What just happened??

[A layman’s view to understanding the present US Financial Crisis]

 

Before we get into the events, it is important to understand certain basic terminology and mechanisms.

Mortgage backed securities – Banks have two primary functions. Accept deposit and lend loans. When a borrower approaches a bank for a loan, the bank (after due diligence of the creditworthiness of the borrower) lends him money from the funds it has accepted as deposits. The bank charges a rate of interest for the time the borrower takes to repay the loan.

Given this simple mechanism, the bank may face a problem when the market rate of interest fluctuates or when it may run out of funds for further lending at a certain point. 

In order to solve these problems the concept of mortgage backed securities was introduced. In this system, the bank issues bonds against the loan and sells it to investors at a rate of interest that is equal to the interest payable by the borrower on the loans.

For e.g, say X borrows $1,000 for a home loan at 8% interest p.a from Bank of America. The bank may sell 100 bonds worth $10 each to an investor promising an interest of 8% on the amount. This way the interest payable and receivable are cancelled out by the borrower and the investor. So basically whatever the borrower pays as interest goes to the investor as his return on investment. The problem arises when X defaults his interest payment.

Subprime lending crisis – Check out my earlier post, Crash, boom, bang!

Credit crunch – A situation in which there is a sudden reduction in the availability of loans or increase in the cost of lending by banks and financial institutions. This is usually caused when banks and institutions have suffered losses in lending and have bad debts.

Bankruptcy – A legally declared inability or impairment of ability of an individual or organization to pay their creditors. This is also known as Chapter 13 in financial circles.

Bailout – A situation where a bankrupt or nearly bankrupt entity, such as a corporation or a bank, is given a fresh injection of liquidity, in order to meet its short term obligations. Often bailouts are by governments, or by consortia of investors who demand control over the entity as the price for injecting funds. 

Housing Bubble – Is a type of economic bubble that occurs periodically in local or global real estate markets. It is characterized by rapid increases in valuations of real property until they reach unsustainable levels relative to incomes and other economic elements.

Foreclosure – Is the legal proceeding in which a mortgagee, or other lienholder, usually a lender, obtains a court ordered termination of a mortgagor’s equitable right of redemption.

 

So… what just happened?

7th September 2008 – Fannie Mae and Freddie Mac takeover

Fannie and Freddie are two very large mortgage companies that are sponsored (but not run) by the Federal Government. Their primary business is to guarantee the mortgage bonds to the investor in case payments are missed by borrowers. They also create a fund(as in insurance) to make up for losses in cases of default. This fund is created by taking a certain percentage of the payments or from sale of the house.

Since Fannie and Freddie, the Government backed institutions provided guarantee, the mortgage securities industry flourished.

When the subprime crisis started in 2007, all the defaults, bad credits and foreclosures largely affected Fannie/Freddie’s business. The two have more than $5 trillion in outstanding mortgage backed securities. The share prices hit rock bottom.

The Government had no option left but to take over the two companies and infuse money from the treasury to clean up the mess.

14th September 2008 – Bank of America acquired Merrill Lynch

ML is a large investment banking and financial firm that incurred billions (app. $51billion) in losses due to investing in mortgage backed securities that went bad during the subprime crisis. The company was recently acquired by its rival, Bank of America.

15th September 2008 – Lehman Brothers bankruptcy

Lehman Brothers is a 158 year old global financial services and investment banking company. It had ventured into mortgage backed securities and during the subprime crisis, one of its firms was closed. The company lost huge sums in the form of goodwill and its share prices tumbled. Neither Bank of America nor Barclays who were called for deals to buy the Lehman, made a bid. The Government also refused to bailout the company from bankruptcy.

16th September 2008 – AIG bailed out

AIG, the largest insurance company in the world is being bailed out by the Government. The problem is the same; loss due to subprime crisis resulting in bankruptcy. AIG’s main line of business is insurance services but the company had diversified and entered other areas including mortgage backed securities.

