Column : Is the crisis over?

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: The crisis, which started sometime in August 2007, has deepened rather than abetted. In September this year when Lehman Brothers went bankrupt, a fault line was crossed, beyond which there is great uncertainty. Banks are seriously dysfunctional as they are not sure whom they can lend to since every other bank’s leverage position is precarious. There is still a lot of bad debt around in the G-7 banking systems. Hank Paulson has now done a turnaround on the issue of toxic assets. How a Treasury Secretary could go to the Congress, utter dire warnings of what would happen if he was not given $700 billion, and then weeks later turn around and say he would not use the money for the purpose for which it was granted is beyond me. How did this man run Goldman Sachs?

Of course, the problem is that no one is quite sure of the variety of financial products still out there whose nominal values are in free fall, and whose settlement is still not being done. In the field of default swaps alone, the sum is in trillions, and although a large part of the gross debt can be cancelled out against parallel claims and the net exposure is small, no one is willing to get into bilateral settlement of mutual claims. The variety and amounts of toxic assets will now be left to banks to sort out since Paulson has decided to pass money on to banks rather than try and get into a price revelation exercise himself.

If you are lost by all this, don’t worry. Most people even in policy-making positions are swimming in half ignorance and trying out anything that might work. One view is that this is not a breakdown in the system but a breakdown of the system. Banks have stopped behaving like banks. Their capital positions are too weak relative to their liabilities, and in many cases they themselves are not yet fully sure of how big their liabilities are. Since everyone was behaving as if the easy money position would last forever, and they had convinced themselves that their new sophisticated financial instruments had practically eliminated risk, they did not realise that they were behaving imprudently. As Keynes once said, it is easier to fail all together than to stand out from the crowd and chart your own success or failure.