The following are the youtube video links of a talk by Prof. Arun Kumar on the current financial turmoil delivered at The Ahmedabad Management Association.
Part 1 http://in.youtube.com/watch?v=KaZIyrPDwSE
Part 2 http://in.youtube.com/watch?v=ghDklXgoJb4
Part 3 http://in.youtube.com/watch?v=8AJSxAyloJ4
Part 4 http://in.youtube.com/watch?v=7qbGT7lbx64
Part 5 http://in.youtube.com/watch?v=tox-I_FEdYg
Part 6 http://in.youtube.com/watch?v=2lwP1uV859U
Part 7 http://in.youtube.com/watch?v=3PZnjQf2INY
Part 8 http://in.youtube.com/watch?v=vFcfzibYsu4
Thursday, December 4, 2008
Thursday, November 20, 2008
Interests of the Unemployed: A Radical Agenda for Obama
Interests of the unemployed: A radical agenda for Obama
by Arun Kumar
The Tribune, November 20, 2008.
Against all odds, Mr Barack Obama has won the Presidency of the US only to be confronted with extraordinary odds — incomparably greater than those faced by any recently elected US President. Economically, socially and politically, the country and the world are in a state of deep crisis. The US as the leader of the world is both a cause of the problems and a possible source of solutions. Without the US being a part of any solution, it is unlikely that the world, as it is, will be able to resolve its problems. In this sense, it is said the whole world should have a vote in the US presidential elections.
The G-20 heads met under the leadership of a lame-duck US President, Mr Bush, in a largely futile talking exercise. Our own Prime Minister made noises about how he saw the crisis coming while till the other day he was saying that there is no crisis; does credibility matter. Mr Obama did not participate, perhaps due to his irreconcilable differences with Mr Bush who only talked of the free markets. Mr Obama’s presence may have given the wrong signals and made his own task more difficult when he takes over in two months. However, this delay could be very expensive.
Not only is the economic weight of the US so large that it determines world economic events but its financial and political clout sways other countries politically and socially as well. It draws the best in the world to its universities and think tanks and leads all others in research in almost all fields. Thus, it is able to set the agenda for the entire world in intellectual terms and also because it has lobbies pushing for its interest in almost all parts of the world. It dominates the multilateral agencies and that is another important source of its influence. From issues of poverty removal, research in health, agenda for the environment, nature of the financial architecture, fight against terrorism and money laundering, etc, the US moulds world events.
To be able to lead in such an extraordinarily complex world on such a broad front requires statespersonship of a high order among the leaders. This has been missing for decades. The US and, following its lead, most other governments in the world have been governed by narrowly defined short-term self-interest. One may say, what is new? But in a far more complex world, old ways will not do. Narrowness of approach is a recipe for disaster and pay-back time has now come. The world as we have known it can hardly survive.
All the above listed problems have a common source, a belief in a narrowly defined national and individual interest, based on greed and unlimited exploitation. Thus, respect for nature and other people has been at a discount. While this was tolerated earlier, today this has serious implications, especially at the economic plane and now we are confronted with a collapse for which no one has an answer.
The governments all over the world are scrambling with packages to salvage their financial institutions and their economies. Huge sums of money are on offer (capital injection, loans, etc.) — amounting to about $5 trillion. The financial bubble, which is in the process of collapse and is dragging down the real economy, was a result of deregulation of the financial markets and an undiluted pursuit of lucre and the resulting massive disparities in society.
The financial assets created (in hundreds of trillions of dollars) were a multiple of the size of the real world economy (around 60 trillion dollars) so that the latter does not have the resources to resolve the problems created by the former. Governments can neither replicate the markets nor their intervention is adequate to stop the financial bubble from collapsing.
The financial bubble consists of borrowings and lending by various economic entities. As the bubble deflates, while asset values decline, the liabilities remain. Hence institutions develop huge holes in their balance sheets. Since the various financial entities are interlinked through borrowing and lending, as one institution collapses and is unable to pay its lenders, the latter runs into problems and this ricochets to yet others leading to further collapse. A vicious cycle sets in and institutions lose trust in each other and stop lending to others and instead try to accumulate capital to cover their own declining asset base. The money given by the government goes to support their own asset base with little lent to anyone else.
While the build-up of the financial bubble is gradual and systematic, its collapse is sudden and chaotic and that is why it is beyond anyone’s control. Release of liquidity and cuts in interest rates do not spur investments and the economy enters a “liquidity trap”. In this scenario, it appears inevitable that the financial markets would collapse and nothing in the short run can save them.
Unfortunately, businesses are inter-linked, a large number of the firms dealing in real products and services also were involved in the financial markets to invest their funds or to cover their risk (say, in foreign exchange). These firms are also suffering losses. Further, they are confronted with a slow- down in demand and a tightening of the credit markets since borrowing and lending has frozen. Thus, the growth rate of the real output which had already started declining in 2007 is now in negative territory over large parts of the advanced world.
Consequently, unemployment is rising dramatically all over the globalised world. This is going to bring real pain to a vast majority of the people while the collapse of the financial world hits only a small percentage of the rich and the upper middle class populations. The collapse of the latter is inevitable but if the former collapses, it would be catastrophic. The choice before the governments is clear — should funds be thrown into the bottomless pit of the financial sector without any real benefits or should they be used to retrieve the real economy and keep it going?
The US government is an establishment run by various vested interests, and the financial sector interests are deeply entrenched in it — they have been running the Treasury and the Fed for long. Their interest is seen as the main interest. That is why the poor are not getting help with their houses or General Motors is not getting $25 billion while AIG has got $150 billion. Mr Obama would have to overcome this bias in policy and put together a radically new plan. This would require him to change his set of advisers and those in the establishment, but that is easier said than done. Mr Obama’s win was like climbing Mount Everest, but can one do so everyday? Or, having climbed it once, can that become a habit? The world needs it to be so. Will Mr Obama, a left-leaning suspect in the eyes of the conservatives, be cautious and play safe? This would be tragic since there is no option but to carry forward a radical programme. His self-imposed limits will determine his achievements or failures and those of the world in the coming years. If he could take on the establishment in the economic sphere, there would be hope that he could also do so in other aspects of life.
by Arun Kumar
The Tribune, November 20, 2008.
Against all odds, Mr Barack Obama has won the Presidency of the US only to be confronted with extraordinary odds — incomparably greater than those faced by any recently elected US President. Economically, socially and politically, the country and the world are in a state of deep crisis. The US as the leader of the world is both a cause of the problems and a possible source of solutions. Without the US being a part of any solution, it is unlikely that the world, as it is, will be able to resolve its problems. In this sense, it is said the whole world should have a vote in the US presidential elections.
The G-20 heads met under the leadership of a lame-duck US President, Mr Bush, in a largely futile talking exercise. Our own Prime Minister made noises about how he saw the crisis coming while till the other day he was saying that there is no crisis; does credibility matter. Mr Obama did not participate, perhaps due to his irreconcilable differences with Mr Bush who only talked of the free markets. Mr Obama’s presence may have given the wrong signals and made his own task more difficult when he takes over in two months. However, this delay could be very expensive.
Not only is the economic weight of the US so large that it determines world economic events but its financial and political clout sways other countries politically and socially as well. It draws the best in the world to its universities and think tanks and leads all others in research in almost all fields. Thus, it is able to set the agenda for the entire world in intellectual terms and also because it has lobbies pushing for its interest in almost all parts of the world. It dominates the multilateral agencies and that is another important source of its influence. From issues of poverty removal, research in health, agenda for the environment, nature of the financial architecture, fight against terrorism and money laundering, etc, the US moulds world events.