The Government decided to bailout AIG due to its enormous funds (trillions), public stake, global ties across industries.

 17th September 2008 – WaMu Auction

Washington Mutual or WaMu is a former mutual fund company which later became the third largest mortgage lender. In 2007, the company suffered huge losses in its home loan divisions due to the subprime crisis which resulted in layoffs and affected stock prices. Now the company has hired Goldman Sachs to take care of its auction.

 

Why this happened?

As you would have noticed by now, the answer to the ‘why’ is quite clearly the subprime crisis. Let us drill down further.

In the early years of this decade, in order to remove the sluggish nature of the economy, the Federal Reserve lowered the mortgage interest rates. This resulted in a trend of rising housing prices. Unlike traditional loan diligence, the borrowers were given loans without looking at their creditworthiness. Instead, people who were lower on their creditworthiness rating were charged a higher rate of mortgage interest. Because of the housing bubble and the high demand for loans, banks and financial companies didn’t waste their chance to make a quick profit out of the situation. Loans were endlessly given out. Very high rates were charged. These loans were in turn sold as mortgage backed securities to investors. This business picked up across companies in the financial industry and everything seemed to go well until the bubble burst.

When the interest rates reached a level where it was too high to afford by many borrowers, lot of the loans went bad. This in turn had an impact on the investments in mortgage backed securities. The demand for Fannie and Freddie guaranteed securities decreased. Foreclosures increased, house prices plummeted, and lenders incurred huge losses unable to value assets resulting in liquidation.

A major argument and an increasing realization is that there was very less regulation imposed on the financial instruments by the Federal Reserve/ Government.

 

Who gets affected?  

The real estate crisis infected the financial markets. This led to enormous job losses and money losses. The financial institutions were unable to lend money to business that really needed it to grow. This is leading to a snowball effect and is slowly hitting every industry one by one. This, coupled with the rising and highly fluctuating gas prices is resulting in a huge economic recession instead of what was hoped to be only a slowdown in the US.

Thats not all. Most of the afore-mentioned companies operate globally. They have presence in all continents. And in this global economy, a financial meltdown in the US market is bound to have far reaching impact on world markets.

 

Solutions?

The current Wall Street crisis is touted to be the biggest since the Great Depression that hit the US economy in the 1930s. It has been a chain reaction with people across industries suffering. Though the Government has been working on immediate short term relief like the economic stimulus package, it is very obvious that the economy needs a long term sustainable solution to get out of this mess.

The 2008 Presidential Elections will certainly be one of the most important of its kind in a very long time. And the policies, ideas, determination and resolve of the next President will be the crucial factors determining this election.

references

www.wikipedia.org ; www.nytimes.com ; www.spiked-online.com  

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Ready…Aim…Shoot – with Clark Mishler

 

The time I spent researching travel to Alaska, really paid off when I came across a video by Clark Mishler on some tips and tutorials on photography.
Clark Mishler is one of the most sought after photographers in the US. He was a National Geographic photographer and his photos have been published in a whole range of books and magazines. Clark has traveled extensively and for the past 30 years he has been living in Anchorage, Alaska and exploring the beauty of the state. While searching for travel info about Alaska, I came across this exceptionally well-maintained site, http://www.alaska.org. The site is very informative, accurately updated, reliable and totally reader centric. We got every teeny bit of detail we were looking for. And my favorite part was a section called photo tips.

Alaska is a haven for nature lovers and photographers; and with all the SLRs, long-range lenses, camera gear and wear – “hunting and shooting” (pun intended) is what it is all about!

Visiting Alaska may not be a regular opportunity for people, given the distance, weather, cost and time required to spend in this beautiful state. So making maximum use of one’s photo and video cameras becomes imperative. And so, this section by Clark on photo tutorials on the website is extremely useful.

This 13 minute video called “Elements of Photography” features 20 “elements”.

According to Clark the use of these elements can really differentiate a good from a great photo. He explains each of the elements in simple words illustrating them eloquently with the help of his own photos.

