GLOBAL FINANCE TURMOIL Group 7 Verónica Vargas

GLOBAL FINANCE TURMOIL Group 7: • Verónica Vargas • Diana Sánchez • Ever Sáenz • Daniel I. Ochoa

WHAT HAPPENED, WHAT IS HAPPENING IN THE FINANCE MARKETS? The principal world financial markets are in a crisis where the primary ingredients are: High volatility • Drops in global markets indexes • Unconfident banks, investors, and finance institutions • Overleveraging of banks and financing companies • Assets infected (principally mortgages in the U. S. ) • Bankruptcies of big finance firms • U. S. and global governments rescue plans •

WHAT HAPPENED? Housing Market Excess Housing Inventory House Prices Decline - Overbuilding because of speculation Negative effects in the economy Mortgage cash flows declines Finance Market Liquidity crunch for businesses Bank failures (Wachovia, Lehman Bros. , Washington Mutual) Government and Industries Responses Central Banks actions Mortgage Delinquency and Foreclosure Wrong borrowing and lending policies - Easy credit policies -Business investment declines -Unemploy ment increases -Stock market declines Inability to refinance mortgage Fiscal stimulus package Home owner assistance Bank capital levels depleted - Fannie & Freddie - AIG - Etc… One-off bailouts and bankruptci es Bank Losses - Bailout Plan $700 billion - Interest rate cuts - Capitalization of Banks - Stop short-selling Systemic Rescue

WHAT IS HAPPENING? • High Volatility in the stock markets CBOE Volatility Index 5 year Last week

WHAT IS HAPPENING? Constant drops in global market indexes DJIA 5 years FTSE 100 5 years DJIA last week FTSE 100 last week

WHAT IS HAPPENING? Constant drops in global market indexes S&P 500 -5 years Nikkei 225 -5 years S&P 500 last week Nikkei 225 last week

WHAT IS HAPPENING? Unconfident financing institutions The high volatility and low liquidity among banks and finance companies create a feeling of distrust among the lenders Credit is shrinking Credit has been diminishing because of the sense of distrust among the banks; consequently businesses will reduce their spending and expansion, as well as domestic spending will diminish Blue-chip stocks poor performance The price of the so called “high performance” stocks are being affected by market volatility and are suffering substantial drops

WHAT IS HAPPENING? • • • Illiquid assets could not be valued yet Latest earnings reports of blue chips companies in the US are lower than forecasted; this drives uncertainty “There’s a continuous vortex of selling, led by levered, scared hedge fund community stepping on each other trying to get in front of the other guy to liquidate, based upon the real investment that they’ve experienced. ”– Doug Kass, president of Seabreeze Partners Disappointing economic reports, a fall in retail sales of 1. 2% last month (the worst in 3 years), and wholesale prices surged suggest the stilltightening of earnings, higher expenses and declining demand in the US Bank customers are transferring funds from troubled to healthier banks, practically deciding which banks will become rescued by the US government bailout plan

WHAT IS HAPPENING? Europe “UK’s bailout plan show some cracks” say some of the lenders in the UK. They claim that market conditions will not let them to overcome the price charged by the government to guarantee their debt, “the price is to high” and “it’s going to become another hit on earnings” -Citigroup Iceland cuts interest rate to 12%. There are “worries on national bankruptcy” - Joel Sherwood (Wall Street Journal) Asia Nikkei falls 9. 55%

WHAT IS HAPPENING? In summary: The finance markets are bouncing after this deterioration of its system (subprime crisis, banks overleveraging, etc. ). Like a ball that was thrown from a higher height, the market will bounce until it stabilizes.

Why this turmoil can be traced back to the U. S. credit crisis? The interdependence of the world’s financial markets

Why this turmoil can be traced back to the U. S. credit crisis? Many reasons of the credit crisis. 1. 2. 3. 4. 5. Subprime Mortgages. Fed Failing to properly gauge and contain credit expansion. An excessive use of credit. Discernible lowering of credit standards. Heavy reliance on leverage.