To be able to lead in such an extraordinarily complex world on such a broad front requires statespersonship of a high order among the leaders. This has been missing for decades. The US and, following its lead, most other governments in the world have been governed by narrowly defined short-term self-interest. One may say, what is new? But in a far more complex world, old ways will not do. Narrowness of approach is a recipe for disaster and pay-back time has now come. The world as we have known it can hardly survive.
All the above listed problems have a common source, a belief in a narrowly defined national and individual interest, based on greed and unlimited exploitation. Thus, respect for nature and other people has been at a discount. While this was tolerated earlier, today this has serious implications, especially at the economic plane and now we are confronted with a collapse for which no one has an answer.
The governments all over the world are scrambling with packages to salvage their financial institutions and their economies. Huge sums of money are on offer (capital injection, loans, etc.) — amounting to about $5 trillion. The financial bubble, which is in the process of collapse and is dragging down the real economy, was a result of deregulation of the financial markets and an undiluted pursuit of lucre and the resulting massive disparities in society.
The financial assets created (in hundreds of trillions of dollars) were a multiple of the size of the real world economy (around 60 trillion dollars) so that the latter does not have the resources to resolve the problems created by the former. Governments can neither replicate the markets nor their intervention is adequate to stop the financial bubble from collapsing.
The financial bubble consists of borrowings and lending by various economic entities. As the bubble deflates, while asset values decline, the liabilities remain. Hence institutions develop huge holes in their balance sheets. Since the various financial entities are interlinked through borrowing and lending, as one institution collapses and is unable to pay its lenders, the latter runs into problems and this ricochets to yet others leading to further collapse. A vicious cycle sets in and institutions lose trust in each other and stop lending to others and instead try to accumulate capital to cover their own declining asset base. The money given by the government goes to support their own asset base with little lent to anyone else.
While the build-up of the financial bubble is gradual and systematic, its collapse is sudden and chaotic and that is why it is beyond anyone’s control. Release of liquidity and cuts in interest rates do not spur investments and the economy enters a “liquidity trap”. In this scenario, it appears inevitable that the financial markets would collapse and nothing in the short run can save them.
Unfortunately, businesses are inter-linked, a large number of the firms dealing in real products and services also were involved in the financial markets to invest their funds or to cover their risk (say, in foreign exchange). These firms are also suffering losses. Further, they are confronted with a slow- down in demand and a tightening of the credit markets since borrowing and lending has frozen. Thus, the growth rate of the real output which had already started declining in 2007 is now in negative territory over large parts of the advanced world.
Consequently, unemployment is rising dramatically all over the globalised world. This is going to bring real pain to a vast majority of the people while the collapse of the financial world hits only a small percentage of the rich and the upper middle class populations. The collapse of the latter is inevitable but if the former collapses, it would be catastrophic. The choice before the governments is clear — should funds be thrown into the bottomless pit of the financial sector without any real benefits or should they be used to retrieve the real economy and keep it going?
The US government is an establishment run by various vested interests, and the financial sector interests are deeply entrenched in it — they have been running the Treasury and the Fed for long. Their interest is seen as the main interest. That is why the poor are not getting help with their houses or General Motors is not getting $25 billion while AIG has got $150 billion. Mr Obama would have to overcome this bias in policy and put together a radically new plan. This would require him to change his set of advisers and those in the establishment, but that is easier said than done. Mr Obama’s win was like climbing Mount Everest, but can one do so everyday? Or, having climbed it once, can that become a habit? The world needs it to be so. Will Mr Obama, a left-leaning suspect in the eyes of the conservatives, be cautious and play safe? This would be tragic since there is no option but to carry forward a radical programme. His self-imposed limits will determine his achievements or failures and those of the world in the coming years. If he could take on the establishment in the economic sphere, there would be hope that he could also do so in other aspects of life.
Tuesday, November 11, 2008
Global Financial Crisis and Government Intervention: Surplus Generation, Gearing Ratio, Asymmetry of Financial Multipliers and Other Considerations
Global Financial Crisis and Government Intervention:
Surplus Generation, Gearing Ratio, Asymmetry of Financial Multipliers
and Other Considerations
Arun Kumar
CESP/SSS, JNU, N Delhi 110067.
arunkumar1000@hotmail.com.
Published: 'Accountancy Business and the Public Interest' Vol. 8, No. 1. February 3, 2009.
http://visar.csustan.edu/aaba/aabajourVol8-No1.html
I. INTRODUCTION: CRISIS NOT ANTICIPATED BY THE EXPERTS.
II. MONEY, RISKY FINANCIAL ASSETS AND UNREGULATED INVESTMENT BANKING
III. PROFITABILITY OF FINANCIAL INSTRUMENTS AND CONSEQUENCES.
III. a. Financial Assets and their profitability
III. b. Anatomy of the Financial Crisis
IV. BASE FOR FINANCIAL ASSETS CREATION: IMPACT OF LOW US SAVINGS PROPENSITY, WAR EFFORT AND TAX HAVENS
V. MONEY, MULTIPLIERS AND GOVERNMENT INTERVENTION IN A CRISIS
V. a. Non-Functionality of the Multipliers
V. b. Limits to Government Intervention in a Crisis: Asymmetric Multipliers
VI. CONCLUSION.
End Notes.
References.
Graphs
Completed: November 11, 2008
Abstract of the Paper:
The paper analyses the roots of the current global economic crisis and the reasons for the failure of the massive government interventions to control the crisis.
The paper tries to understand whether the crisis is a generalized crisis of capitalism or a specific crisis originating from the financial sector. If it is the latter, a reform of the financial system would have been enough to resolve the crisis but if it is the former then a more basic solution would be required.
The paper analyses the deregulated financial markets and the nature of their instability. The paper presents a simple model linking the returns on financial instruments to capital gains and the gearing ratio. As the gearing ratio rises, the instability increases. Further, the paper points to the inter locked balance sheets of the financial institutions so that as collapse sets in it spreads from one to the other. It points to the fact that when the asset values fall, liabilities do not decline in value to that the balance sheets have big holes in them and this is particularly the case due to the provision of mark to market.
It traces the trigger for the instability in the real economy to rising disparities, the growing challenge to the dollarization of the world economy, rising speculative activities, falling savings propensity of the US economy so that more and more of the assets of the US economy were being owned by foreigners and the surplus generated in the US economy was going out. This was being aggravated by the growing use of the tax havens and the rising war effort and the internal security expenditures. All this led both to the creation of the sub-prime assets in the US economy and their eventual collapse.
It is pointed out that in the current crisis, trust has disappeared amongst borrowers and lenders and credit has frozen. Entities wish to remain liquid. Consequently, the money multiplier is tending to one and the financial multiplier to zero. In the circumstances, the monetary authority’s steps to reflate the economy become ineffective even though under normal circumstances, they would have led to hyper inflation. The economy appears to be in a liquidity trap. Fiscal steps also do not yield the required results due to the downward adjustment of the private sector’s expectations about profits and investments.
The paper points out that an orderly reversal of the financial markets is not feasible because while there maybe micro reversibility there is macro irreversibility. It is like in a random walk where each step can be reversed but the probability of going back to the origin is low.
The paper discusses the need for global coordination of fiscal steps otherwise demand may leak out and leave the economy trying to inflate itself in deeper crisis. It points to the dangers of countries going in for protectionism and suggests that the architecture of the International financial institutions is likely to change because the US position has been severely dented. Further, it suggests that the free market paradigm is likely to undergo a rethink and there would be greater receptivity in the public to alternatives.
