Hello Arun,
I read your letter with interest
& I’m glad that you have become a good thinker. You have raised some very
basic questions like how & why this bad state of economy has arisen. Why
honest tax payers should be made to pay for the crimes committed by crooks
& cheats? So on & so forth.
But at the same time you have
answered most of the questions that GREED is the right word to describe it all.
Also high level corruption by a nexus of politicians, CEOs, banks, etc. is the
main cause of this crisis. Still the question remains how did it happen? Well
I’m also not qualified to answer all these facts but whatever little I know, I will try to tell.
The first wave of shocks came
sometimes in Jan.2008. It was the crisis of P- notes (Participatory notes).
P-notes are the loans with almost
zero interest rates. They are lent in any currency but the repayments have to
be made in dollars only. Their amounts are very huge & interest rate is
very low. But appreciating & depreciating of different currencies with respect
to US dollar can make them very mean or dangerous loans. If I’m not wrong, in
Jan.2008, dollar started depreciating against Yen & Indian rupee & also
against many other currencies. There were defaults in repayments of loans taken
via P-notes. The debtors of P-notes had invested the money in equity markets/housing
market. So in order to pay back; they sold their stocks or settled their
derivative trades. This caused end of Bull Market & since 8th
Jan, 2008 it headed for the Bear phase.
Nobody knows even today the exact
amount lent through P-notes.
The second & bigger cause of
this economic down turn was in the form of ‘Sub- prime lending’.
Their actual mechanism is not
understood by me but what I know is that they are exotic but most complex
Derivative Contracts in equity markets. They are carried over longer periods. They are highly leveraged contracts. It means
a buyer pays only a small amount upfront say 10% & rest is financed by a
broker. They are enormously large contracts having huge financial implications.
If you win you are a millionaire/billionaire, if you lose you are doomed. You
can see GREED is the main force behind this trade. These contracts were repacked
& resold many times till they reached at their high valuations. This is how
the stock markets were witnessing boom time & BSE index went up by even
1000 points in a single trading day. The problem started when the last buyer
tried to sell them at that high valuation. There were no takers. And there was
no one who could give exact value of that high value stocks. This happened with
multiple buyers & at the same time brokers/investment banks started giving
margin calls. They wanted their money back & in cases of default those
stocks were sold out. Thus, the grand slide in equity markets started. Today
stock indices are down by 55 to 60% & stock prices are as low as 70% to
75%. The bubble was bursting but everyone refused to hear its sound.
Warren Buffett the great investment
Guru said, “Derivatives are the weapons of mass (wealth) destruction” And we
have seen it in the year 2008. Losses on exotic derivative products have pushed
up some of the biggest names of the financial world to extinction. IRONICALLY,
TODAY’S NEWS PAPER REPORTS THAT HATHWAY BIRKSHIRE OWNER WARREN BUFFETT HAS
REPORTED A LOSS OF $2.5BILLIONFOR DEC, 2008 QUARTER IN DERIVATIVE TRADING &
HIS TOTAL NET WORTH IS DOWN BY $10.2BILLION.
When troubles come, they come not
single spies but in battalions. (William Shakespeare.) Then the 3rd
shock wave came.
Third cause of economic down turn
is attributed to Housing industry/ Housing mortgages. On 23rd
Aug.2008 it was reported that Fannie Mae & Freddie Mac the two largest
mortgage financial companies don’t have any net worth. They had Federal Govt.’s
guarantee so they could withdraw without any restraint. They had a blank check
from Federal govt. Therefore they could borrow at lower rates & make money
by purchasing higher yielding mortgages from home lenders. Fannie Mae was
created in after the great depression of 1930 & Freddie Mac in 1970 after
Vietnam War when US economy was in trouble. These firms were flouting all norms
of fiscal control & it became apparent in 2007 but no action was taken till
finally both went bankrupt. What is their fate today I don’t know but remember
these two were having the backing/guarantee of the Federal Govt.? Now, why no
action was taken? Because there was no regulatory authority
to check these frauds. Mr.Obama is now talking of a regulatory authority
as he announced appointment of a Director General to keep a tab on the
implementation of the policies declared in his first speech. Will it help? Your guess is as good as mine.
