Friday, January 23, 2009


The ripple effects of global credit crisis has hit the world economy hard triggering global credit recession. As the world enters what many see as the worst economic crisis since The Great Depression, several factors begin to interfere with our daily life.

Before understanding the genesis of the recession let us basically know what is recession......


The downturn of economic activities or a constant fall in demand is termed as recession. As observed the trade cycle boom precedes recession and depression and ultiamately recovery succeds recession.


The Great Depression of 1929 was a worldwide economic depression that lasted approximately 10 years. On October 24, 1929, “Black Thursday” 12.9 million shares of stock were sold in one day, triple the normal amount prices .This great depression ended under the supervision of U.S President Franklin.D.Roosevelt.


To understand the genesis of the current financial meltdown we need to start with the U.S housing market, a $22.5 trillion major economic driver larger in size than US stock market. Ratio of home prices to household incomes were at an all time high and appeared unsustainable as the home prices increased by nearly 85% overall with a per year compound rate of 12% between 2000 and 2005.

The idea that the housing prices would only appreciate caused US banks and mortgage companies to loosen their credit standards and start lending to families with no credit history and only tenous ability to service their mortgage. SUBPRIME lending , which in the us context meant lending to credit histories, grew rapidly during he housing bubble.

The first death knell for sub-prime mortgage holders was the increase in oil and commodity prices, which pushed up inflation and the all important interest rates. Unable to meet the higher payments, sub-prime borrowers began defaulting on their mortgages in large numbers. In various cases home owners walked away from the debt, ultimately resulting in sub-prime crisis.

Though this type of situation was encountered in the past, what makes the current crisis unique is its severity and global reach.


It took nearly a year of falling home prices and subsequent mortgage defaults to leak into larger economy. $56 billion 'New Century Financial Corporation', one of the largest sub-prime lenders was one of the first banks to fall. Two investment banks, 'Bear Sterns' and 'Lehman Brothers' filed for bankruptcy. After the 158-year old Lehman Brothers failed, the floodgates opened for insolvencies. Most of the investment banks failed as unlike retail banks, they typically do not have capital. When the news spread that banks were in financial difficulties, the loss of confidence caused a run on several institutions, and mainly banks in Europe and USA became insolvent. Not surprisingly the US markets began a long and unchecked downward slide, eventually loosing 40% of its value.


Due to the sub-prime crisis, property prices have appreciated much more rapidly. India has opportunity to learn from America’s mistakes. With the whole American industry in recession it is likely that India's export may take a downward trend affecting the manufacturing sector thus resulting in loss of jobs. We are already feeling the pinch. Many IT professionals may also lose their jobs. The government of India with the assistance of RBI has taken measures to combat the recession effects in India, by cutting CRR rate, repo rate and interest rates.

For India to be unperturbed by the recession, a well functioning disclosure and regulatory environment, an infrastructure that supports clear communication to the investors and high quality audits are to be followed by India thus leading itself on the path of growth and making itself an economic superpower.

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