Surplus Generation, Gearing Ratio, Asymmetry of Financial Multipliers
and Other Considerations
Arun Kumar
CESP/SSS, JNU, N Delhi 110067.
arunkumar1000@hotmail.com.
Published: 'Accountancy Business and the Public Interest' Vol. 8, No. 1. February 3, 2009.
http://visar.csustan.edu/aaba/aabajourVol8-No1.html
I. INTRODUCTION: CRISIS NOT ANTICIPATED BY THE EXPERTS.
II. MONEY, RISKY FINANCIAL ASSETS AND UNREGULATED INVESTMENT BANKING
III. PROFITABILITY OF FINANCIAL INSTRUMENTS AND CONSEQUENCES.
III. a. Financial Assets and their profitability
III. b. Anatomy of the Financial Crisis
IV. BASE FOR FINANCIAL ASSETS CREATION: IMPACT OF LOW US SAVINGS PROPENSITY, WAR EFFORT AND TAX HAVENS
V. MONEY, MULTIPLIERS AND GOVERNMENT INTERVENTION IN A CRISIS
V. a. Non-Functionality of the Multipliers
V. b. Limits to Government Intervention in a Crisis: Asymmetric Multipliers
VI. CONCLUSION.
End Notes.
References.
Graphs
Completed: November 11, 2008
Abstract of the Paper:
The paper analyses the roots of the current global economic crisis and the reasons for the failure of the massive government interventions to control the crisis.
The paper tries to understand whether the crisis is a generalized crisis of capitalism or a specific crisis originating from the financial sector. If it is the latter, a reform of the financial system would have been enough to resolve the crisis but if it is the former then a more basic solution would be required.
The paper analyses the deregulated financial markets and the nature of their instability. The paper presents a simple model linking the returns on financial instruments to capital gains and the gearing ratio. As the gearing ratio rises, the instability increases. Further, the paper points to the inter locked balance sheets of the financial institutions so that as collapse sets in it spreads from one to the other. It points to the fact that when the asset values fall, liabilities do not decline in value to that the balance sheets have big holes in them and this is particularly the case due to the provision of mark to market.
It traces the trigger for the instability in the real economy to rising disparities, the growing challenge to the dollarization of the world economy, rising speculative activities, falling savings propensity of the US economy so that more and more of the assets of the US economy were being owned by foreigners and the surplus generated in the US economy was going out. This was being aggravated by the growing use of the tax havens and the rising war effort and the internal security expenditures. All this led both to the creation of the sub-prime assets in the US economy and their eventual collapse.
It is pointed out that in the current crisis, trust has disappeared amongst borrowers and lenders and credit has frozen. Entities wish to remain liquid. Consequently, the money multiplier is tending to one and the financial multiplier to zero. In the circumstances, the monetary authority’s steps to reflate the economy become ineffective even though under normal circumstances, they would have led to hyper inflation. The economy appears to be in a liquidity trap. Fiscal steps also do not yield the required results due to the downward adjustment of the private sector’s expectations about profits and investments.
The paper points out that an orderly reversal of the financial markets is not feasible because while there maybe micro reversibility there is macro irreversibility. It is like in a random walk where each step can be reversed but the probability of going back to the origin is low.
The paper discusses the need for global coordination of fiscal steps otherwise demand may leak out and leave the economy trying to inflate itself in deeper crisis. It points to the dangers of countries going in for protectionism and suggests that the architecture of the International financial institutions is likely to change because the US position has been severely dented. Further, it suggests that the free market paradigm is likely to undergo a rethink and there would be greater receptivity in the public to alternatives.
Wednesday, November 5, 2008
Growing Uncertainty: Time to Invest in Real Economy
Growing uncertainty: Time to invest in real economy
by Arun Kumar
The Tribune, November 5, 2008.
These are extraordinary times, so strange and unexpected things occurring should not surprise us. The only thing predictable is that one cannot predict correctly (that also applies to the Indian cricket team!). The US government, after promising under different heads a few trillion dollars, seems to be fighting a losing battle with the economy steadily declining.
The Indian government, after so much song and dance in the last few years about the need for strict adherence to FRBM, has thrown it out of the window by announcing huge expenditures. Much was also made of the RBI’s autonomy but that is also a thing of the past with the government requiring it to act quickly and, of all things, it has released almost Rs 2,70,000 crore of liquidity in a month — an unthinkable amount till recently.
The latest data from the US economy points to a worsening economic situation. For the first time in several decades, consumer expenditures have dropped and that too sharply. Worse, this data is for the quarter immediately preceding the big pain induced by the collapse in the financial sector in mid September. So, analysts have argued that the last quarter of 2008 is likely to be much worse.
There are straws in the wind, suggesting that the recent rise in the stock markets is a blip. Reports suggest that the largest insurance firm AIG, which has been given a total bailout package of $123 billion, has more or less exhausted this amount in a month. The bailout of $ 85 billion announced in September looked huge but another $38 billion had to be given and even that has disappeared into a bottomless pit. How much more would be needed by the AIG?
That depends on the liabilities on its books and how much have its assets degraded in the present situation of rapid economic decline. All this indicates the difficulties that every business, and not just financial institutions, may be currently facing. All of them may be headed for difficulties because the assets on their books have lost value with the decline of the markets while their huge liabilities may be intact. The balance sheet may have huge holes.
The largest Japanese bank, Mitsubishi Financial Group that took equity in Morgan Stanley to bail it out, is now in trouble. It is trying to raise an equity of $10.7 billion. The shares held by Mitsubishi have fallen in value by 40 per cent. This has shaken confidence not only in Japan but also in the rest of the world. So entities that may look healthy at one point of time and may be asked to bail- out the not-so-healthy ones may themselves be in trouble very quickly not only because they took on another collapsing entity but because their own portfolio has degraded — not in years but in days and months.
The clear lesson is that given the disastrous financial situation worldwide, one does not know which entity is headed for trouble in the coming days and months. Under the circumstances, every entity is protecting itself. One way to do so is to become conservative and not trust others, not invest, etc. This becomes an added source of trouble.
The situation has gone out of the control of governments as far as the financial markets are concerned. The losses in the books have become so large that even the governments do not have the resources to save these entities. The monetary authorities have lost their power to regulate since their instruments are now blunted by the loss of trust and abnormal events in the economy. They may lower interest rates, but investments in the current situation of growing uncertainty will not rise. They may release money but it will simply sit with economic agents since they do not want to take on fresh commitments and want to stay liquid rather than commit funds. In brief, demand has collapsed.
The real economy is being severely dented since most businesses have also indulged in buying the financial instruments that are now in trouble. After all, they like to make as high a profit as possible and the financial markets were promising that and luring all and sundry — everyone was trapped by greed.
An Indian conglomerate bought a Europe firm at what was then thought to be a high price. Today the price of that asset would have collapsed in the market but the debts taken to buy the company would stand. The financial situation of the firm must be poor. The same company also bought two more firms later for the sake of prestige and again they would have taken a hit. How this firm would fare in the coming months is a moot question.
Assocham put out a report that soon some major industries will retrench in a big way. Not so surprisingly, within a week, they have withdrawn the report under pressure for the government which is still claiming that the economy would grow at 7 per cent. Is this feasible, given that the industrial growth has fallen to 1.5 per cent for the latest month and major parts of the tertiary sector, like the financial sector, hotels, tourism, trade, travel and housing, are seeing sharp declines? The Finance Minister has claimed that more jobs would be generated this year than during the entire NDA regime — a poor game of political one upmanship.
