Was asked by my boss once as to whether anyone could sum up the reason behind the Global Crisis we all see. To me it seemed simple: Wall street sold products whose risks weren't understood clearly. Agencies rated these instruments as AAA securities cause they didn't understand them and others bought it cause they pretended to understand them.
So the whole world is in a tailspin now. Products created by Quant geniuses who are bad with numbers, MBA's who haven't got their basic economics right, analyst's that predict earnings of others but are not sure whether their own company can survive the downturn. I actually wonder what right does Merrill, Lehman and Morgan have to rate any company. I once told a good friend that Morgan De-rated x company on liquidity issues. He reply was to ask whether Morgan had any idea about their own companies states of affairs.
If PWC messed up with Satyam's audits and issues a more bizarre statement that it's audits cannot be relied on, we all question it's right to audit the books of any company. Don't we?
The point I am getting here to about selling. Various theories have been purported about what led to this credit crisis. The two main points
1. Interest Rates: Obviously easy liquidity and interest rates fuelled the credit bubble along with accompanying surge in Real Estate prices. If interest rates and easing liquidity could propel growth Japan wouldn't have been in a prolonged recession. So don't think interest rates are so much at fault.
2. Complex Instruments: Some have credited it to the complex instruments(CDS's, CDO's) created arrogant newbie "foreign educated" junkies. I don't think so. It's reported that of huge portion of the credit off take was towards people who couldn't afford.
From CNN -
"For instance, in both 2006 and 2007, well over 40 percent of sub prime borrowers were awarded mortgages with either little or no documentation of their ability to pay. With these so-called "liar loans," borrowers did not have to show proof of either earnings or assets."
These problems could happen without these derivatives. In early 90's Indian banks were running huge NPAs. Bank of India had a NPA of 10%. These derivatives didn't exist. The indian banking system especially some large private sector ones run the risk of huge NPAs without having any exposure to Credit derivatives.
To me essentially the problem lies with "Selling". Selling products individuals don't understand, selling theories/opinions that lack basic foundation of reasoning and understanding of financial products and on which risk mechanism evolve. And also the drive for what looks good instead of how reliable it is.
To cut a long story short, - Been reading bloom berg.com and its cousins for the past 2 years and the Eco times for the past 8 years. The quality of opinion closer is far better and superior than Uncle Sam's prodigy. It's kinda like the difference between the suave sophisticated suit wearing investment banker and the very orthodox and conventional Venkateswar,Krishnmurthy, Subramanium types who to me are the best to listen to when it comes to economics. Ask an tie-wearing ICICI salesman on how Fiscal Deficit is linked to inflation and new theories would be sold and sold convincingly. Forget the good ol school classic economics.
Contd to post 2