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Thursday, December 10, 2009

Things Fall Apart

It was Bear Stearns in March. A couple of weeks back, it was Fannie Mae and Freddie Mac—the two giants of America’s mortgage market with combined assets of $1.8 tn. Then came the turn of world’s two oldest investment banks with a combined assets of $1.5 tn: Lehman Brothers filed for bankruptcy, and Merrill Lynch is acquired by Bank of America. And now, it is the turn of AIG to desperately seek a bailout, which the Fed perforce offered under the threat of imminent systemic risk—should it fail, the very global financial architecture will collapse. What an incredible celebration of the anniversary of the US Subprime crisis!
        The man in the street is wonderstruck: Who is blasting off these Bamiyan monoliths of capitalism? No one is sure of the magnanimity of the impending crisis. The collapse of financial companies in hundreds, if not thousands, is what experts are predicting. And they may not be far away from the truth, except for the timing. The former Fed Chairman, Alan Greenspan has termed the current crisis “The most wrenching since the end of the Second World War,” while a few others have called it the beginning of a crisis comparable with that of the Great Depression. 
        Letting money make money is always profitable, but it reels under a constant threat of collapse simply because profit generation is not backed here by real production. There is a limit to leverage: inexorable lending of monies more than what is owned and borrowing monies more than one’s “instant capacity to meet engagements” is a sure recipe for collapse. And, no amount of intelligent application of crazy ‘Quants’ to ‘over-trading in money’ can ever avert the burst, for they can only, at best, defer the imminent but cannot eliminate it. Someone or the other has to pay for it, for the only certainty is the ‘whole’—the critical mass as defined by the real economy—which tends to remain constant. For sure, it abhors to remain out of equilibrium, that too, for long.
        That being the reality, the most disturbing question now is: What next? Obviously, answering the crisis is what is more important now, than brooding over what has happened and how. As some experts observed, takeovers by the government is, perhaps, a good answer for getting the financial system back into working condition. When persons of the stature of Paul Volcker, the former Fed chairman, suggest that creation of a new government agency sort of body to purchase the ‘troubled paper’ of the troubled institutions is the only alternative to end the present liquidity crisis, it merits consideration. As the market reports trickle in, the American government appears to be all set to create such a special agency. Central banks of the developed world have already pumped in $247 bn to create liquidity in markets. Indeed, the risk of not pursuing such a course would, perhaps, be more catastrophic. Yet, this is, for certain, only a short-term measure to get the financial system back on rails. 
        Back to reality, the obvious and the most important long-term requirement is to make the greedy and giant financial institutions submit to the laws of finance. The institutions such as AIG, which were once considered too big to fail, must now be made to submit to regulatory supervision. An accounting system that could measure the risks correctly and, more importantly, make them transparent is what is urgently needed to be put into practice. At the same time, too much reliance on regulators can create only a spurious sense of security, for these giant financial institutions are always capable of outsmarting the regulators owing to the fact that the true financial picture of any institution is known only to its owner. 
        Which is why the investors are required to take care of themselves. The only way to become wealthy or even to remain wealthy is—as said by an interviewee in The New Elite: Inside the Minds of the Truly Wealthy—to operate from a frame of mind: “I have a Chevrolet taste on a Mercedes income.”

Anyone to take heed?

- GRK Murty


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