What is special about this crisis? It is play out in the markets & institutions in the world’s financial centers. It is harder to determine the magnitude of the problem. Directors and Seniors managers of the financial institutions that fail to implement policies. Private credit rating agencies. The explosion of securitization.

How this Crisis Affect the Global Economy? Economic slow down Liquidity Bad assets Confidence Shortage capital Higher Inflation Lower growth

Contd. “We still have a very long way to go. We don't all need to have the same policies, but we must all talk to each other about our policies, and consider the effects of our actions on our partners. ” (Strauss. Kahn )

The interdependence of the world’s financial markets. How the countries are inter related: 1. 2. 3. 4. 5. 6. Exchange rates. Financial Institutions. Financial Centers. International monetary Fund. Imports / Exports. Interest Rates.

Central Bank’s Coordinated Effort

Governments across the world have stepped up their interventions to stem the worst financial crisis in decades. They are taking a variety of measures to restore liquidity, revive the ailing banking system and rebuild investors’ confidence.

Interest Rates Reductions … Federal Reserve European Central Bank of England Canada’s Central Bank Sveriges Riskbank Swiss National Bank ▫ ▫ 2. 00% 4. 25% 5. 00% 3. 00% 4. 75% 3. 00% The People’s Bank of China: Reserve Bank of Australia Hong Kong Monetary Authority: Bank of Japan (Support) 1. 50% 3. 75% 4. 50% 2. 50% 4. 25% 2. 50%

Liquidity and Lending Guarantees US: Government guarantee senior debt issued by banks in 3 yrs EU: Unlimited liquidity to be offered Portugal, € 20 bn in guarantees Spain, up to € 100 bn of bank debt France, € 320 bn to guarantee bank lending Germany, € 400 bn Belgium guarantee all new financing Uk, new short and medium-term debt issues, £ 250 bn borrowing, and £to swap China: reduced holding deposits, waved 5% withholding tax levied Japan: $20 bn additional liquidity injection

Bank deposit guarantees US, from $100, 000 to $250, 000 per depositor; unlimited guarantees on deposits in accounts. EU: guarantee € 50, 000 savings for one year, some up to € 100, 000 UK, increased level to £ 50, 000 from £ 35, 000 Australia: from A$600 bn to A$700 bn guaranteed

Bank Recapitalization US: up to $250 bn to be used to buy preferred. Injected into nine big banks. Japan: Restrictions on companies buying back shares, and suspend the sale of government-owned stocks. France: Government € 40 bn to buy stakes in companies Germany: Government provide € 100 bn in state funds Iceland: Took 3 largest banks

Asset Purchase US: Up to $100 bn to be used to purchase bank assets Australia: Government double to A$8 bn its planned purchase of residential mortgage backed securities

Short-Selling crackdown US: Banned short selling in 900 companies; ban lifted on Oct 8. Canada: Banned short selling in 13 companies; ban lifted on Oct 8. UK: Banned short selling in 34 financial stocks till Jan 16 2009. Iceland: Banned short selling in six financial institutions.

Will these policies work? According to Central Banks: “Credit markets will take some time to unfreeze; even if they stabilize. . . broader economic recovery will not happen right away. However, some easing of global monetary conditions is therefore warranted. “ Lord Norman Lamont, former UK Finance Minister: “All of these moves I think are meant mainly just to demonstrate that the authorities in different countries can act together. I think it was seen as symbolic rather than anything else. We have debt deflation; people have amassed huge debts. ”

Will these policies work? Analysts in favor: Shows Governments proactive Specially when confidence is not a strong: “…these policies do will help the confidence, even if they have lost their power to spur stock market rallies” (Wall Street Journal) “… the move is to be applauded, the playbook to avoid depressions says rates need to be as close to zero as possible. ” (Shepherdson, chief United States economist at High Frequency Economics)

Time of recession • Probably 6 to 9 months as longer 1 year • Longer and severe • Last recession

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World Economic Outlook