The problem is likely to aggravate as time passes because the world economy is headed into a prolonged recession or even a depression. Major Indian industries are likely to slow down or show negative growth. Can industry carry surplus labour in times when its bottomline is being hit due to lack of orders and build-up of inventories? Its losses can only mount even faster and it would sink sooner than later unless a national strategy is worked out as to how India will cope with the coming difficult time. There is no point in living in denial and not preparing.
Malaysia delinked itself from international capital flows in 1997 to save itself from the ongoing economic collapse in South-East Asia. The US and the IMF lectured it then for wrong policies but later held it up as a model for others. We also need to protect our interest and not open ourselves indiscriminately. The FIIs brought in funds but now they are withdrawing and leading to the collapse of the stock market. The government is opening up the insurance sector to greater FDI. In these times when the insurance sector is also in deep trouble (AIG being the biggest one) where will these funds come from? If they do come, would they also not try to quickly exploit the situation to shore up their parent companies, etc?
We need to invest in our real economy, keep employment up, encourage investment and keep our savings moving within the economy and not let them leak out through opening up the sector. Are we learning anything from anyone? If not, that is not unusual but a part of the predictability.
arunkumar1000@hotmail.com
The Tribune, November 5, 2008.
These are extraordinary times, so strange and unexpected things occurring should not surprise us. The only thing predictable is that one cannot predict correctly (that also applies to the Indian cricket team!). The US government, after promising under different heads a few trillion dollars, seems to be fighting a losing battle with the economy steadily declining.
The Indian government, after so much song and dance in the last few years about the need for strict adherence to FRBM, has thrown it out of the window by announcing huge expenditures. Much was also made of the RBI’s autonomy but that is also a thing of the past with the government requiring it to act quickly and, of all things, it has released almost Rs 2,70,000 crore of liquidity in a month — an unthinkable amount till recently.
The latest data from the US economy points to a worsening economic situation. For the first time in several decades, consumer expenditures have dropped and that too sharply. Worse, this data is for the quarter immediately preceding the big pain induced by the collapse in the financial sector in mid September. So, analysts have argued that the last quarter of 2008 is likely to be much worse.
There are straws in the wind, suggesting that the recent rise in the stock markets is a blip. Reports suggest that the largest insurance firm AIG, which has been given a total bailout package of $123 billion, has more or less exhausted this amount in a month. The bailout of $ 85 billion announced in September looked huge but another $38 billion had to be given and even that has disappeared into a bottomless pit. How much more would be needed by the AIG?
That depends on the liabilities on its books and how much have its assets degraded in the present situation of rapid economic decline. All this indicates the difficulties that every business, and not just financial institutions, may be currently facing. All of them may be headed for difficulties because the assets on their books have lost value with the decline of the markets while their huge liabilities may be intact. The balance sheet may have huge holes.
The largest Japanese bank, Mitsubishi Financial Group that took equity in Morgan Stanley to bail it out, is now in trouble. It is trying to raise an equity of $10.7 billion. The shares held by Mitsubishi have fallen in value by 40 per cent. This has shaken confidence not only in Japan but also in the rest of the world. So entities that may look healthy at one point of time and may be asked to bail- out the not-so-healthy ones may themselves be in trouble very quickly not only because they took on another collapsing entity but because their own portfolio has degraded — not in years but in days and months.
The clear lesson is that given the disastrous financial situation worldwide, one does not know which entity is headed for trouble in the coming days and months. Under the circumstances, every entity is protecting itself. One way to do so is to become conservative and not trust others, not invest, etc. This becomes an added source of trouble.
The situation has gone out of the control of governments as far as the financial markets are concerned. The losses in the books have become so large that even the governments do not have the resources to save these entities. The monetary authorities have lost their power to regulate since their instruments are now blunted by the loss of trust and abnormal events in the economy. They may lower interest rates, but investments in the current situation of growing uncertainty will not rise. They may release money but it will simply sit with economic agents since they do not want to take on fresh commitments and want to stay liquid rather than commit funds. In brief, demand has collapsed.
The real economy is being severely dented since most businesses have also indulged in buying the financial instruments that are now in trouble. After all, they like to make as high a profit as possible and the financial markets were promising that and luring all and sundry — everyone was trapped by greed.
An Indian conglomerate bought a Europe firm at what was then thought to be a high price. Today the price of that asset would have collapsed in the market but the debts taken to buy the company would stand. The financial situation of the firm must be poor. The same company also bought two more firms later for the sake of prestige and again they would have taken a hit. How this firm would fare in the coming months is a moot question.
Assocham put out a report that soon some major industries will retrench in a big way. Not so surprisingly, within a week, they have withdrawn the report under pressure for the government which is still claiming that the economy would grow at 7 per cent. Is this feasible, given that the industrial growth has fallen to 1.5 per cent for the latest month and major parts of the tertiary sector, like the financial sector, hotels, tourism, trade, travel and housing, are seeing sharp declines? The Finance Minister has claimed that more jobs would be generated this year than during the entire NDA regime — a poor game of political one upmanship.
The problem is likely to aggravate as time passes because the world economy is headed into a prolonged recession or even a depression. Major Indian industries are likely to slow down or show negative growth. Can industry carry surplus labour in times when its bottomline is being hit due to lack of orders and build-up of inventories? Its losses can only mount even faster and it would sink sooner than later unless a national strategy is worked out as to how India will cope with the coming difficult time. There is no point in living in denial and not preparing.
Malaysia delinked itself from international capital flows in 1997 to save itself from the ongoing economic collapse in South-East Asia. The US and the IMF lectured it then for wrong policies but later held it up as a model for others. We also need to protect our interest and not open ourselves indiscriminately. The FIIs brought in funds but now they are withdrawing and leading to the collapse of the stock market. The government is opening up the insurance sector to greater FDI. In these times when the insurance sector is also in deep trouble (AIG being the biggest one) where will these funds come from? If they do come, would they also not try to quickly exploit the situation to shore up their parent companies, etc?
We need to invest in our real economy, keep employment up, encourage investment and keep our savings moving within the economy and not let them leak out through opening up the sector. Are we learning anything from anyone? If not, that is not unusual but a part of the predictability.
arunkumar1000@hotmail.com
Growing Uncertainty: Time to Invest in Real Economy
Growing uncertainty: Time to invest in real economy
by Arun Kumar
The Tribune, November 5, 2008.
These are extraordinary times, so strange and unexpected things occurring should not surprise us. The only thing predictable is that one cannot predict correctly (that also applies to the Indian cricket team!). The US government, after promising under different heads a few trillion dollars, seems to be fighting a losing battle with the economy steadily declining.
The Indian government, after so much song and dance in the last few years about the need for strict adherence to FRBM, has thrown it out of the window by announcing huge expenditures. Much was also made of the RBI’s autonomy but that is also a thing of the past with the government requiring it to act quickly and, of all things, it has released almost Rs 2,70,000 crore of liquidity in a month — an unthinkable amount till recently.
The latest data from the US economy points to a worsening economic situation. For the first time in several decades, consumer expenditures have dropped and that too sharply. Worse, this data is for the quarter immediately preceding the big pain induced by the collapse in the financial sector in mid September. So, analysts have argued that the last quarter of 2008 is likely to be much worse.
There are straws in the wind, suggesting that the recent rise in the stock markets is a blip. Reports suggest that the largest insurance firm AIG, which has been given a total bailout package of $123 billion, has more or less exhausted this amount in a month. The bailout of $ 85 billion announced in September looked huge but another $38 billion had to be given and even that has disappeared into a bottomless pit. How much more would be needed by the AIG?
That depends on the liabilities on its books and how much have its assets degraded in the present situation of rapid economic decline. All this indicates the difficulties that every business, and not just financial institutions, may be currently facing. All of them may be headed for difficulties because the assets on their books have lost value with the decline of the markets while their huge liabilities may be intact. The balance sheet may have huge holes.
