Ten years on, in uncharted waters (US Lehman crisis, 2007)

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Ten years on, in uncharted waters (US Lehman crisis, 2007)

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Read more on - Polity | Economy | Schemes | S&T | Environment

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• Series of crisis in US and elsewhere: First, the East Asian Crisis 1997 forced economists to rethink full capital account convertibility, with fixed exchange rates. Then the 2000 Dot Com bust and other bust in early 2000s in US forced a rethink on impact of technology on productivity growth. But nothing matched what came around in 2007!
• Global Financial Crisis 2008: It peaked in September 2008, and was caused by several factors. 

1. Global macro-economic imbalances,
2. US’s loose monetary policy,
3. Housing bubble in the US,
4. A bloated financial sector, 
5. Flawed belief in efficient markets,
6. Greedy bankers and useless rating agencies, etc.

• The biggest villain: The biggest villain remains bad regulation. How?

1. Banks were allowed high debt to equity ratios. 
2. Banks were allowed to move away from core business of making loans to investing in “securitised assets” 
3. Banks had low standards for making housing loans, pay was linked with risks, Boards were not supervising. Regulatory Capture was rampant as the “revolving door” phenomenon was prominent.

• Difference between the two businesses: Banks had shifted from loans to investments. When banks make loans (give loans), any losses are recognised over time. Investments (in securitised assets) are mark to market, and losses are to be recognised immediately.
• Why did the investments fail? Securitised assets were bundles of securities built on sub-prime housing loans. Banks invested in them. When many borrowers started defaulting, and housing prices started falling, the assets lost value. Losses to the banks were crushing!
• A domino effect: Losses to banks eroded their capital. Those who lent to these banks panicked. These lenders were not only retail depositors, but short-term lenders in wholesale market. Regulation again had failed.
• Worldwide contagion: Banks elsewhere had invested in these assets. Many of them had borrowed from US wholesale market and financed these assets. When one fell, they all did.
• Central Banks stepped in: As wholesale markets dried up, Federal Reserve gave dollar funds to others in Europe and Asia. Governments ran to save their FIs. Central Banks gave liquidity to banks.
• Human cost: Since jobs were lost on a large scale, political repercussions followed in myriad ways – Eurozone Debt crisis, Brexit, Anti-immigration politics, Nationalism, Protectionism, Trump etc.
• Zero accountability: Not one top banker was ever jailed!
• India was saved: Lack of full capital account convertibility, low amount of short-term foreign borrowings, lack of access to foreign banks (thereby escaping the crunch due to sudden exit post-crisis) – all these saved India!
• Are we safe now? 3 things tell us we are not – 

1. Too Big To Fail has only accentuated, 
2. Huge rise in global debt, and 
3. Financial globalisation had made everyone vulnerable to US policies. We are beholden to the dollar!

• Summary : The global financial crisis 2007 was due to total regulatory failure and huge debt levels, but crucial lessons haven’t been learnt and the dollar’s domination of the world economy makes everyone vulnerable.

Read more on - Polity | Economy | Schemes | S&T | Environment

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