1. The Financial Crisis of 2008
Special Lecture

2. Easy Credit – The main culprit
American economy is based on credit
From heating up homes in winter to buying homes, people use credit
In the booming financial market, it became very easy to take loan
Rise in Property prices
Low interest rates
Loose lending policy - expecting rising property prices

3. The Mortgage brokers
Mortgage brokers approved credit for all type of customers (including sub-prime loans)
This way they increased their commission income
brokers absolved themselves of responsibility by packaging these bad mortgages with other mortgages and reselling them as “investments.”

4. Home buyers contact a mortgage broker
MB Approves loans including risky ones to get more commission
Loans are given by a mortgage bank (Countrywide, Indy Mac, Fannie & Freddie , Citibank)
Investment Bankers (Bear Stearns, Lehman, Merrill Lynch) classify loans according to risk level called CDO
The AAA CDOs are paid first incase of mortgage defaults, but the rate of return is lower
Lenders Issue Mortgage backed securities (MBS) and sell to investment banker
The rated CDOs were sold and junk kept in SPV

5. V(A) + V(E) > V(D) House Income MBSs CDOs Mortgage Lenders Banks
Subprime
Mortgage Lenders
(Countrywide, Indy Mac, Fannie & Freddie)
Banks
(Citibank, BOA)
Insurers
(AIG)
Rating
MBSs
Investment Banks
(Bear Stearns, Lehman, Merrill Lynch)
CDOs
Root of crisis is housing price and economic condition :
Low FED rate make it cheap to borrow money to invest in real estate and reduce mortgage rate
Assuming always-up about house’s price lead to open-up lending policy created subprime lending
Economic recession and housing bubble started 2006 lead to growth of unemployment rate and massive loses of mortgage-related derivative assets
SPV
Investors
(Banks, Funds, Insurance) 5

6. The loan bubble Swelled
Thousands of people took out loans larger than they could afford
With the hope to sell the house for profit or refinance with lower rate
But slump in the property prices disturbed everything…..

7. Homeowners Equity vs. Mortgage
Source: The Federal Reserve

8. Slump in the property prices and Unemployment
In 2006, property prices started falling down
and investors could no longer ssell their homes for a quick profit
adjustable rates mortgages adjusted skyward
Also in 2006, unemployment rate increased
mortgages no longer became affordable for many homeowners
thousands of mortgages defaulted

9. Home Price Indices
Source: Standard & Poor’s

10. Money started bleeding
The defaults caused massive losses in mortgage backed securities
The property prices fell further that caused slower growth in construction of new homes and thousands of jobs were lost
Due to fall in prices of mortgage backed securities many investors chose to walk away without paying the loan, increasing further the losses of banks

11. Write-Offs by Financial Institutions11 11

12. Credit well dried up
As the losses went up, banks tightened control on credit
Many banks could not survive the bolt and sank under the heavy losses, others merged and some got help from govt
Govt did not support all of the falling firms

13. Pakistan and US financial crisis
Pakistan escaped from the direct effect of US financial crisis
But indirectly, there are several areas of concern:
tightened terms for access to international debt markets
Slowing world growth rate can effect our exports
But at the same time, recession will translate into lower demand which will cause fall in oil prices

14. Pakistan economic problems
Pakistan’s economic problems are not tied to the current global financial crisis
The main economic problems of Pakistan are:
Trade deficit
Budget deficit
Currency devaluation
Inflation