 2007, Investors were not used to watch their financial stocks plummet more than 70 percent in close quarters.  American taxpayers were ignorant of left holding defaulted mortgages and abandoned homes while executives who presided over balance sheet implosions walked away with millions.  Taxpayers were also given the bill to bailout poorly managed Bear Sterns.

Over the course of this 18-month financial crisis, US lurched from financial land mine to land mine. The crisis from the fallout of Fannie Mae and Freddie Mac, the giant government-sponsored enterprises set up to provide affordable housing across the nation was a setback.  By issuing debt, these shareholder-owned companies guarantee or owned more than $5 trillion in home mortgages.  The majority of them were good, but because of the subprime mortgage mess, the percent that default increased over the past 18-months.

Investing in Fannie Mae and Freddie Mac seemed like conservative investments.  These were government established companies.  The implied guarantee is what drove Fannie and Freddie’s business models.  However, investors were foolish to think they were still government backed and therefore were guaranteed.

The reason why crisis hit these two companies was because they were not required to keep as much cash on their books as banks.  But with so many mortgages defaulting, there low cash supplies lead them in a dangerous state.  To raise the necessary capital to stay afloat, these companies called on the American taxpayers to bail them out.
Speculation that mounting losses at Fannie Mae and Freddie Mac would require billions of dollars in additional capital had fueled a firestorm, sending stock investors fleeing. Fear spread across financial markets after the government offered no hint that it would step in to help the companies.

The companies combined have about $1.6 trillion in debt outstanding, much of which was held by central banks around the world. They used the money to fund the portfolios and securities that lawmakers have increasingly relied on to support the ailing housing market.

So were government funded companies also not safe for investment, and did investment pundits learn anything from this fall out?

Source: Financial Times, Swapnil Pawar (CIO, Karvy Wealth)

Read more on demystifying facts of Global Economic Crisis by Swapnil Pawar, CIO, Karvy Wealth.

A real life case from Global Economic Crisis

Ripple Effect of the Subprime crisis

•   The effects of the US Subprime Mortgage crisis on the global market were huge. The crisis had ripple effect on the Asian, European as well as the Australian market.

•  The Asian market witnessed a massive sell off. It also has hit the stock markets of Australia, Germany and Thailand such that BNP Paribas had to hold all it withdrawals and IKB Deutsche had to seek a bailout of $11.1 billion.

•    Post the housing bubble burst in US the underlying mortgage defaults increased which affected adversely the global markets.

•    In the Great Britain, the stock market experts failed to realize the underlying faults and WestLB had to file bankruptcy.

•    One of the giant of Australian financial services Macquarie Bank, declared that the investors may lose 25% of their money.

•   The Nikkei stock average in Japan has decreased by more than 2%.

•   In Germany, France and Britain major indexes have fallen down, but by less than 2%.

•    Australia and Hong Kong's benchmark indexes have fallen down by above 3%.

•    South Korea's key index has dropped by 4%.

•   The First State Investment had withdrawn its entire share from the Asian financial market.

  

Source: Multiple

                               

                               

Global economic imbalances

One of the most important and immediate causes of the real estate bubble is the US and a lot of other economies, was low interest rates for remarkably long period of time. While there have been several reasons cited for this phenomenon, the most plausible answer seems to be the global economic imbalances starting in the 90’s. Both the theory and the practice of these imbalances is fairly intricate & a very recent economic development.  

Theory of Economic Imbalances

In a closed economy with zero mobile capital, the income levels are fine tuned to domestic demand. Any sudden decrease or increase in this demand or supply alters the incomes of all participants in the economy and establishes a new equilibrium.

Without capital flows, it’s impossible to have a current account deficit or surplus. In this case, the exports and the imports are merely terminologies to describe overseas flow of goods. For all other purposes, the exporters and importers in the faraway country are another element of the domestic economy itself.

Even with capital flows, there is an upper limit on the time for which a country can have trade deficit- since with each year, the capital flows from deficit country to surplus country. There has to be a way of getting the capital back for the next round of deficit.  Thos is the famous imbalance described above in which the capital does flow back from Asia to the US as a credit. Till here, fluid currencies are not required.

Even with gold standard currencies, a country can have sustained deficits if the surplus country is willing to lend money to the deficit country (the mechanism of this can be detailed) – the question is why would it do that?

The Asian attempt to hold the dollar already versus their currencies was a strategy in effect to enforce the gold standard on the dollar. In purchasing dollars to prop it, the Asians did two things – one was to lend money to US to fund its deficit & two, was to  signal the US that it would print more dollars if it wished and that dollar would still be held in a  certain value range by them.

The Asians were propping up the dollar to ensure that the Americans have something to pay with for their imports of Asian goods .Why did Asians need American consumers? Were they an easy target than domestic?

Source : Anatomy of froth

Chronology of Economic Crisis - The three phased crisis

There was a lot of confusion and divergence of opinion about when the crisis really began.The pursuits claim that it started with the Fed’s attempt to overcome the previous crisis (the dotcom bubble). We will concern ourselves first with the ‘what’ of it- in order to understand all that happened under the broad headings of credit crisis, financial crisis & global economic crisis.

