RECESSION IN UNITED STATES OF AMERICA

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WHAT IS RECESSION ?WHAT IS RECESSION ?

• In economics, the term recession describes the reduction of a country's gross domestic product (GDP) for at least two quarters.

• A Recession is a contraction phase of the business cycle.

• National Bureau of Economic Research (NBER) is the official agency in charge of declaring that the economy is in a state of recession.

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They define recession as :

“significant decline in economic activity lasting more than a few months, which is normally visible in real GDP, real

income, employment, industrial production, and wholesale-retail sales”.

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Indicators to say a nation is in recession;

- People buying less stuff - Decrease in factory production - Growing unemployment - Slump in personal income - An unhealthy stock market

HOW TO KNOW RECESSION?

What What Causes Causes

Recession ?Recession ?

What What Causes Causes

Recession ?Recession ?

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• An economy typically expands for 6-10 years and tends to go into a recession for about six months to 2 years.

• A recession normally takes place when consumers loose confidence in the growth of the economy and spend less.

• This leads to a decreased demand for goods and services, which in turn leads to a decrease in production, lay-offs and a sharp rise in unemployment.

• Investors spend less as they fear stocks values will fall and thus stock markets fall on negative sentiment.

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U.S ECONOMIC RECESSION HISTORY

The United States has encountered 32 cycles of expansions and contractions, with an average of 17 months of contraction and 38 months of expansion. Let’s see adetail history of economic recession in the United States -:

• Late 2000's Recession• Early 2000's Recession• 1990's Recession• 1980's Recession• 1970's Oil Crisis• Late 1960's Recession• Early 1960's Recession• Late 1950's Recession• Early 1950's Recession• Late 1940's Recession• Recession of 1945

• The Great Depression

•The Great Depression•Recession 1926•Post World War I Recession•Panic of 1907•1870's Recession•1890's Recession•Panic of 1857•Panic of 1837•Depression of 1807•Panic of 1819•Panic of 1797

• U.S.A – Consumption based Economy.• 2/3rd Economic activity i.e. GDP –

comes from consumers.• Credit - free flowing for U.S consumers

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(SUBPRIME CRISES)

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WHAT IS A SUB-PRIME LOAN? • In the US, borrowers are rated either as ‘prime’ - indicating that they have a

good credit rating based on their track record - or as ‘sub-prime’, meaning their track record in repaying loans has been below par.

Loans given to sub-prime borrowers, something banks would normally be reluctant to do, are categorized as sub-prime loans. Typically, it is the poor and the young who form the bulk of sub-prime borrowers

What Was The Interest Rate On Sub-prime Loans?

Since the risk of default on such loans was higher, the interest rate charged on sub-prime loans was typically about two percentage points higher than the interest on prime loans. This, of course, only added to the risk of sub-prime borrowers defaulting.

The repayment capacity of sub-prime borrowers was in any case doubtful. The higher interest rate additionally meant substantially higher EMIs than for prime borrowers, further raising the risk of default.

 

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WHY LOANS WERE GIVEN?

In roughly five years leading up to 2007, many banks started giving loans to sub-prime borrowers, typically through subsidiaries.

They did so because they believed that the real estate boom, which had more than doubled home prices in the US since 1997, would allow even people with dodgy credit backgrounds to repay on the loans they were taking to buy or build homes.

Government also encouraged lenders to lend to sub-prime borrowers, arguing that this would help even the poor and young to buy houses.

  With stock markets booming and the system flush with liquidity, many

big fund investors like hedge funds and mutual funds saw sub-prime loan portfolios as attractive investment opportunities. Hence, they bought such portfolios from the original lenders. This in turn meant the lenders had fresh funds to lend. The subprime loan market thus became a fast growing segment.

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HOW DID THIS TURN INTO A CRISIS?

The housing boom in the US started petering out in 2007. One major reason was that the boom had led to a massive increase in the supply of housing. Thus house prices started falling. This increased the default rate among subprime borrowers, many of whom were no longer able or willing to pay through their nose to buy a house that was declining in value.

Since in home loans in the US, the collateral is typically the home being bought, this increased the supply of houses for sale while lowering the demand, thereby lowering prices even further and setting off a vicious cycle.

That this coincided with a slowdown in the US economy only made matters worse. Estimates are that US housing prices have dropped by almost 50% from their peak in 2006 in some cases. The declining value of the collateral means that lenders are left with less than the value of their loans and hence have to book losses.

Result

Overconsumption/ Extravagant

spending by the consumer

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for years the prices of homes in the U.S. kept rising.for years the prices of homes in the U.S. kept rising.

For years prices of homes in US kept

rising

for years the prices of homes in the U.S. kept rising.for years the prices of homes in the U.S. kept rising.for years the prices of homes in the U.S. kept rising.

Thus

• Felt a need to Preserve capital. Therefore Started tightening credit , Started restricting lending to the U.S consumer and businesses.

• Since then Loans became difficult to come by banks, Bank cut Credit card limits.

• U.S. consumer significantly reduce spending.

Dollar value Declined Stock market crashed

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• In early July, depositors at Los Angeles offices of Indy Mac Bank lined up in the street to withdraw their money.

