Instead of asking around where to invest, the current situation, in which there are so many unknown unknowns, calls for letting your money rest in the bank

As the crisis in the world markets deepen, readers? mails asking for what to do with the money has increased. My sense is, having a job, an income, and some surplus money on hand is itself a big blessing in these times. As large institutions fail in the West, it is the smaller economies like ours that remain steady. Our integration into the global system has not been complete, and that is the reason for such seclusion ? no other grand merit. Instead of asking around what to do, such dramatically negative situations call for restraint from action. My take would be to simply keep quiet, and leave the money in the bank. There are so many unknowns now that it is tough to even speculate what will happen next and how long it would be before calm prevails. Doomsday prophets would call this the next great depression, and optimists will look for a revival in the next quarter. All that we know at this time is that 2009 would be a recessionary year for the developed countries. We cannot speak of revival when recession has not even begun to play out.

More liquidity needed
The coordinated action of central banks across the world, to reduce interest rates, at least points to one thing. The interest rate cycle has perhaps peaked. In our case, the short-term markets are crying for liquidity, as dollars move out and liquidity dries up. We don?t have a crisis on hand, but the 50 basis points CRR cut is too little. We need more sops for NRIs, given the current account deficit situation, and we need bigger rate cuts to keep business confidence high. The case for tight money policy has weakened since the last policy review and all eyes are on the review for October 24th or an earlier rate action, given the domestic liquidity situation.

Risk disguised, not distributed
After the column on September 29 about the global crisis, many have written asking me to pinpoint just the one thing that was at the root of the crisis. Beyond low interest rates, bubbles and growth in derivatives, was there a wrong assumption somewhere? I think the answer to that question would be in the way home loans were structured. Financial markets look at various ways in which liquidity can be created. This is because, in the market there is no situation of zero risk, only there are unknowns. The best way to deal with the unknown is to be able to sell off when the risk increases. It is on this basis that secondary markets get created. When a home loan is made, it is well known that the asset is not liquid. Therefore, restructuring and selling off the loan to many people will distribute the risks, but this will always be limited by the fact that the underlying asset is illiquid, and does not generate any income on its own. Therefore, when it falls in value, it promptly loses liquidity, and all the risks simply come together. We need fresh thinking on the risks in the home loan market, and whether the securitisation of the home loan disguises these risks.

Over-extended developers
Another popular question this season is about the real estate markets in India. Is there a bubble? There is an important difference here. To some extent the original borrowers seem to have extended themselves, and are unable to pay EMIs. But it is the builders who seem to have extended themselves so much more in this season. They are in the process of moving from informal to formal markets, and in the lure of easily available equity and debt, have extended themselves beyond their abilities to deliver. The drop in property prices is likely to hurt them more than the buyers. If the fall in realty stocks and the desperate rates at which they are borrowing in the market are an indication, they need to concede a fall in prices or sell out, to be able to stay afloat.

Illiquid small caps
Anand Kumar wanted to know if he should invest in small caps or large caps. He believes that small caps will gain in value quickly if the market revives. In a panic-striken market like the current one, all stocks will lose, and if money were to come in, it would be in safer bets which large caps represent, not the small caps. Flight to safety is what investors seek in markets like these, and small caps may not be the right place to seek that.