Monday, March 2, 2009

From Wall Street to Main Street(On Financial Meltdown)

The year 2008 must be remembered as watershed year in the financial history as it shattered the confident tone of financial management which has generated through the
recent successes especially from the credit bubble of post 2003-04.Since the year 1987 crash, there have been many financial upsets –the 1997 –98 Asian financial crises, failure of the hedge funds long term capital management in 1998,the puffing Of the stock bubble in 2000,and now the sub prime ‘Mortgage debacle ‘.None has turned into a full-fledged panic, So all three mishappening formed a temptation that we have got mastership over these occurring problems .
Unfortunately situation this time is much grave than initial speculation…gravity of problems recognized very late which deepens the fear of loss and insecurity among both the participant and regulators. The main reasons for the financial mess seem to be the allocation of large funds with U.S Banks and the structural products developed to pass on the risk to investors.

Through January the United State saw on average the loss of over 800 jobs every hour, or 17000 every day since the meltdown began in September ; Off course here in India, too things are shipping but the lessons remain unlearnt .Even in such gloomious atmosphere ,corporate kleptocracy kept very profoundly as Citi group spent $50million on a corporate jet. Now the disgraced CEO of Merrill Lynch, John Thain, spent $1.22million on redecorating his office in early 2008,All that was happening when he prepared to cut thousands of jobs. The amount included purchase of an antique “Commode on legs”.
Even more top bankers from wall street didn’t felt even a bit of reluctance to acquire the hefty amount of perks and bonuses until the U.S President curb such extravagant practices in present troubled phase ,he also barred the maximum compensation to $50,000.No such initiative made from the top notch professional circle except the Citi group chief Mr. Vikram Pandit who voluntary abandoned any fees for his service till the recovery of reputation of his banks .No doubt ,it is suffice to acknowledge the lacking of corporate ethics, among the professional especially who possessed top notch authority.


When wall street was run by individuals without exotic degrees from Ivy Leagues, they had proper skepticism towards fancy models and managed their risk with a great deal of humility and caution.Indeed they create conducive atmosphere for the practice of “Charuvaka Economics (From the epic MAHABHARATA)”, Which expected from people to borrow, spend and live happily without bothering of repayment of debt and not feel guilty if unable to pay it back .
In same manner, the US financial system consciously pushed sub-prime loans to put cash in the hands of gullible and not creditworthy borrowers and make them splurge at shopping malls, so that wealth shifted from Individuals to corporates; And when things fall apart it was also at the cost of the global community.All credit crises having the same origins. They are spotted in buoyant economic growth that promotes over-optimism, excessive risk taking and extreme demands on liquidity. Some of the typical cases are:-

#.1907:BANKERS PANIC-Run on U.S banks and trust companies what J P Morgan did in 1907?At quarter five on a November morning, Mr Morgan presented assembled bankers a documents telling them what they showed through the kitty to restore confidence. The bankers meekly signed, and the crises was over.

#.1909:WALL STREET CRASH-Stock prices plummet for there years following rampant speculation taking almost twenty five years – Until 1954 to regain pre 1929 value.

#.1973: OIL CRISES-Oil embargo and international withdrawal from Breton Woods agreement trigger stock crash.

#.1987:BLACK MONDAY-Panic leads to 22%drop in single day.

#.2000:DOTCOM CRASH-Teach stock bubble bursts.

#.2008:CREDIT CRUNCH-Defaulters on Sub prime mortgage leads to liquidity problems for financial institution worldwide.


#.Collateral Debt Obligations (CDO)-Late1970’s:-Mortgage were packaged together and sold to investors as CDO’s.

#.Mortgaged-Backed Security (MBS): -1983;Larry fink pioneers MBS market while leading bond department at first Boston Corporation .MBS divides package at Mortgages into different tranches of risk. Softest investment grade bonds receive interest rate while riskiest tier-so called toxic dept-is paid 2-3%higher. Investor is now induced for accepting risk, not for lending money.