The largest Japanese bank, Mitsubishi Financial Group that took equity in Morgan Stanley to bail it out, is now in trouble. It is trying to raise an equity of $10.7 billion. The shares held by Mitsubishi have fallen in value by 40 per cent. This has shaken confidence not only in Japan but also in the rest of the world. So entities that may look healthy at one point of time and may be asked to bail- out the not-so-healthy ones may themselves be in trouble very quickly not only because they took on another collapsing entity but because their own portfolio has degraded — not in years but in days and months.
The clear lesson is that given the disastrous financial situation worldwide, one does not know which entity is headed for trouble in the coming days and months. Under the circumstances, every entity is protecting itself. One way to do so is to become conservative and not trust others, not invest, etc. This becomes an added source of trouble.
The situation has gone out of the control of governments as far as the financial markets are concerned. The losses in the books have become so large that even the governments do not have the resources to save these entities. The monetary authorities have lost their power to regulate since their instruments are now blunted by the loss of trust and abnormal events in the economy. They may lower interest rates, but investments in the current situation of growing uncertainty will not rise. They may release money but it will simply sit with economic agents since they do not want to take on fresh commitments and want to stay liquid rather than commit funds. In brief, demand has collapsed.
The real economy is being severely dented since most businesses have also indulged in buying the financial instruments that are now in trouble. After all, they like to make as high a profit as possible and the financial markets were promising that and luring all and sundry — everyone was trapped by greed.
An Indian conglomerate bought a Europe firm at what was then thought to be a high price. Today the price of that asset would have collapsed in the market but the debts taken to buy the company would stand. The financial situation of the firm must be poor. The same company also bought two more firms later for the sake of prestige and again they would have taken a hit. How this firm would fare in the coming months is a moot question.
Assocham put out a report that soon some major industries will retrench in a big way. Not so surprisingly, within a week, they have withdrawn the report under pressure for the government which is still claiming that the economy would grow at 7 per cent. Is this feasible, given that the industrial growth has fallen to 1.5 per cent for the latest month and major parts of the tertiary sector, like the financial sector, hotels, tourism, trade, travel and housing, are seeing sharp declines? The Finance Minister has claimed that more jobs would be generated this year than during the entire NDA regime — a poor game of political one upmanship.
The problem is likely to aggravate as time passes because the world economy is headed into a prolonged recession or even a depression. Major Indian industries are likely to slow down or show negative growth. Can industry carry surplus labour in times when its bottomline is being hit due to lack of orders and build-up of inventories? Its losses can only mount even faster and it would sink sooner than later unless a national strategy is worked out as to how India will cope with the coming difficult time. There is no point in living in denial and not preparing.
Malaysia delinked itself from international capital flows in 1997 to save itself from the ongoing economic collapse in South-East Asia. The US and the IMF lectured it then for wrong policies but later held it up as a model for others. We also need to protect our interest and not open ourselves indiscriminately. The FIIs brought in funds but now they are withdrawing and leading to the collapse of the stock market. The government is opening up the insurance sector to greater FDI. In these times when the insurance sector is also in deep trouble (AIG being the biggest one) where will these funds come from? If they do come, would they also not try to quickly exploit the situation to shore up their parent companies, etc?
We need to invest in our real economy, keep employment up, encourage investment and keep our savings moving within the economy and not let them leak out through opening up the sector. Are we learning anything from anyone? If not, that is not unusual but a part of the predictability.
arunkumar1000@hotmail.com
by Arun Kumar
The Tribune, November 5, 2008.
These are extraordinary times, so strange and unexpected things occurring should not surprise us. The only thing predictable is that one cannot predict correctly (that also applies to the Indian cricket team!). The US government, after promising under different heads a few trillion dollars, seems to be fighting a losing battle with the economy steadily declining.
The Indian government, after so much song and dance in the last few years about the need for strict adherence to FRBM, has thrown it out of the window by announcing huge expenditures. Much was also made of the RBI’s autonomy but that is also a thing of the past with the government requiring it to act quickly and, of all things, it has released almost Rs 2,70,000 crore of liquidity in a month — an unthinkable amount till recently.
The latest data from the US economy points to a worsening economic situation. For the first time in several decades, consumer expenditures have dropped and that too sharply. Worse, this data is for the quarter immediately preceding the big pain induced by the collapse in the financial sector in mid September. So, analysts have argued that the last quarter of 2008 is likely to be much worse.
There are straws in the wind, suggesting that the recent rise in the stock markets is a blip. Reports suggest that the largest insurance firm AIG, which has been given a total bailout package of $123 billion, has more or less exhausted this amount in a month. The bailout of $ 85 billion announced in September looked huge but another $38 billion had to be given and even that has disappeared into a bottomless pit. How much more would be needed by the AIG?
That depends on the liabilities on its books and how much have its assets degraded in the present situation of rapid economic decline. All this indicates the difficulties that every business, and not just financial institutions, may be currently facing. All of them may be headed for difficulties because the assets on their books have lost value with the decline of the markets while their huge liabilities may be intact. The balance sheet may have huge holes.
The largest Japanese bank, Mitsubishi Financial Group that took equity in Morgan Stanley to bail it out, is now in trouble. It is trying to raise an equity of $10.7 billion. The shares held by Mitsubishi have fallen in value by 40 per cent. This has shaken confidence not only in Japan but also in the rest of the world. So entities that may look healthy at one point of time and may be asked to bail- out the not-so-healthy ones may themselves be in trouble very quickly not only because they took on another collapsing entity but because their own portfolio has degraded — not in years but in days and months.
The clear lesson is that given the disastrous financial situation worldwide, one does not know which entity is headed for trouble in the coming days and months. Under the circumstances, every entity is protecting itself. One way to do so is to become conservative and not trust others, not invest, etc. This becomes an added source of trouble.
The situation has gone out of the control of governments as far as the financial markets are concerned. The losses in the books have become so large that even the governments do not have the resources to save these entities. The monetary authorities have lost their power to regulate since their instruments are now blunted by the loss of trust and abnormal events in the economy. They may lower interest rates, but investments in the current situation of growing uncertainty will not rise. They may release money but it will simply sit with economic agents since they do not want to take on fresh commitments and want to stay liquid rather than commit funds. In brief, demand has collapsed.
The real economy is being severely dented since most businesses have also indulged in buying the financial instruments that are now in trouble. After all, they like to make as high a profit as possible and the financial markets were promising that and luring all and sundry — everyone was trapped by greed.
An Indian conglomerate bought a Europe firm at what was then thought to be a high price. Today the price of that asset would have collapsed in the market but the debts taken to buy the company would stand. The financial situation of the firm must be poor. The same company also bought two more firms later for the sake of prestige and again they would have taken a hit. How this firm would fare in the coming months is a moot question.
Assocham put out a report that soon some major industries will retrench in a big way. Not so surprisingly, within a week, they have withdrawn the report under pressure for the government which is still claiming that the economy would grow at 7 per cent. Is this feasible, given that the industrial growth has fallen to 1.5 per cent for the latest month and major parts of the tertiary sector, like the financial sector, hotels, tourism, trade, travel and housing, are seeing sharp declines? The Finance Minister has claimed that more jobs would be generated this year than during the entire NDA regime — a poor game of political one upmanship.
The problem is likely to aggravate as time passes because the world economy is headed into a prolonged recession or even a depression. Major Indian industries are likely to slow down or show negative growth. Can industry carry surplus labour in times when its bottomline is being hit due to lack of orders and build-up of inventories? Its losses can only mount even faster and it would sink sooner than later unless a national strategy is worked out as to how India will cope with the coming difficult time. There is no point in living in denial and not preparing.
