Bubbles And Bailouts

Prepared by: Nikhil Swarogi Nikhil Swarogi Sonabh Bubna

B bbl Bubbles and Bailouts d B il t

Can you name these 14 bubbles?

What is a bubble? What is a bubble? • It is an extended period of overvaluation  which cannot be defined by its fundamentals which cannot be defined by its fundamentals • Focus shifts from intrinsic value to resale value • Ben Bernanke: You don’t know it’s a bubble till  it bursts it bursts

Observe the following charts Observe the following charts

South sea bubble South sea bubble 1720

Nikkei 1984‐1995

Japanese asset price bubble 1980s

Nasdaq

Dot com bubble Dot‐com bubble 1995‐2000

Inflation-adjusted home price index

225

N i lh i iindex d Nominal home price

200 175

Home P Price Index

150 125 100 75 50 25

US Housing Bubble 2000‐2008

2008

2006

2004

2002

2000

1998

1996

1994

Year

1992

1990

1988

1986

1984

1982

1980

1978

1976

1974

1972

1970

0

Causes of bubbles Causes of bubbles • Excessive money supply • The greater fool theory of investing Th t f l th fi ti • Speculative demand Speculative demand • Greed • Loose regulations

Tulip Mania Tulip Mania 1634 – 1637 Holland

Tulip Bulbs

p • First recorded speculative bubble • Turks introduced Tulips to Dutch in 1593 Turks introduced Tulips to Dutch in 1593 • Status symbol • Non‐fatal virus – MOSAIC

• Everyone began to buy tulip bulbs, including  Everyone began to buy tulip bulbs including speculators • People started trading life‐savings, land etc for  one bulb – and not even to plant  it!

• Government stepped in and created  egu at o s regulations • Few Few started to sell – started to sell and before you know it – and before you know it panic selling (domino effect) • In less than 6 weeks, tulip prices crashed by  over 90% (The price at its height was $76000)1 1. http://www.stock‐market‐crash.net/tulip‐mania.htm

A standardized price index for tulip bulb contracts, created by Earl  A standardized price index for tulip bulb contracts created by Earl Thompson. He had no price data from Feb 9 to May 1, thus the  shape of decline is unknown.

Dot – Com bubble Dot  Com bubble 1998‐2001 USA

• It was a stock market bubble • Referred to the unprecedented commercial  growth of the internet with the advent of  th f th i t t ith th d t f www and tech industry in general

Causes • Jump in internet users  1995 – 16 million users 2000 – 248 million users2

• Most start ups engaged in unusual and daring  businesses • Absurd business models • Heavy promotion 2. source: http://www.gottaquirk.com/2009/09/04/friday‐fact‐box‐dear‐internet‐happy‐40th‐birthday/

• Sky high IPOs  Sky high IPOs

excel xlsx excel.xlsx

• Lavish internal spending • Role of speculators and day traders

Why did the party end? Why did the party end?

• O Over 1999 and early 2000, Fed increased  999 d l 2000 d i d interest rates several times

10 9.8 9.6

9.5

9.4 9.2

9

Prime Ratte %

9 8.8

85 8.5

8.6

8.25

8.4 8.2 8 7.8

7.75

7.6 74 7.4 7.2 7

Month ‐ Year

• Accelerated business spending in preparation  of Y2K switchover of Y2K switchover • United States v Microsoft case d f • Poor results of internet retailers was made  public in march p

200 35.3 0 ‐200

‐149.1

‐400

1999

‐600

‐567.3

2000 2001

‐800

‐720

2002 2003

‐1000 ‐1200 ‐1400 ‐1411.3 ‐1600

Amazon.com Net income (in $million)

0 ‐2.6 ‐11

‐20

‐40 ‐40.6 ‐60

1999 2000

‐49.6

2001 2002 2003

‐80

‐100 ‐103.9 ‐120 120

Theglobe.com, inc. Th l b i Net income (in $million)

NASDAQ  NASDAQ • March 10 (Friday)  March 10 (Friday) – 5048.63 points 5048 63 points • March 13 (Monday) – h 3( d ) opens 4% lower at 4879  %l 8 9 points • March 15 – 4580 points p

Source: www.nasdaq.com

The Aftermath The Aftermath • $5 trillion in market value of tech firms wiped  $ out between March 2000 and October 20021 • Communication companies p • Loss of jobs Loss of jobs

