A Modern Day Tragi=
c Play
By virtu= e of which much is lost. 2008, year extraordinaire, Annus horribilis, continues to surprise and do so horribly. At every turn, the foibles of the powerful have scripted an epic drama of horror, proving once again how truth can outdo fiction.
This is = no longer a narrative of sub-prime loans made to US home-owners, their travails as ho= use prices fell and adjustable rates re-set higher. Even the story of warehoused mortgage loans and packages Collateralised Debt Obligations (CDO) and the strange golden sheen they had acquired in the financial world are things of= the background. Today it is a generalised financial crisis, its ever-expanding = arms enveloping the citizenry in the US, Europe and most parts of the world. It = has wreaked havoc on asset prices, business and consumer confidence, far beyond the relatively limited ambit of sub-prime residential mortgages and the CDO cit= y built upon them.
What was= it that transformed the nature of the crisis? From a problem with sub-prime US mortgages into a generalised global financial panic? There are two parts to the answer: (1) Event and (2) Process. The event unambiguously was the ill-advised decision= to allow Lehman to fail over the weekend of 12–14 September 2008. The process was the inability of those-in-charge-of-affairs to contain the contagion that was spreading outwards from the sub-prime mess.
The egre= gious bungling that has cost the US (and others) dearly in Iraq has been well documented by Bob Woodward and Tom Ricks in their excellent and eponymous books: “S= tate of Denial” (Simon & Schuster) and “Fiasco” (Penguin).= The financial crisis of 2008 has the hallmarks that characterised the Iraq misa= dventure till the autumn of 2006. Unlike the US establishment in Iraq, the people in charge of that country’s financial sector were unable to change tack = and come up with appropriate solutions. It might be argued that the world of finance is far less forgiving and does not give anyone three years to stew = in the juice of self-made mistakes. But the fact is that those at the helm of = the US financial system did get much more than a year’s grace, and tragic= ally, they blew it.
Remember= that HSBC, in early February 2007, had set aside unexpected and large loan losse= s on its US sub-prime assets in its annual accounts for 2006. Shortly thereafter= New Century Financial Corporation the second largest sub-prime lender in the US said that it would have to restate its 2006 results to account for much lar= ger loan losses and then went on to go belly up just weeks later. If you were in the industry, by the closing months of 2006, the bad smell was strong enoug= h to gag on. Perhaps, the stench did not reach high enough to the Olympian heigh= ts where the people in charge hung out. In any case, they clearly had all of 2= 007 to deal with the problem. No ostensible signs of movement however materiali= sed, until the sub-prime crisis broke into the financial world in early August.<= /span>
From the= earliest days, when trade was being financed by letters of credit (hundi) issued out of Multan and Sidon, from the days of the Flo= rentine merchant financiers and the British financiers who established the Bank of England, what you do with a difficult credit was well understood. If the de= btor was willing to repay, but in some temporary difficulty, the solution of cho= ice was accommodation: That is, to co-share the pain, so that the principal val= ue was protected and a business association was not disrupted. Only when the debtor was able, but not willing, or was entirely unable to pay, was forecl= osure the unavoidable option.
Hence, w= hen by the end of 2006, or at the latest by early 2007, it had become clear that a ser= ious crisis was brewing in the sub-prime residential business the policy response should have been to ameliorate the problem. That is, to bring the lender and the debtor together to re-write terms of the loan so that the debtor could hopefully repay and the loan not turn delinquent. Not all loans could have = been fixed, but many could. The number of homes foreclosed and brought to the ma= rket would have been much smaller and to that extent home prices would not have plummeted as much as it did over the past two years.
When one= class of residential properties begin to plummet, other residential and commercial properties follow suit. Hence, the difficulties in the sub-prime residential segment have brought all property prices crashing down. It has been recently estimated that as many as 1 in 6 American homeowners now find that the valu= e of their outstanding loan exceeds the market value of their homes; that is, th= eir home equity has become negative.
Will the= y all default? Of course, most will not. But it will not be for want of trying, by those who had the ability and the duty, but not the good sense, to prevent = the sub-prime mess from careening all over the place leaving behind a trail of devastation. When so many people see their home equity vanish in smoke, oth= ers see the value of their financial savings wither on the branch, they spend l= ess. Yet others are laid off, are unable to obtain credit and reduce spending and default on their loans. Total credit card debt in the US is believed to aggregate over $1 trillion. As many as 4 out of 10 credit card holders pay = only the minimum charges and most are paying interest at rates close to 20%. Tru= e, the credit card debt problem has been around for some years, testimony to a legacy of bad habits or of its flipside, the resilient hopefulness of Ameri= ca. But this is a bad time to have so much pre-existing stress in household bal= ance sheets, to which to add the current woes of eroded home equity and financial savings and the ill effects of an economic recession.
Without = doubt, it would have been impossible to avert a significant financial correction. But= it need not have been the disaster that it has become and is as yet unfolding.= At the end of August 2007, the US government started a scheme called “FH= A-Secure”, which went nowhere. Unfazed, a second scheme called “Hope Now” = was launched in December 2007, with the similar distinction of an absence of su= ccess. In July 2008 with an authorisation of $300 billion “Hope for Homeowne= rs” was re-launched; it is yet to make a dent. The skill at coining sexy tag-li= nes contrasts starkly with the absence of ability to make a difference on the g= round. Either it is lack of conviction, or of purpose or sheer physical inability = to get a job done, or a mix of all three.
The seri= al bungling of the Bush administration and the devastation it has wreaked is post-partisan. The financial bungling has not only laid the US financial industry and the American economy low, badly hit the rest of the world, albeit to different degrees; it ha= s also wrecked the Republican Party in the forthcoming elections. It now stands po= ised to hand power to absolute Democrat control over both the executive and legislative branches. Of an economy with a quasi-nationalised banking indus= try, enormous public liabilities and a discredited marketplace, of a nation redu= ced in its power and prestige.
Not by t= he effort of its opposition at home and abroad, but purely self-inflicted, through it= s remarkable penchant for bungling and incompetence. As in Hamlet’s final words to Horatio, “… the election lights... On Fortinbras … The re= st is silence”, Exeunt, beari= ng off the dead bodies.
(The =
author is
Economic Advisor, ICRA)
<end&= gt;
Number o= f words: 1,256
Publi=
shed in
Mail Today, Wednesday, 17 October 2008
Saumitra Chaudhuri
ICRA Limited
2F, Bldg 8, Tower A
Oct 16, 2008