The three phased crisis

There were three phases to the crisis of which is still prevalent in 2011.

The first phase

It was the uncovering of losses in the subprime mortgage market in US.  This was largely a wake up phase. It started in February 2007 & continued till early 2008. During this phase the reactions of most experts were mixed – some believed it to be the harbinger of a larger global crisis while others thought of it as nothing more than a serious setback in a specific sector of the American economy.  However, even for the lenders & investors the extent of the impact was limited to losses in subprime mortgages. This phase started in the US and the spread to the rest of the world through subprime mortgage investments.

The second phase

The second phase was the wider credit crisis across the US and Europe brought about by the impact of the first phase, as well as other factors at work. This phase started in early 2008 with the collapse of Bear Stearns and continued till September 2008. This phase covered a larger section of the financial services industry. As mentioned in the first phase quite a few of American subprime lenders failed & many large American investment banks lost heavily on their investments in the subprime mortgages. If the problem was subprime credit alone, the crisis would have been contained at this stage. The second phase would have never come about.

The third phase

The third phase was the global economic crisis. The substitution of ‘economic’ for’ financial’ in the descriptor, has significant & dark connotations, It was in the phase that the crisis engulfed the wide economy began affecting the lives of people outside the financial services industry. This phase started in October 2008 – after series of big tickets bank failures on wall street & continued through 2009 & 200. In the first two phases, much of the brunt of the crisis was borne by the financial services industry in US & Europe. Banks and financial institutions lost close to $1500bn during the time according to IMF. However, the rest of the global economy was still chugging along. There were predictions of a slowdown no doubt; however, the real impact was not felt till September 2008.

It is important to understand however that these three phases unfolded not as an unhappy accident of the first leading to the second and that in turn leading to the third. It was not a disease that began in a section of the economy & then spread to the other sections.

So was there more to it? What were the main driving forces that lead to the global economic crisis?

Source : Anatomy of Froth by Swapnil Pawar

Popular Move by the US Treasury - Broke Back Mountain for the Indian IT!

The US Senate has raised a Bill which proposes to double the H1, L1 Visa Fees. It is been estimated by Nasscom that the move to hike visa fees will raise costs for Indian IT firms. The cost estimate is based on the assumption that the increase in fees is $4,500 (on top of the existing fee of $2,500 for H1 visas) and the fact that India uses approximately 50,000 H1 and L1 visas a year.

This move would significantly impact the India IT industry when there’s actually a need for the markets to open and make companies more competitive from a global perspective. One of the key impacts on this could also be on the stock market prices of the leading IT companies.

Source: Times of India
Photo : topnews.in

Top 5 US Luxury Vacation Destinations

The United States is a diverse country, with so many interesting travel destinations that people could spend every vacation in a different destination and never grow weary of it.

These are this column's picks for the top five luxury vacation destinations in the USA.

1.) Sedona, Arizona

People often talk rapturously about Southwest splendor, and no place exemplifies this concept quite like Sedona, Arizona. The red cliffs, mesas, and buttes are awe-inspiring, and Oak Creek gives hot tourists a place to cool off during the summer months. Outdoor adventure reigns supreme here, but the best luxury resorts offer pampering respites that rival any in the world, making Sedona an international superstar of luxury travel, outdoor adventure-style.

2.)New York City, New York

The 24-hour lifestyle, the museums, galleries and Broadway shows add up to one of the most popular urban tourist destinations in the world (and the most, definitely, in the United States). Manhattan can be visited on a budget, of course, but the luxury hotels in NYC – on the Upper East Side, or Columbus Circle, along Central Park South or in Times Square – all are testament to the draw of a high-end New York City vacation.

3.) Napa Valley, California

With the Culinary Institute of America right there, it's a given that some of the best upscale restaurants are in Napa Valley as well. The rolling hills and ocean breezes come together to replicate the feel of the wonderful vineyards of Tuscany (albeit without the Medieval and Renaissance architecture, needless to say). Add an array of lovely 5-star resort hotels in the mix, and both wine connoisseurs and culinary travelers have the best vacations of their lives.

4.) US Virgin Islands, Caribbean Ocean

Yes, they're in "the Caribbean," but they are legitimately part of the United States, and worthy of inclusion. St. John, with its huge national parkland (2/3 of the island is National Park) provides a completely different Caribbean island vacation experience than St. Thomas, with that busy, crowded port of Charlotte Amalie. St. Croix is the least traveled to by luxury vacation seekers. but St. John and St. Thomas alike offer terrific water sports, snorkeling and scuba, plenty of dining options and exclusive luxury resort hotels.

5.) Maui, Hawaii

It is tought choosing just one Hawaiian island. They are all unique, and wonderful, with luxury vacation options galore. But Maui wins "best island vacation" awards annually for a reason. The Wailea stretch has three impeccable luxury resorts (Grand Wailea, Four Seasons, and the Fairmont Kea Lani) along the most calm, family-friendly stretch of beach of all Hawaii, and other luxury hotels and resorts dot the island as well. The Road to Hana, Haleakala, and other day trips satisfy the upscale adventure traveler, and the "spirit of aloha" provides memories to last a lifetime.


Source: Suite101.com
Photo: Photobucket