Every crisis (financial or otherwise) generates more confusion than clarity; more heat than light. When financial in nature, it induces proselytising about moral hazard and more retrospection than insight. It triggers a torrent of comment, but few pearls of genuine wisdom. Only after the fog of crisis has cleared do we understand what happened, how and why. This crisis is no different. Those who are quite rightly incensed about the ?privatisation of profit and the socialisation of cost? are having a field day. But, such knee-jerk reactions offer little by way of either insight or remedy.
To many, this crisis marks the end of market capitalism, investment banks, excess leverage, etc. To the French, it signals the demise of Anglo-Saxonism, which they suspected all along. To anti-Americans, like the Indian Left, it shows up the chimera of American market liberalism. What this crisis actually marks is the end of yet another period of egregious excess, of serial asset bubbles being blown since 2000 in technology-stocks, property, emerging markets, and commodities. It is not that new.
Between 1980 and 2000, similar bubbles were blown by developing country governments first in Latin America and Africa, then in Asia and Eastern Europe. These governments were unmindful of their fiscal excesses (like India is now) yet financed by bankers like Walt Wriston of Citibank who asserted that countries could never go bankrupt.
The ongoing crisis was encouraged, if not instigated, by loose-money federal regulators in the US whose state-level cohorts, for the third time in the last half-century, forgot how to monitor the simplest financial contract: i.e. the home loan mortgage. To be sure, this crisis will curb some peculiar tendencies; but it is not the end of financial history as we know it. It is merely the end of another chapter in a book on human greed and folly whose ending will never be written.
Successive new millennium bubbles?the cause of this crisis?were blown too large for too long by under-capitalisation, excessive leverage, and excessive risk-taking with other people?s money. Operators, regulators and sophisticated institutional buyers were blinded by the quantitative complexity of securitisation. These bundles became complex. It was hard to assess what they contained, how creditworthy they were, what their true value was, or what prices they should be traded at. That problem was ?resolved? by rating agencies who rated AAA these collateralised debt obligations (CDOs), risk-hedged by credit default swaps (CDS), and 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.
Alan Greenspan thought that opaque securitisation, resulting in capital markets being able to finance mortgages for NINJAs (people with no income, no jobs and no assets), was a terrific demonstration of financial inclusion. That phrase is resonating fervently in India right now with our own NINJAs as elections loom. It will bite back with a vengeance when the inevitable write-offs?of ?too much inclusion too soon??have to be made a few years down the line. Obviously our five-yearly write offs of huge amounts of rural credit made through the politically driven state-owned banking system have not taught us very much!
But it is so much more satisfying to blame greedy bankers, bonuses, incompetent regulators, and inert derivatives (rather than the foolishness of people who hid behind them) for this mess by overlooking our own greed and thirst for instant profit-making. What about those who signed on to mortgages they knew they could not service? Is anyone blaming them? Or are they poor victims of rapacious bankers as well?
The author is an economist and corporate finance expert. He chaired the committee that laid out the roadmap for making Mumbai an international financial centre