Malaysia delinked itself from international capital flows in 1997 to save itself from the ongoing economic collapse in South-East Asia. The US and the IMF lectured it then for wrong policies but later held it up as a model for others. We also need to protect our interest and not open ourselves indiscriminately. The FIIs brought in funds but now they are withdrawing and leading to the collapse of the stock market. The government is opening up the insurance sector to greater FDI. In these times when the insurance sector is also in deep trouble (AIG being the biggest one) where will these funds come from? If they do come, would they also not try to quickly exploit the situation to shore up their parent companies, etc?
We need to invest in our real economy, keep employment up, encourage investment and keep our savings moving within the economy and not let them leak out through opening up the sector. Are we learning anything from anyone? If not, that is not unusual but a part of the predictability.
arunkumar1000@hotmail.com
Saturday, October 11, 2008
Financial Crisis Worsens: Public Needs to know the Truth
Financial crisis worsens: Public needs to know the truth
by Arun Kumar
The Tribune, October 11, 2008.
Foreboding headlines confront the middle and the rich classes, the primary savers in the economy. They are quaking at the rapid depreciation in their wealth. Stock markets, mutual funds, real estate, etc., are down. While the going was good, they dreamt of a life of luxury but now they don’t know where to duck.
The financial analysts and the reassuring noises by policy makers had lulled them into believing till early this year that the good days would last forever little realising that the story could go horribly wrong in six months. Such was the euphoria, that those cautioning prudence were seen to be Cassandras of doom.
Ben Benarnke, the Fed chief and Paulson, the US Treasury Secretary, the two people at the top of the heap of the global financial markets were assuring one and all in August 2007, at the start of the sub-prime crisis that matters were under control. Not till February 2008 did Benarnke suggest that something was remiss. It was on September 19, 2008 that both said that the USA faced a deep financial crisis and that the $700 billion bailout package was necessary to save the system from collapse. But with the system continuing to spin out of control, is there a con game all the way through?
The Finance Minister and the Deputy Chairperson, Planning Commission, the two worthies in charge of the country’s financial planning, followed a similar path, assuring the country that India is insulated and that growth would remain intact at around 8 per cent while it can slip to 5 per cent or less.
On October 8 with international markets tumbling, in spite of the coordinated intervention by the central banks (an unprecedented step), Indian markets also followed suit. They stabilised because of the old game of government-induced intervention by certain institutions. The Finance Minister came out of a Cabinet meeting to say, that there was nothing to fear and more liquidity would be infused into banks. He said that Indian banks have strong balance sheets and no one need worry about the safety of deposits. The FM, a lawyer-politician is no economist and maybe excused for not comprehending what is going on.
But the Deputy Chairperson is an economist. He is reported to have said, “ … when normalcy is restored (in global financial markets), normalcy would also be restored to stock markets”. He apparently added that stock values are not a measure of the country’s economy and that stock markets are always more volatile. What a turn around? The government was till recently suggesting that the stock market rise reflected the economy’s performance. However, it is the first statement that needs analysis since it is vacuous.
When would normalcy be restored in global markets? It does not appear to be in sight. In spite of the trillions of dollars being poured in by governments a collapse has set in. In February, a tax cut of $ 160 billion was said to be adequate and then a few hundred billion dollars to take over Fannie Mae and Freddie Mac and AIG was thought to be adequate. Next, $ 700 billion was thought to be adequate and then a coordinated rate cut but the markets continue to collapse. As mentioned in this author’s piece in these columns (February 6, 2008), this is a case of `too little, too late’.
The situation is a dynamic one with matters deteriorating rapidly and faster than anyone is able to anticipate. As argued by Kaldor, once expectations turn negative, nothing helps and that seems to be the current world situation. There is a complete lack of trust so that institutions are running scared, the financial markets are in a state of freeze and liquidity has dried up. Further, the real economy which was already slowing down in 2007 has rapidly gone further downhill. The US has lost close to a million jobs. Now even the IMF has woken up and predicted a slowdown/ recession. The implication is clear that with the real economy sliding, profits all across will tumble and businesses may go broke. Under the circumstances, all investments are uncertain and financial markets already in turmoil can hardly revive. Even companies and banks that today look safe may rapidly sink into losses.
The recent past is a good guide to all this. Even in June 2008, the demise of WaMu, Lehman Brothers, Merrill Lynch etc., the nationalisation of Fannie Mae, Freddie Mac, AIG etc., and the spread of the contagion to Europe could not have been imagined. The decline of Dow Jones to below 10,000 or that of Sensex to below 11,000 were in the realm of impossible. One of the big Indian private banks is 19th in a list of 36 risky banks in the world. Even tiny Iceland faced bank failure. Not only has all this happened, much more is feared in spite of the various packages.
A projection of all this into the future is frightening and a turnaround is not in sight. Hence when the Deputy Chairperson of Planning Commission said “when normalcy returns” he should honestly also add that there are few prospects of that in the near future and no one really knows when that may happen. Was the public being conned?
Analysis of the international financial markets over the last 20 years suggests that an unsuspecting public has been conned. Many were sucked in by greed and invested in unsafe instruments (even the Chinese Central Bank) due to the con job pulled off by the financial experts/advisors. The FBI is reportedly investigating Lehman, Merrill and AIG for possible fraud. While the markets rose, everything seemed to be as scripted but few asked what if the script went horribly wrong as it has done now. Even the most savvy financial experts have lost because they had also conned themselves and invested in the instruments that are now sinking. An NRI steel tycoon is reported to have lost over $16 billion in the last four months in spite of his battery of financial advisors.
The financial sector is not buying the turnaround story and continuing to collapse. It cannot trust others in this dynamic situation where what is apparently safe today can be risky tomorrow so that any investment can turn bad and they can themselves be the next victim. Hence, government bailouts are being treated as good to clean up one’s own balance sheet and improve one’s situation but not good enough to trust anyone else.
The nightmare of a bad script is with us but the con job continues. Rather than admit that the problem is systemic and needs an overhaul, policy makers the world over are busy fire fighting and not doing a basic reassessment which would require a change in priorities. They are attempting to shore up the collapsing financial structures which seem to be beyond repair and ignoring the real sectors of the economy which could react to stimuli much more quickly. A paradigm shift is called for but that requires a mind set change which the current breed of policy makers are proving to be incapable of because of their predisposition(s).
by Arun Kumar
The Tribune, October 11, 2008.
Foreboding headlines confront the middle and the rich classes, the primary savers in the economy. They are quaking at the rapid depreciation in their wealth. Stock markets, mutual funds, real estate, etc., are down. While the going was good, they dreamt of a life of luxury but now they don’t know where to duck.
The financial analysts and the reassuring noises by policy makers had lulled them into believing till early this year that the good days would last forever little realising that the story could go horribly wrong in six months. Such was the euphoria, that those cautioning prudence were seen to be Cassandras of doom.
Ben Benarnke, the Fed chief and Paulson, the US Treasury Secretary, the two people at the top of the heap of the global financial markets were assuring one and all in August 2007, at the start of the sub-prime crisis that matters were under control. Not till February 2008 did Benarnke suggest that something was remiss. It was on September 19, 2008 that both said that the USA faced a deep financial crisis and that the $700 billion bailout package was necessary to save the system from collapse. But with the system continuing to spin out of control, is there a con game all the way through?