1. source: http://www.wisegeek.com/what‐was‐the‐dot‐com‐bubble.htm

1995  Geocities, Yahoo,  MSN, eBay

2000 Jan 11 AOL  acquires Time Warner 1998  Google, Boo.com, Flooz.co m, Go.com, Kozmo.com,  m Go com Kozmo com

2000 Mar 10 dot‐com bubble reaches peak

Pets.com

1999  kibu, MVP, Webvan 1997 eToys 1994 Amazon

2000 Jan 30 Super Bowl XXXIV  features 17 dot‐com companies

Source: http://timelines.com/topics/dot‐com‐bubble

2000 Apr 3 Microsoft  declared  monopoly

2001 Jan 28 – Super Bowl  XXXV features just 3 dot‐ com companies Webvan, Go.com, kozm,  Flooz collapses

2000 May 18‐ Boo.com bust

2003 Oct

2000 Mar 10

Nov 6‐

Market opens  4% lower

Pets.com goes

AOL Time Warner  drops AOL from  name

Source: http://timelines.com/topics/dot‐com‐bubble

US Housing bubble US Housing bubble USA 2000 2008 2000‐2008

• An economic bubble affecting many parts of  An economic bubble affecting many parts of the US housing market • It roughly coincided with the real estate  bubbles of Hong Kong, South Korea  UK, Spain, Poland and Hungary

Causes • Americans love their homes • Over leveraging • Popular belief that home prices do not fall in value • Also widely believed that home values yield better  returns • Heavy promotion in media Heavy promotion in media

• Price appreciation was non‐uniform throughout the  country  US map.flv • Crash of the dot‐com bubble • Historically low interest rates 10 00% 10.00% 8.00%

Prime rate

6.00% 4.00% 2.00%

4% Jan‐01 Apr‐01 Jul‐01 Oct‐01 Jan‐02 Apr‐02 Jul‐02 Oct‐02 Jan‐03 Apr‐03 Jul‐03 Oct‐03 Jan‐04 Apr‐04 Jul‐04 Oct‐04

0 00% 0.00%

• Financial innovation and complexity • Speculative trading • Surge in subprime mortgages 

Subprime mortgages How it worked k d X gets loan from bank or broker

Who sells it to an Investment firm on  Wall Street

This is now sold to investors all over  the world

Piles of such mortgages are collected  and converted into a product

The heavy demand The heavy demand • By around 2003, everyone who qualified for a  mortgage got one mortgage got one. • But the global pool wanted more, so things  changed – mortgage qualification guidelines  did!

No Income No Job No Assets  (NINJA)  (NINJA) Don’t prove or state anything. All you need to  have is a credit score!

• In 1994, less than 5% of total mortgages were  p y g subprime in US. But by 2005, that figure  ballooned to 20%1

1. source: http://www.economywatch.com/us‐subprime/crisis.html

The Risk The Risk • Agencies such as Moody’s, Fitch, Standard &  Poor’ss, etc blessed these mortgage based  Poor etc blessed these mortgage based securities with AAA ratings

• Suspicious Activity Reports pertaining to  Mortgage fraud increased by 1 411% between Mortgage fraud increased by 1,411% between  1997 and 20051

1 source: USA Today 1. source: USA Today

A classic speculative housing bubble A classic speculative housing bubble

More and  more people  bought  h homes

Easy loan  availability

Increased  d demand led to  increased  prices Investors and  Investors and speculators  stepped in – g further fueling  prices

The crash The crash • Between 2004 and 2006, the Fed raised  interest rates 17 times increasing them from interest rates 17 times, increasing them from  1% to 5.25% • In contrast to the rising house prices, the  average household income didn't increase

The basic assumption became false The basic assumption became false Oversupply Oversupply  of houses Home prices  stopped stopped  rising

+ People  began  defaulting – i increased  d foreclosures

lack of  demand Panic in  Panic in Wall Street

• Foreclosures increased – very very difficult to  find who the actual current owner of  mortgage is

After effects After effects

• Mini oil bubble i i il b bbl • The credit crunch

• Impact on financial institutions: ‐ IMF estimated that US and European banks lost over $1  trillion on toxic assets and bad loans from Jan 07 to Sep 09.  These are expected to hit $2.8 trillion from 07‐10 ‐ Over 100 mortgage lenders went bankrupt during 07‐08 ‐ Several major institutions failed, acquired or were subject to  government takeover. 

