“The standard explanation is very simple. The American housing sector acts as a compressor to its economy, which in turn acts as an engine for the global economy. Now as the compressor malfunctions the engine splutters.” That is how Raju put it across in simple metaphor to me. Despite my assurance to Raju that I basically understood the problem, he went on, as is his wont explaining the finer details. “As financial institutions and banks had lent to NINJA – No Income No Jobs Assets – borrowers, they knew pretty well that they were lending to high-risk category. The assumption was that they were lending for creation of assets, which were continuously increasing in value. Naturally they did not bother about the track record of the borrowers, their credit worthiness or their ability to repay.”
Needless to emphasise this was done to earn a higher rate of interest. As the housing market in US collapsed, borrowers defaulted and banks and financial institutions suddenly found that they were holding the wrong end of the stick. As everyone panicked, it began to create a stampede to exit the market. And to boost liquidity to meet repayment, institutions began offloading their global holding. No wonder markets across continents gyrated. “Yeah I too understood the problem. After all every pink paper and white paper carried out the issue pertaining to the sub-prime in graphic detail in the past week or so.” I pointed out to Raju. After all I read these dailies. Yet Raju was unimpressed.
His face was a dead give away. I knew he had something up his throat. I impelled him to clear his throat. “Narada,” he said after some moments of silence and added clearing his throat “as you may be aware the American financial sector is governed by phantoms who masquerade as investment bankers, hedge funds and so on.” “So,” I interjected, knowing fully well that I need to goad him further. “Narada, the American economy requires approximately USD 2.5 billions per day to stay afloat. When you are dependent on other’s money to this extent you can afford to be reckless. This is the fundamental truth.” Now it was my turn to remain silent. As I powered my grey cells to get the import of what he meant, Raju continued, “Narada, the problem with the managers in the global financial system is that their pay is intrinsically linked to their performance. In effect this means profits are privatised while losses are not. Naturally, this encourages the US financial sector to be reckless.” “But Raju,” I interjected, “your suggestion that the financial sector in the US is reckless is a rather simple and innocent argument. Unlike in other parts of the globe, there are auditors, rating agencies and other regulatory mechanisms to take care of any delinquent behaviour of players in the US.” Raju smiled and it was pregnant with a billion meanings. I pressed for an answer. “Narada understand that the arrangement between players is so delicate that it hardly leaves anyone independently. In fact in the present arrangement no one can act in a professional manner. Rather, the manifestation of the sub-prime problem is a clear indication that some watchdog has not done its duty. After all, dogs don’t bark at Phantoms, especially when Phantom know how to tame dogs.” “Are you then suggesting that what we know is a mere tip of the iceberg about the sub-prime crisis?” I enquired fearing the worst. “Yes,” he said without hesitation. Was he a prophet of gloom or was he a cold-blooded analyst telling me what he honestly believed? I wouldn’t know. Do you?