Column : We the greedy people

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: insured by insurance companies, accompanied by put options on the issuers who were also rated AAA.

Regulators were so focused on the risk of institutional failure that they did not develop risk models to examine the likelihood of systemic failure if all these instruments were impaired by sudden mortgage defaults. When Ben Bernanke was asked at a Congressional hearing in September 2007 what he thought the absolute maximum impact on the US financial system might be, he said “at the most I’d say $150 billion”. He was only out by a multiple of nine or ten! The recent underpinning of illiquid American securitised assets by the US Treasury and Federal Reserve has resulted in the (temporary) nationalisation of a large part of the American financial system.

It is possible, even likely, that the next bubble which causes yet another financial crisis, will be blown by the fiscal excesses of developed countries like the US, UK and Italy (not to mention India). Hooked on debt-fuelled domestic consumption, which is politically difficult to reign in, these governments have lost sight of the fact that they need to restore macroeconomic balance by curtailing consumption, reducing public expenditure, increasing savings and investment, especially in physical infrastructure reconstruction. They are forgetting everything they preached for decades to developing countries like India through the auspices of the IMF and World Bank. Being developed does not provide a blanket exemption from the need to adjust with painful contractions when a country has overindulged in public and private excess for far too long. And too many OECD economies pandering to their populations with cradle-to-grave welfare states have done exactly that. Their adjustment will exact a toll on the world economy. The longer it is delayed, the larger and more painful it will be.

But, coming back to our present crisis, as long as everyone was making money everything was fine. And everyone did make money for a long time, including the defaulting mortgagers. In India too when stock markets and property prices are spiralling upwards, everyone thinks that is fine.