OR My guess is as good as yours.
Talk of collapse of big financial
names like Lehman Brothers which was one of the financial pillars of US
financial system for more than 150 years. It has shown profit in its last nine
quarters till June 2008. In Sept.2008 it was bankrupt, how? Nobody knows. The
only satisfactory explanation is manipulated balance sheets, bogus profit &
loss accounts, defrauded audit reports & everything crooked that is
associated with these financial crimes.
AGAIN I WILL SAY THE ABSENCE OF A
PROPER REGULATORY AUTHORITY CAUSED THIS HIGH LEVEL ORGANISED LOOT.
In comparison I’ll tell you what
happens in India.
Here SEBI (security & exchange
board of India), RBI (Reserve bank of India) & finance ministry are the
regulatory authorities. SEBI keeps a tab on stock market irregularities, RBI on
banks & other financial institutions & finance ministry has the overall
control. SEBI will check inside trading in any share, manipulations by market jobbers
& operators. Now the trading is fully computerized therefore it can keep a
proper tab for trading irregularities & take quick action. RBI determines
the CRR (cash reserve ratio) for all banks. It simply means that all banks keep
with RBI a particular amount say 25% of their all deposits. If a bank needs more liquidity it borrows
from RBI at a very low interest rate called REPO rate. If it has surplus
liquidity that is invested with RBI at a low interest rate called reverse repo.
Finance ministry determines certain policies for traders, importers &
exporters, corporate houses & much more which I cannot explain now. And
despite high level corruption in India too, these regulators are seen to be
very effective. Here banks are much safe. Even cooperative banks have generated
huge deposits & depositors are not unduly worried. Satyam computer like
scams are rarer of the rarest and its effects/fall out will be more stringent
accounting standards for all other companies. That means chances of such frauds
will be further minimized.
SATYAM FRAUD IS ANOTHER CLASSIC
EXAMPLE OF HUMAN GREED.
CONCLUSION:
US are the biggest & richest
economy. George Bush was a gullible president. It seems he was an economic
illiterate. His subordinates & govt. officials plus a nexus of crooks in
wall street, high profile bankers & CEOs of various financial institutions
like Freddie Mac & Fannie Mae they all colluded in this systematic
loot. For us It
is difficult to say who were the actual beneficiaries. But strangely no names
have been taken. One Satyam chief is caught & admitted to the crime. So
there are group litigations in US to claim the losses because Satyam was a
listed company at NYSE. Can you tell me how many court cases are filed against
various banks that vanished with billions of dollars of public money? I’m
surprised that no names have been taken & no one is facing prosecution
either.
In such circumstances what Mr.
Obama will do? His speech is full of passion & compassion. These speeches
are fine for a politicians but of little use for an economic reformer. However
he seems to be an honest statesman with good intensions. IT IS SAID,“THE PATH PAVED WITH
GOOD INTENTIONS MAY ALSO LEAD TO HELL”. But his
policy of protectionism (be American, buy American & the bailout benefits
to those industries which will use American goods /steel/cement/chemicals etc.)
does not augur well for revival of American economy. This is the negation of
the free market economy & also a setback to world trade organization. If
other nations also give a call for protectionism, American companies will lose
their exports. US exporter will never allow it to happen.
What he should immediately do is
1. To appoint a strict regulatory
authority for banks/financial institutions & also for stock markets.
2. His govt. should decide on new
fool-proof accounting & auditing standards.
3. He should abstain from a policy
of American protectionism.
4. He should ensure the benefits of
bailout packages reach those for whom they are actually meant for.
5. His economic agenda should take
precedent over his political agenda.
Today I can think thus far & no
more.
Arun, this subject is too much for
ordinary people like us. It is however important to know the basics of this. I
have written whatever I knew & whatever I could remember at this time. I
will end with a couplet from Mirza Ghalib,
FIKRE DUNIYA MEIN SAR KHAPATA HUN,
MEIN KAHAN AUR YEH BAVAL KAHAN.
KAMAL UNCLE