THE WORST-EVER financial crisis faced by the United States was the great depression that ravaged the world economy in 1930 which started with the stock market crash at the end of 1929.
ARE COMPARISONS WITH THE GREAT DEPRESSION JUSTIFIED?
The real comparison now is with the financial crisis that preceded the Great Depression, centred on the stock market collapse of 1929. At that time inspite of a 36% fall in the share index, all the Wall Street merchant banks made it through
the Great Depression.
This time, all five Wall Street behemoths have either -
Failed (Lehman Brothers),
Been taken over at bargain-basement prices (Bear Stearns, Merrill Lynch),
Have sought to change their status to that of commercial banks before they failed (Morgan Stanley and Goldman Sachs).
And the expected economic downturn has only begun. So the financial crisis is much worse than in 1929.
The global financial crisis of 2008–2009 began in July 2007 when a loss of confidence by investors in the value of securitized mortgages in the United States resulted in a liquidity crisis that prompted a substantial injection of capital into financial markets by the United States Federal Reserve, Bank of England and the European Central Bank.
With the financial meltdown continuing unabated, US has already seen the collapse of 16 banks in the last few months -- which is more than one-fourth the total number of failures in the last nine years. With ten bank collapses in February, a total of 68 banks have failed since 2000 in the US.
Moreover, 16 bank failures this year is more than half of the total collapses in 2008. Last year, a whopping 25 banks went belly up, mainly after the financial crisis turned severe with the bankruptcy
WHAT CAUSED THE CRISIS?
The immediate cause was the collapse in American house prices, which had doubled between January 2000 and August 2006, and have since fallen by 20%. More than 1% of American households have defaulted on their mortgages.
Up to a quarter of mortgages were "subprime” and financed by the issuing of "residential mortgage-backed securities" rather than by traditional bank loans. The bonds were then sold to investors, pension funds and councils all over the world. Those buyers have since lost not just their anticipated interest but also much of their principal.
EXAMPLE:
Let us suppose MR X is a fresh 23yrs. and has just passed his CA final examinations. He got a job in a company on a pay roll of Rs100, 000 per month. Few months latter he started thinking himself well settled and thought to get married. He got himself married. As usual after marriage the liabilities of his balance sheet increased. But he was expecting that he will manage it soon.
The Booming Years
One day, his boss calls him into his office and tells him that they are going through a business deal which will get them massive amount of profits, and he will receive 50% increment on his yearly salary. That is, instead of receiving 100,000 that month, he will now get 150,000 every month.
He was really excited about this news as he knew that he will be able to manage all the new expenses of his wife. Since the Boss assured that the deal will go through, he goes to the local bank and takes a loan of 50,000. He plans that as soon as he will get the increment he will pay back the loan. he walks back to his home, and tells the news to everyone. Since he already has the cash in hand, he gives the proportional extra allowance to his wife and his mom.
Now this small economy of 2 people has extra cash flow (which technically nobody is sure of), and people are ready to spend. He goes and buys a new car he wanted and some necklaces for his wife.
Months pass by, but there is no sign of deal going through. And soon a year passes by. The family has done large amount of expenditures, all perfectly economically calculated, adjusted for the 150,000 salary.
Since his boss ensures that the deal will pass through and he will get his deserved increment, he goes to another bank and takes another loan for 50,000. Now the total loan on the family is 100,000 + Interest from the first loan.
The family consistently gets another extra 50,000 this month. So everything continues the way it is. Another year passes by, and now he is worried about the financial liquidity of the family. The bank which gave his dad the first loan got in touch with him and somehow he convinced them that he will be able to pay their loan back to them.
The Bust
Now at the end of 3rd month, when he got his salary of 100,000, he needs 50,000 immediately to adjust the family budget, but now his Credit history has gone so bad that he cannot get any more loans from any bank. So he is now only able to allocate the increased ventures like he was not being able to pay the installment of his car, etc.
The Meltdown
And just when they thought that they have faced all the problems, they seem to be just started. The banks, from which he took loan, are now knocking on their doors demanding their money back. Now the had two possible solutions.
1) Cut back all the excess expenditures, sell his car, mortgage the house they live in, for Loan, return all the previous loans, and slowly buy their house back over the years.
2) Go to the local Mafia boss/Loan Shark who does not need credit checks, take 50,000 loans from them and continue on their life and hope that they will pay the loan back once their life goes back to normal. This way the can enjoy their increased ventures. He terms it as the “Bailout Plan”.
His argument:
We cannot go to the local Mafia boss for loan, there is no way we will be able to pay that much amount of loan with our current expenditures. We must go for the first plan. If we choose the “Bailout option” we will not be solving the problem but only postponing it to eventually come back at us at even bigger level.
His wife arguments
You gotta bail us out. We need more liquidity. I have to pay my installments. If you don’t pay me, I will have no social life ever, We will become the most unpopular surely you don’t want that, do you?
Well here the story ends.
Now let me explain you who is what in real world. MR. X is the Government. His Boss is Federal Reserve. His wife is the Market.
So what really happened?
The Federal Reserve inflated the money supply believing that it will result in more economic growth. It does not. So all that extra money resulted in massive economic malinvestment. When all that investment eventually failed to balance the books all hell broke lose.
Now the only solution is to let these companies fail and let’s start from scratch, but as you might know what has happened, that govt has taken EVEN MORE loan, they are going to sustain all those malinvestment by pumping even more money in the economy.
It’s like solving the problem by overdoing the cause of the problem.
Impact of global economic meltdown on India:
What I think India is not greatly affected by the economic slowdown because the banking structure which India has does not provide space for such a downturn. There is no doubt that if the global economies suffer then India is also bound to suffer. But the very fact that India is a domestic consumption-and-investment-driven market where contribution of exports to the growth is not as big goes in her favor to tackle this crisis in much better way than few of the other emerging economies. The inflation rate has also reached in some what comfortable zone and thus economists believe that the government has more room now to focus on the growth rate of our economy.
The stock market crash in India is nothing but the market correction which the large investors are creating to increase their profits at the cost of small investors. The Indian employers are trying to increase the hidden reserves by taking the advantage of foreign crash. I am not saying that the Indian firms are not affected by the economic slowdown but it’s not affected to such an extent as it seems to be.
“We are going to be affected as we are not insulated by the developments taking place in the US and Europe. But, as we have a regulatory system in place, the effect of the Global Meltdown will be less severe in India,” said Prof Tandon. Our Union Finance minister has maintained that India will not be very affected by the recession but the fact remains that Indian Inc are getting hit by this slump worldwide. The stock market in the country has crashed in last few months.