• Loss of wealth • Bailout packages

How did it affect India? How did it affect India? 25000

20000

15000

10000

5000

0 Jan‐02 Jan‐03 Jan‐04 Jan‐05 Jan‐06 Jan‐07 Jan‐08 Jan‐09

Sensex

Are we living in a gold bubble? Are we living in a gold

What Does Bailout Mean? What Does Bailout A situation in which a business, individual or  ggovernment offers money to a y failing  g business in order to prevent the  consequences that arise from a business's  downfall…

Different ways of bailout Different ways of bailout • Bailouts‐the Bailouts the most common way most common way‐ through  through loans, third party guarantees, direct subsidies. • Through capital injections‐generally preferred  Through capital injections generally preferred stock • Unloading ‘toxic assets’ U l di ‘ i ’ • Nationalization! • Repayment terms are eased.

Hey!! then H h I’m I’ eligible too!!!

In Bailouts we will cover… In Bailouts we will cover… • The The recent bailouts! recent bailouts! • The Swedish bailout. • The Great Depression bailout. h G i b il

So let’ss begin the story … So let begin the story … Q)When did the bailout process start? Q)When did the bailout process start? • option 1‐march 20,2008 • Option 2‐september 20,2008 O i 2 b 20 2008 • Option 3‐september 15,2008 • Option 4‐Don’t know, you tell!

WARNING(!) SIGNALS: It all begin with the credit crunch when people started defaulting in 2007 It all begin with the credit crunch when people started defaulting in 2007. APRIL 2007‐NEW CENTURY FINANCIALS, specialists in sub‐prime mortgages files for protection  under chapter 11 JULY 2007‐ Federal Reserve chairman Ben Bernanke follows the news with a warning that the  US sub‐prime crisis could cost up to $100bn (£50bn).

THE SCALE OF CRISIS EMERGES :  AUG 2007 ‐>Problems with BNP PARIBAS EMERGES… ‐>Problems with BNP PARIBAS EMERGES ‐>THE EU CENTRAL BANK starts pumping…(POURS IN $65 BN) ‐>FED CUTS INTEREST RATES (TO 5.75 %) THE BANK RUN: NORTHEN ROCK—ROCKED BY DEPOSITORS! B O E COMES TO RESCUE B.O.E COMES TO RESCUE. FED AGAIN CUTS INTEREST RATES( to 4.75 %)

• MAJOR LOSSES BEGIN TO EMERGE: (BY UBS, CITIGROUP, ML) OCT  2007 • GOVT.  AND FED START HELPING  NOV‐DEC 2007 • AND THE RATINGS FALL!!! (S&P’S AND MOODY’S)  JAN 2008 • WB  WB FORECASTS

SLOW ECONOMIC GROWTH FOR 2008

• G7 LEADERS PREDICT HUGE LOSSES

($400 BN)  FEB‐MARCH 2008

• MORE IMF PREDICTIONS—MORE B.O.E. HELP APRIL‐MAY 2008 • CREDIT CRUNCH DEEPENS  JUNE 2008 • STOCK MARKETS DECLINES JULY STOCK MARKETS DECLINES JULY‐AUG AUG 2008 2008

And the race begins… And the race begins… • • • • •

Bear Stearns. Bear Stearns Then Freddie Mac and Fannie Mae Then Lehman brothers‐not rescued! h h b h d! Then AIG! Llyods TSB takes over HBOS

THE FIGHTBACK:

‐>The Emergency  economic  stabilization  Act 2008 Act,2008 ‐>TARP

Program

Troubled ASSET RELIEF PROGRAM Invested

Description

American International  Group 

$69.8 billion

$70 billion in preferred  shares were converted to  so‐called so called non non‐cumulative cumulative  shares that more closely  resemble common stock. 

Asset Guarantee Program Citigroup  Bank of America 

$5 billion $5 billion  $0 

Funds set aside to backstop  potential losses to  government from Citigroup  and Bank of America loans.