On July 11,Indy Mac - the largest mortgage lender in the US - was seized by federal regulators.

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• During the weekend of September 14-15, Lehman Brothers declared bankruptcy after failing to find buyers.

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HOW DID THE CRISIS BUILD UP?

An investment bank uses its proprietary book (own money) to lend others and invest. It started with the subprime crisis. Banks like Lehman, buy mortgage loans from other banks, and then package them to sell bonds against the loan pool. Often they add cash to make the loan pool more attractive, so that the bonds can be sold at a higher price.

  Suppose mortgage was earning 6%, these bonds are sold at 4%. The

difference is the spread which the investment bank earns. By selling these structured bonds, it raises money and frees capital. But when homebuyers started defaulting, these bonds lost their value. It all began like this, and then the virus spreads across markets.

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• Bank of America agreed to purchase Merrill Lynch, & consortium of 10 banks created an emergency fund of at least $70 billion to deal with the effects of Lehman's closure.

• Another bank failure occurred on September 25 when JP Morgan Chase agreed to purchase the banking assets of Washington Mutual

LIST OF BANKRUPT AIRLINES

• Dec 26, 2007 - Maxjet Airways files

• March 31, 2008 - Aloha Airlines files and discontinues passenger transporting operations

• April 03, 2008 - ATA Airlines files and discontinues operations

• April 05, 2008 - Sky bus Airlines files and discontinues operations

• April 10, 2008 - Frontier Airlines files

• April 26, 2008 - Eos Airlines files and discontinues operations

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IMPACT OF US RECESSION ON INDIAN ECONOMY

A slowdown in the US economy is bad news for India.

• Indian companies have major outsourcing deals from the US. India's exports to the US have also grown substantially over the years. The India economy is likely to lose between 1 to 2 percentage points in GDP growth in the next fiscal year. Indian companies with big tickets deals in the US would see their profit margins shrinking.

• The worries for exporters will grow as rupee strengthens further against the dollar. But experts note that the long-term prospects for India are stable. A weak dollar could bring more foreign money to Indian markets. Oil may get cheaper brining down inflation. A recession could bring down oil prices to $70.

• Between January 2001 and December 2002, the Dow Jones Industrial Average went down by 22.7 per cent, while the Sensex fell by 14.6 per cent. If the fall from the record highs reached is taken, the DJIA was down 30 per cent in December 2002 from the highs it hit in January 2000. In contrast, the Sensex was down 45 per cent.

• The whole of Asia would be hit by a recession as it depends on the US economy. Asia is yet to totally decouple itself (or be independent) from the rest of the world, say experts.

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• Most people have sold the shares.• Foreign investors have pulled out from stock

market.• Stock broking houses are laying-off people.• People have started saving money.

SHARE MARKET

• Government and other private companies are reluctant in starting new ventures and starting new projects.

• Car, bike & truck sales down.

• Steel plants also started cutting production.

• Hospitality and airlines are hit by poor demand.22

INDUSTRIAL SECTOR

• Companies in the private sector and government sector are hesitant to take up new projects. And they are working on existing projects only.

• Projections indicate that up to one crore persons could lose their jobs in the correct fiscal ending March.{as given by Federation of Indian Export Organisations (FIEO)}

• The textile, garment and handicraft industry are worse effected. Together, they are going to lose four million jobs by April 2009, according to the FIEO survey

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BANKING SECTOR

• Indian banks are facing through a tough time of liquidity crunch. Lehman Brothers had invested a great amount in the stocks of Indian banks that have invested in derivatives.

• A sudden fall in the economy directly affected Lehman and Merill, eventually forcing them to file a bankruptcy.

• Falling down of Lehman had a great impact on the leading international bank, ICICI Bank, a bank that had invested in Lehman’s bonds.

• The interest rates have drastically increased from 11.5% to nearly about 16%.

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AGRICULTURE(NO EFFECT)

• No major on impact on Indian agriculture

• Negligible foreign investment

• Normal and distributed rainfall in 2008

• Production increased from 231-234 million tonnes (07-08)

Government has 2 plans

Fiscal Policies(By Govt.)

Monetary Policies(By RBI)

How it spends and collects money

Supply of money in the country

How to come out of recession?

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MONETARY POLICY

• Fed will maintain historic low target for key interest rate before raising it toward the end of 2009.

• Inflation will be relatively low over the year, and core inflation will slow.

• Central bank is widely expected to pursue financial lending andmonetary stimulus initiatives.

•Federal Reserve's most-recent decision on March 11, 2008 to increase liquidity via the launch of its new, $200 billion Term Securities Lending Facility for 28-day loans for primary dealers

•Mr Obama has emphasised the need for a “green recovery” – one based on sustainable technologies, not merely on consumption spending.

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IS RECESSION OVER IN US ECONOMY ? 

• Unemployment stood at 9.8 per cent in September 2009, the highest rate in 28 years, and is widely expected to reach 10 per cent in 2010.

• Consumer spending, which accounts for about two-thirds of the US economy, jumped 3.4 per cent.

• US stocks jumped more than 0.5 per cent in opening trading on Wall Street.

• President Barack Obama said, the 19-month US recession had reached the “BEGINNING OF THE END” 

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