The turmoil in the international financial markets of advanced economies, that started around mid-2007, has exacerbated substantially since August 2008. The financial market crisis has led to the collapse of major financial institutions and is now beginning to impact the real economy in the advanced economies. As this crisis is unfolding, credit markets appear to be drying up in the developed world India, like most other emerging market economies, has so far, not been seriously affected by the recent financial turmoil in developed economies The global financial crisis, brewing for a while, really started to show its effects in the middle of 2007 and into 2008. Around the world stock markets have fallen, large financial institutions have collapsed or been bought out, and governments in even the wealthiest nations have had to come up with rescue packages to bail out their financial systems. On the one hand many people are concerned that those responsible for the financial problems are the ones being bailed out, while on the other hand, a global financial meltdown will affect the livelihoods of almost everyone in an increasingly inter-connected world. The problem could have been avoided, if ideologues supporting the current economics models weren’t so vocal, influential and inconsiderate of others’ viewpoints and concerns. CAUSES
As with any large event in any field of human endeavour, it is never about just one thing. There were many causes of the financial crisis, some recent and some longstanding. I would like to focus on three of those causes today: the misperception and mismanagement of risk; the level of interest rates; and the regulation of the financial system. Perhaps the most basic underlying driver of the crisis was the inherent cycle of human psychology around risk perceptions. When times are good, perceptions of risk diminish. People start to convince themselves that the good times will go on forever. Then, when the cycle turns, risk aversion increases again, often far beyond normal levels, let alone those seen during the boom. 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.
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...