#.Sub-Prime Mortgages:-In 1990’s demands for MBS results in lenders lowering interest rates and offering 100% Sub prime Mortgage to individuals with questionable ability to pay. Rising house prices protect these borrowers from defaulting.

#.Credit Default Swaps (1997):-Invented by Blythe Masters at Investment Bank J.P Morgan Chase. CD’S or credit swaps are Insurance like contracts intended to remove risk from companies balance sheets. Presently International Swap and Derivative Association regulate Swaps.

#.Shadow Banking System (Late1990’s):-Swaps now used to package everything from Mortgages ,business card, credit card debt, and even education loans are brought by unregulated speculators and hedge funds on behalf of insurance companies and pension funds worldwide value for global CDs market rose from $1trillion in 2001 to $62.1trillion in 2007 and lastly fall to $28trillion in January 2009.

#.Credit Crunch(2006):-Interest rate rises to 5.25%;Housing market begins to confront defaulter –one in five U.S borrowers falls behind on mortgage payments.

#.2007-08:-Banks worldwide suffer huge losses and stop lending despite massive bailouts by taxpayers.


Even before the Bernard Madoff’s scam may other Ponzi scam –In August 2007;the process of price discovery began a long time back when Bear Sterns declares that investment in one of its hedge funds set up to invest in mortgage tracked securities had lost all its value and there is a second such fund were valued at nine cents for every dollar of original investments. Being an interconnected institution holding assets valued at $395.4 billion dollar in November 2007 on an equity base of just $11.8billion,despite having such portfolio, its came under the severe pressure which concluded only with the life support from J.P Morgan Chase at huge loss of share prices.
Normally banking sector considered as the core of financial sector; The equity base of more banks are relatively small even when they follow Basel norms with regard to capital adequacy. Despite such allocation of trenches Banks having considerable derivative exposure.

Citi Group and Bank of New York Mellon estimated to have an exposure to the institution (Derivatives) that was placed at upward of staggering $155billion.In same manner fourth largest bank of Wall street Lehman Brothers came under the severe losses through the Derivative exposure and bad lending, ultimately came to the table with request for support, but it was refused the same. The refusal of the state sends out a strong message.
In a surprise move Bank Of America that was being spoken to as a potential buyer of Lehman Brothers was persuaded to acquire Merrill Lynch instead. But even that deal was not taken place properly and before any move from Bank of America, Black Rock acquired major arms of Merrill Lynch, consequently bringing down two of the iconic and major independent investment bank on Wall street.

In its update to the Financial Stability Report for 2008,issued on January 28,2009,the IMF has estimated the losses incurred by U.S and European Banks from bad assets that originated in the U.S at $2.2trillion.Barely two months back it had placed the figure at $1.4 trillion. So scale of severity can be easily measured since the late 1940s.U.S. has suffered to recessions, joblessness, 6.1% in September, would have to rise spectacularly to match post second world war highs .
The great depression, that followed the stock market collapse in october1929 was a different beast. By the low point in July 1932,Stock was dropped almost 90% from their peak .The accompanying devastation. Bankruptcies, foreclosures, breadlessness lasted a decade. Even in 1940s unemployment was almost 15%,it was the onset of second world war that boosted spending and bailed out the economy.