The Finance Minister and the Deputy Chairperson, Planning Commission, the two worthies in charge of the country’s financial planning, followed a similar path, assuring the country that India is insulated and that growth would remain intact at around 8 per cent while it can slip to 5 per cent or less.
On October 8 with international markets tumbling, in spite of the coordinated intervention by the central banks (an unprecedented step), Indian markets also followed suit. They stabilised because of the old game of government-induced intervention by certain institutions. The Finance Minister came out of a Cabinet meeting to say, that there was nothing to fear and more liquidity would be infused into banks. He said that Indian banks have strong balance sheets and no one need worry about the safety of deposits. The FM, a lawyer-politician is no economist and maybe excused for not comprehending what is going on.
But the Deputy Chairperson is an economist. He is reported to have said, “ … when normalcy is restored (in global financial markets), normalcy would also be restored to stock markets”. He apparently added that stock values are not a measure of the country’s economy and that stock markets are always more volatile. What a turn around? The government was till recently suggesting that the stock market rise reflected the economy’s performance. However, it is the first statement that needs analysis since it is vacuous.
When would normalcy be restored in global markets? It does not appear to be in sight. In spite of the trillions of dollars being poured in by governments a collapse has set in. In February, a tax cut of $ 160 billion was said to be adequate and then a few hundred billion dollars to take over Fannie Mae and Freddie Mac and AIG was thought to be adequate. Next, $ 700 billion was thought to be adequate and then a coordinated rate cut but the markets continue to collapse. As mentioned in this author’s piece in these columns (February 6, 2008), this is a case of `too little, too late’.
The situation is a dynamic one with matters deteriorating rapidly and faster than anyone is able to anticipate. As argued by Kaldor, once expectations turn negative, nothing helps and that seems to be the current world situation. There is a complete lack of trust so that institutions are running scared, the financial markets are in a state of freeze and liquidity has dried up. Further, the real economy which was already slowing down in 2007 has rapidly gone further downhill. The US has lost close to a million jobs. Now even the IMF has woken up and predicted a slowdown/ recession. The implication is clear that with the real economy sliding, profits all across will tumble and businesses may go broke. Under the circumstances, all investments are uncertain and financial markets already in turmoil can hardly revive. Even companies and banks that today look safe may rapidly sink into losses.
The recent past is a good guide to all this. Even in June 2008, the demise of WaMu, Lehman Brothers, Merrill Lynch etc., the nationalisation of Fannie Mae, Freddie Mac, AIG etc., and the spread of the contagion to Europe could not have been imagined. The decline of Dow Jones to below 10,000 or that of Sensex to below 11,000 were in the realm of impossible. One of the big Indian private banks is 19th in a list of 36 risky banks in the world. Even tiny Iceland faced bank failure. Not only has all this happened, much more is feared in spite of the various packages.
A projection of all this into the future is frightening and a turnaround is not in sight. Hence when the Deputy Chairperson of Planning Commission said “when normalcy returns” he should honestly also add that there are few prospects of that in the near future and no one really knows when that may happen. Was the public being conned?
Analysis of the international financial markets over the last 20 years suggests that an unsuspecting public has been conned. Many were sucked in by greed and invested in unsafe instruments (even the Chinese Central Bank) due to the con job pulled off by the financial experts/advisors. The FBI is reportedly investigating Lehman, Merrill and AIG for possible fraud. While the markets rose, everything seemed to be as scripted but few asked what if the script went horribly wrong as it has done now. Even the most savvy financial experts have lost because they had also conned themselves and invested in the instruments that are now sinking. An NRI steel tycoon is reported to have lost over $16 billion in the last four months in spite of his battery of financial advisors.
The financial sector is not buying the turnaround story and continuing to collapse. It cannot trust others in this dynamic situation where what is apparently safe today can be risky tomorrow so that any investment can turn bad and they can themselves be the next victim. Hence, government bailouts are being treated as good to clean up one’s own balance sheet and improve one’s situation but not good enough to trust anyone else.
The nightmare of a bad script is with us but the con job continues. Rather than admit that the problem is systemic and needs an overhaul, policy makers the world over are busy fire fighting and not doing a basic reassessment which would require a change in priorities. They are attempting to shore up the collapsing financial structures which seem to be beyond repair and ignoring the real sectors of the economy which could react to stimuli much more quickly. A paradigm shift is called for but that requires a mind set change which the current breed of policy makers are proving to be incapable of because of their predisposition(s).
Tuesday, September 30, 2008
The US Financial Crisis: Collapsing Sand Castles
The US Financial Crisis: Collapsing Sand Castles.
Arun Kumar.
Published in The Tribune, September 30, 2008.
Since August 2007 the crisis in the US financial system is big news. It is the deepest crisis in the last eighty years. Initially, the US establishment denied that there was a crisis. A deteriorating situation forced a financial package of tax cuts and bail out of Bear Sterns. Then came the crisis of the two housing mortgage giants, Freddie Mac and Fannie Mae. After much dithering the government took over these two companies to prevent a collapse of the US financial system. From not admitting to a crisis to accepting that if it did not act, the whole financial system could collapse was a long journey for an admittedly right wing government that has preached to the rest of the world the powers of free markets.
There followed a sigh of relief in the financial markets that they had escaped the inevitable collapse. But that was premature since three of the biggest global financial players collapsed. Lehman Brothers filed for bankruptcy; no one was willing to buy/bail it out. Merrill Lynch was sold to BankAm for a bargain price and AIG was almost on the verge of collapse and with that it appeared much of the financial system was teetering on the brink. Again after dithering, the US government stepped in by putting together a bail out package. The markets recovered.
However, confidence was now at such a low ebb that no one was willing to trust anyone else and lend to them. This has undermined the financial systems because they run on trust between institutions that lend and borrow amongst themselves. There exist layers upon layers of financial assets with little solidity because all the actors were building castles in the air and convincing each other that they were solid - much like the kings clothes which did not exist.
The inevitability of a collapse of the US financial edifice is now apparent to the policy makers in Washington and the financial institutions all over the world. Hence the US government and the Legislature are putting together a massive $700 billion bail out package for the financial industry. Counting all the bail outs in the last one year, the government is giving to the financial institutions about $ 1 trillion. This is about $3,000 per US citizen or more than India’s annual production.
However, trouble continues to brew since it is not clear how this bail out package will work? How will the assets be priced in a market where their prices are collapsing? If they are bought at higher than current prices, it would be seen as a dole to the super rich financial players. If the assets are priced at current prices, the crisis would continue with more institutions failing over time. Indeed, news is that Washington Mutual is also going under.
Perceptive analysts have been pointing out that unregulated financial systems are a bubble waiting to burst. Keynes had pointed to this danger and so had Minsky in the late seventies.
However, increasingly over the last 50 years it is the world of finance that had become politically and economically powerful and it manipulated policies to have its functioning more and more deregulated. This accelerated with the onset of Thacherism in the late Seventies. In the Nineties, Greenspan the ruling US deity propagated this philosophy and believed that markets are self correcting – how erroneous.
Diehards suggest that the US government is turning socialistic. But, the bail out is for the private financial markets to stem problems for the real economy. Subsidies are for the rich and not the poor.
The real economy had been suffering due to the collapse of the housing markets, rise in food and energy prices and the consequent decline of the automobile industry etc. Since January, more than 700,000 jobs have been lost. This decline in the real economy is linked to the growing financial crisis - a two way linkage (See this author’s article in EPW of July 12, 2008).
An understanding of the functioning of the financial markets will help analyse the reasons for the collapse. Money is created by deposits and their lending in the commercial banking system. For security, a certain percent of the deposits are held in the Central bank which acts as the lender of last resort guaranteeing the entire system. This assures the depositors that their money is safe and they can get it back when needed. The banks are regulated by the Central bank so that they follow prudential norms.