Auto Supplier Support  Program GM Supplier  Chrysler Chrysler 

$80 billion

Program to help stabilize  auto suppliers suffering  from risk

Capital Purchase Program  $204.7 billion BOA,JP MORGAN  , , CH.,CITI,GOLDMAN  SACHS,MORGAN STANLEY…

DIRECT CAPITAL INJECTION

TOTAL AMT. COMMITED ‐ $700 Bn.     INVESTED(TILL DATE)‐$403.6 Bn Source: CNNMoney.com

LETS GO AROUND THE WORLD LETS GO AROUND THE WORLD

CENTRAL BANK

DATE

RATE REDUCED

NEW RATE

FEDRERAL RESERVE

Aug 2007 Sept 07 Jan 2008 SEPT 2008 SEPT 2008 NOV 08

Half pp 1 pp 1.25  pp 2 00 PP 2.00 PP .5% PP

5.75% 4.75% 3.50% 1 5% 1.5% 1%

Sept 2008 NOV 08

1.5 pp .5 PP

3.75% 3.25 %

Dec 2007 Feb 2008 A il 08 April 08 SEPT 2008 NOV 2008

1 pp .25 pp .25 pp 25 .5 PP 1.5 PP

5.5% 5.25% 5 0% 5.0% 4.5 % 3.00 %

ECB

BANK OF ENGLAND

The same story everywhere… The same story everywhere…

•

Lloyds TSB announces it is to take over Britain's biggest mortgage lender  HBOS in a £12bn deal  European banking and insurance giant Fortis is partly nationalized In Britain, the mortgage lender Bradford & Bingley is nationalized Icelandic government takes control of the country's third‐largest  g y g bank, Glitnir Dexia, EU bank—bailed out Irish govt. guarantees all bank deposit for 2 years Irish govt. guarantees all bank deposit for 2 years Germany announces a 50bn euro plan to save one of the country's biggest  banks The UK government announces details of a rescue package for the The UK government announces details of a rescue package for the  banking system worth at least $88bn+$350bn short term funding China sets out a two‐year $586bn economic stimulus package

•

REF: news.bbc.co.uk

• • • • • • • •

NEXT VICTIM: AUTO INDUSTRY NEXT VICTIM: AUTO INDUSTRY • President President George W Bush says the US  George W Bush says the US government will use up to $17.4bn of the  $700bn meant for the banking sector to help $700bn meant for the banking sector to help  the Big Three US carmakers, General  Motors Ford and Chrysler Motors, Ford and Chrysler.  • The US Treasury unveils a $6bn bail‐out for  GMAC the car loan arm of General Motors GMAC, the car‐loan arm of General Motors. 

FATA POSTER,NIKLA OBAMA! FATA POSTER,NIKLA OBAMA! • Barack Barack Obama describes A Obama describes AMERICA'S economy  economy as "very sick" and says that the situation is  worsening.  worsening • US President Barack Obama signs his $787bn  (£548bn) economic stimulus plan into law (£548bn) economic stimulus plan into law • Says that 80% of the spending will take place  within 18 months. i hi 18 h

being jobless … being jobless  • Official Official figures show the US jobless rate rose  figures show the US jobless rate rose to 7.2% in December, the highest in 16 years.  The figures also indicate that more US workers  lost jobs in 2008 than in any year since World  War II.  • The International Labor Organization said that  as many as 51 million jobs worldwide could be  l lost this year because of the global economic  hi b f h l b l i crisis. 

Swedish banking rescue What happened in Sweden

What happened in America

• Happened in 1990‐1993 • Similar things: housing  Similar things: housing bubbles, loan defaults  • banks going bust • Govt. comes in with 64  billion knurs • Banks nationalized Banks nationalized • Money paid back‐re‐ privatisation

• Same tenure‐3 yrs • Similar things: house price  Similar things: house price escalating, foreclosures. • Banks going bust • Govt. comes up with %700  Bn • Capital infused, bailouts Capital infused bailouts • Still blocked!

The Great Depression(1930‐41) The Great Depression(1930 41) rescue rescue THE OLD ONE THE OLD ONE • Tenure‐almost 10 years • Started after huge boom Started after huge boom • Banks closed in thousands • Unemployment rate‐25% • Govt. comes in to rescue • No major support from  central bankers t lb k • Ultimately recovers with  WW‐2

THE NEW ONE! THE NEW ONE! • Not likely to exceed like that • Ditto. • 123 failed  till date • Around 7‐8 % • Govt. Again! • Full support from all central  b k banks • Still recovering!(…get well  soo ☺) soon☺)

What are the lessons we learnt? What are the lessons we learnt? • For the term investor F th t i t • For the short term investor F h h i • Life altering changes don’t happen overnight (for  f l h d ’ h h (f decades in most cases) • Hold on to your wallets every time you hear – This time its different! This time its different!