I jotted down the points in a small paper and now regularly carry it in my camera bag. Not that I have to refer to it whenever I click 😉 but quickly running through it, during long journeys has been refreshing and has certainly made a difference.

The list of elements is given below. I have found that taking a look at the video is helpful in remembering their usage

1) angle of view                                          11) frames
2) use of backlight                                     12) silhouettes
3) diagonals                                               13) scale
4) motion                                                   14) negative space
5) s curves                                                 15) dark-light-Dark
6) patterns                                                 16) human element
7) selective focus                                       17) crop
8 ) contrasts                                               18) camera tilt
9) color                                                       19) rules of Thirds
10) stop Action                                           20) humor

Happy clicking!

References – www.alaska.orgwww.mishlerphotos.com

Enterprise 2.0

 

In my attempt to keep track of Web 2.0 trends, I came across a wide range of terms that have adopted the 2.0 series. There is Office 2.0, Enterprise 2.0, Blog 2.0, News 2.0, RSS 2.0, Community 2.0, and guess what, I even found a blog titled Everything 2.0; I guess that’s the easiest way to put it!
I am not sure whether all these terms are in use officially or informally, but the clear indication is that all media types have a new implication and a new meaning to their users in the Web 2.0 era.

Out of these, Enterprise 2.0 is a term that I read in a McKinsey article illustrating a survey taken on the use of Web 2.0 by enterprises to run their businesses. The term was also found documented in Wikipedia.

We know that Web 2.0 is being widely used by individual users through applications like Facebook, eBay, Wikis, and social networking sites. Enterprise 2.0 is the usage of Web 2.0 applications in a company or corporate environment. That is, when individuals in a company use applications to share knowledge, information, ideas and expertise in a way that may benefit them in a professional and intellectual level, it also enhances their functioning in the company. This in turn helps the company leverage the benefits by building a competitive workforce to achieve its goals.

Does this strike a chord somewhere? We have heard and worked on something similar in our work environment, right? Yes, Knowledge Management. A simple contrast in this context will help understand the distinctive features of Web 2.0 from 1.0. KM is a classic example of a Web 1.0 practice in a company’s internal environment. KM involves imparting company practices, industry trends, processes, knowledge and expertise. This is done in a structured manner and the employees are only at the receiving end. So it is a “read only” application.

Enterprise 2.0 would a Web 2.0 version of KM where everybody participates. It is also termed as a “social software” which has no pre-determined structure. There will be sharing by everyone from all sides, in the form of RSS, Wikis, Blogs, Networking sites, Podcasts, etc. In this case, the company’s objective would be to bring about a culture of learning. Rather than imparting or training what the company knows and believes in, it is giving a chance to its employees to share their knowledge and opinions. This way, people get more involved, there is innovative thinking, zillions of ideas are thrown up, and each day employees learn at least a thing more than what they already know. Hence the word “sharing” in this context is being replaced by the buzzword “collaborate”.

 
Like any Web 2.0 application, for this concept to work well, there has to be maximum participation by employees. As we know, it is mainly the users and not just the technology that makes sites like Linkedin, Technorati or Amazon successful. So there has to be an effort from the management to not only make the interface attractive enough, but also to get employees involved. It is not an IT department responsibility; of course, they provide the support; but the initiative has to come from all business units. It is an enormous task and the results don’t come quick. It not only involves setting up of infrastructure and latest technology but also deciding the boundaries and limits.

In this context it is worth mentioning that apart from internal applications, Web 2.0 can also help in interacting with customers, by knowing what they want, how they want it and thereby fit the marketing strategy of a company. Similarly, it can help in the operations side as well, in terms of interacting with suppliers on a regular basis to ensure overall efficiency and effectiveness.

At the end of it all, when carried out well, Enterprise 2.0 promises to develop and instill a culture of learning in the organization. In a global economy with tremendous competition, only the fittest can survive; Enterprise and Web 2.0 incorporated in an organization can help breed the fittest.