The deregulation of Banking was crucial for this transaction that was made possible by the process of deregulation that began in the 1980s and culminated in the Gramm-Leach-Billey Financial Modernization Act of 1999,which completely dismantled the regulation structure and the restriction on cross-sector activity put in place by Glass-Steagall in the 1930s.It is noteworthy that Glass-Steagalll’s own conception that there is less profitability In regulatory regime itself bounded with a deep inner contradiction in the system which set up pressure for deregulation .
Those pressure gained strength during the inflationary years in the 1970s when right monetary policies pushed up interest rates elsewhere but not in the banks .But such any claim deregulation is not justifiable in present circumstances, even the policy maker’s like Allan Greenspan who even facing a staunch liberalist, stressed on need for temporary regulation .This is need of hour, even U.S newly president elect Barack Obama ,not stop to saying that U.S should have the privately held banking system regulated by government.
Bank of Ireland and Allied Irish Banks and in the U.K whose Royal Bank of Scotland and Lloyds group are now under dominant public control, and others are expected to follow. The U.S and the U.K now have what India called the social control of banks. While in India bankers and policy makers are not stopping to encourage riskier loans by banks, In the U.S and U.K, the objectives are exactly opposite .In present circumstances India and rest economy of the world can learn a lot of tracts from Latin America where the first time in a century ,Latin America has managed to atleast partially “cushioned” itself from the seismic waves of economic turmoil in the U.S and Europe.
Even this partial success comes through the balanced monetary policies which undertaken to boost peoples development instead of fascinating merely towards numerical growth.
According to Hayek ,if monetary tightening is undertaken after the upper turning point of inflationary cycle is passed ,the downturn is accelerated. This useful concept is however anathema to Indian policy makers, who’s main focus now is on spurring higher growth. But such measures will add to the suffering of the poor. Now it is quite imperative to think about the falling purchasing capacity at mass level while prices at staple goods are reached at record high up 50%,in the last six months ,global food stocks are reached to historic lows. So, the poor can’t afford the food in present mechanism.
In present circumstances, if there is one enduring idea from Friedman, that central bankers in China and India would be well advised to heed, it is the” Monetarist Paradox” that almost every rate cut leads one time to a higher interest rate. And tightening moves such as raising the CRR do not necessarily ensure that policy has tightened, Reading Friedman tends to be a revelation .

It may interesting to note that popular rhetoric exaggerates damage done by recessions; but recessions have often overlooked benefits too. They moderate inflationary tendencies and punish reckless financial speculation and poor corporate practices like bad instruments, irresponsible lending etc. These effects contribute to an economy’s long term strength .
So, it is imperative to take some very impeccable measures to heed from ongoing downward movement of financial world, International Monetary Fund (IMF)s Global Financial Stability Report (April2008),suggested some very vital policy options to sub-prime crises:-
2.Bank balance sheet repair
3. Management of compensation structure
4. Consistency of treatment
5.More intense supervision
6.Early action to resolved institutional maladies
7. Public plans for impaired assets.


1.Standardization of some components of structured finance products.
2.Transparency at origination & subsequently.
3.Reform of rating system.
4.Transparency & disclosure.
5.Paying greater attention to applying fair value accounting results.
6.Reexamining incentives to set up Special Investment Vehicles{SIV} and its conducts.
7.Tightening oversight of mortgage originators.

Some of these recommendation are really very close to the solution, its judicious formulation may heed the problem to an extent. Apart from this, countries must understand what was lost in 1944 (Bretton Woods Conference) one of the reasons for financial crises is the imbalance of trade between nations. Countries accumulate debt partly as a result of sustaining a trade deficit.
They can easily destined to trapped in vicious circle; the bigger their debt, the harder it is to generate a trade surplus. International debt wracks peoples development, trashes the environment and threatens the global system with periodic crises. There have been more than a dozen financial crises since the beginning of 20th century. The aftermath of each was transitory, and markets rebounded rather quickly.

The current may be different, it will usher in profound and lasting structural behaviour and regulatory changes .In present troubled time a fresh approach is needed on overall policy matters and its implementation to curb occurring such mishappening. For restoration of confidence in financial markets a new look on corporate governance is quite imperative, this is the measure area where a lot of work have to be done in near future, personally I think governance is a biggest determinant in shaping of an administrative order, whatever we have seen in back times may be termed as failure of governance ðical work style.
It would be quite nice to see a new financial world free from such wrong practices, but before this, indeed we have to pass through a long wait…. like the Samuel Backetts Waiting For Godot….
Atul Kr Thakur
New Delhi,March 2,2009


  1. A very detailed and through analysis,Atul.Keep it up-Amitav Thakur,SP(Intel),Faizabad,Monday 2nd March 2009.

  2. Thanks-went to the blog,looks more intresting,even though I don't understand finance and economics!
    Ramchandra Guha,Thursday,26th March2009