Outside this regulated system, newer financial institutions, like the Investment banks emerged which started trading in financial instruments. They used their own funds and those of their clients to leverage more funds and buy financial assets. High profitability was assured as long as the prices of assets rose. The movement of funds in the financial markets were hundreds of times greater than the real output. The profits of the financial sector were based both on squeezing the surplus out of the real economy and by creating a speculative bubble which yielded capital gains.
This was an unstable situation. If, for any reason, the asset prices declined then just as huge profits were generated, big losses would follow. Billions of dollars of capital of Bear Stearns, Fannie Mae, Freddie Mac and Lehman Brothers was wiped out in short time and they had to go for sale or bankruptcy.
Three additional factors need to be factored in. First, the low savings rate of the US economy which has meant that the rest of the world holds a large part of the capital in the USA. Secondly, the war in Iraq and Afghanistan has been bleeding the US economy and eroding its asset base. Finally, super profits have been spirited out to off shore banking channels (of which there are 77). Thus, the financial bubble has been backed by a smaller and smaller base of real output and US owned assets.
All this was leading to the decline of the dollar, thereby aggravating the crisis for the US because the rest of the world started to move away from the dollar. This weakened dollars status as a reserve currency. The USA is not able to export its deficits as easily as earlier. The swelling bubble had a crumbling base and the US economy fell into a vicious trap so that even a small disturbance was enough to deflate the financial bubble. The trigger was the collapse of the housing market followed by the sub-prime crisis.
The above also explains why it is the US financial system that has faced a crisis and not that in other developed countries. However, given the global reach of the US financial system and the integration of the markets, the crisis will hit other economies including those of the developing countries. India will be no exception (See the author’s article in these columns, February 6, 2008) with its stock markets in turmoil, FIIs withdrawing money and the leveraged buying by cash rich companies likely to face a crisis.
In brief, given that the US financial assets are backed by a small real base the government bail out worth $ 700 billion is unlikely to stem the crisis. The US budget deficit is likely to balloon and create fresh problems since the rest of the world is unlikely to hold this uncertain asset which can also collapse. The crisis is systemic and a Tsunami is moving in.
Arun Kumar.
Published in The Tribune, September 30, 2008.
Since August 2007 the crisis in the US financial system is big news. It is the deepest crisis in the last eighty years. Initially, the US establishment denied that there was a crisis. A deteriorating situation forced a financial package of tax cuts and bail out of Bear Sterns. Then came the crisis of the two housing mortgage giants, Freddie Mac and Fannie Mae. After much dithering the government took over these two companies to prevent a collapse of the US financial system. From not admitting to a crisis to accepting that if it did not act, the whole financial system could collapse was a long journey for an admittedly right wing government that has preached to the rest of the world the powers of free markets.
There followed a sigh of relief in the financial markets that they had escaped the inevitable collapse. But that was premature since three of the biggest global financial players collapsed. Lehman Brothers filed for bankruptcy; no one was willing to buy/bail it out. Merrill Lynch was sold to BankAm for a bargain price and AIG was almost on the verge of collapse and with that it appeared much of the financial system was teetering on the brink. Again after dithering, the US government stepped in by putting together a bail out package. The markets recovered.
However, confidence was now at such a low ebb that no one was willing to trust anyone else and lend to them. This has undermined the financial systems because they run on trust between institutions that lend and borrow amongst themselves. There exist layers upon layers of financial assets with little solidity because all the actors were building castles in the air and convincing each other that they were solid - much like the kings clothes which did not exist.
The inevitability of a collapse of the US financial edifice is now apparent to the policy makers in Washington and the financial institutions all over the world. Hence the US government and the Legislature are putting together a massive $700 billion bail out package for the financial industry. Counting all the bail outs in the last one year, the government is giving to the financial institutions about $ 1 trillion. This is about $3,000 per US citizen or more than India’s annual production.
However, trouble continues to brew since it is not clear how this bail out package will work? How will the assets be priced in a market where their prices are collapsing? If they are bought at higher than current prices, it would be seen as a dole to the super rich financial players. If the assets are priced at current prices, the crisis would continue with more institutions failing over time. Indeed, news is that Washington Mutual is also going under.
Perceptive analysts have been pointing out that unregulated financial systems are a bubble waiting to burst. Keynes had pointed to this danger and so had Minsky in the late seventies.
However, increasingly over the last 50 years it is the world of finance that had become politically and economically powerful and it manipulated policies to have its functioning more and more deregulated. This accelerated with the onset of Thacherism in the late Seventies. In the Nineties, Greenspan the ruling US deity propagated this philosophy and believed that markets are self correcting – how erroneous.
Diehards suggest that the US government is turning socialistic. But, the bail out is for the private financial markets to stem problems for the real economy. Subsidies are for the rich and not the poor.
The real economy had been suffering due to the collapse of the housing markets, rise in food and energy prices and the consequent decline of the automobile industry etc. Since January, more than 700,000 jobs have been lost. This decline in the real economy is linked to the growing financial crisis - a two way linkage (See this author’s article in EPW of July 12, 2008).
An understanding of the functioning of the financial markets will help analyse the reasons for the collapse. Money is created by deposits and their lending in the commercial banking system. For security, a certain percent of the deposits are held in the Central bank which acts as the lender of last resort guaranteeing the entire system. This assures the depositors that their money is safe and they can get it back when needed. The banks are regulated by the Central bank so that they follow prudential norms.
Outside this regulated system, newer financial institutions, like the Investment banks emerged which started trading in financial instruments. They used their own funds and those of their clients to leverage more funds and buy financial assets. High profitability was assured as long as the prices of assets rose. The movement of funds in the financial markets were hundreds of times greater than the real output. The profits of the financial sector were based both on squeezing the surplus out of the real economy and by creating a speculative bubble which yielded capital gains.
This was an unstable situation. If, for any reason, the asset prices declined then just as huge profits were generated, big losses would follow. Billions of dollars of capital of Bear Stearns, Fannie Mae, Freddie Mac and Lehman Brothers was wiped out in short time and they had to go for sale or bankruptcy.
Three additional factors need to be factored in. First, the low savings rate of the US economy which has meant that the rest of the world holds a large part of the capital in the USA. Secondly, the war in Iraq and Afghanistan has been bleeding the US economy and eroding its asset base. Finally, super profits have been spirited out to off shore banking channels (of which there are 77). Thus, the financial bubble has been backed by a smaller and smaller base of real output and US owned assets.
All this was leading to the decline of the dollar, thereby aggravating the crisis for the US because the rest of the world started to move away from the dollar. This weakened dollars status as a reserve currency. The USA is not able to export its deficits as easily as earlier. The swelling bubble had a crumbling base and the US economy fell into a vicious trap so that even a small disturbance was enough to deflate the financial bubble. The trigger was the collapse of the housing market followed by the sub-prime crisis.
The above also explains why it is the US financial system that has faced a crisis and not that in other developed countries. However, given the global reach of the US financial system and the integration of the markets, the crisis will hit other economies including those of the developing countries. India will be no exception (See the author’s article in these columns, February 6, 2008) with its stock markets in turmoil, FIIs withdrawing money and the leveraged buying by cash rich companies likely to face a crisis.
In brief, given that the US financial assets are backed by a small real base the government bail out worth $ 700 billion is unlikely to stem the crisis. The US budget deficit is likely to balloon and create fresh problems since the rest of the world is unlikely to hold this uncertain asset which can also collapse. The crisis is systemic and a Tsunami is moving in.
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