Shafey Danish
It now looks likely that the worst nightmares of economic pundits would indeed come true. Headlines have been screaming about ‘bloodbath’ and ‘carnage’ on the money street. Imaginative copywriters have dubbed Dalal Street as ‘Halal street’, post Tuesday`s fall.
All of it may still prove to be a lot of scare-mongering with the market bouncing back tomorrow; but it looks unlikely that the underlying problems would be resolved with the same ease. The US hasn’t decided whether it should call the acute economic crisis it is facing a ‘recession’ yet, but the pain is quite evident. Fed on Jan 22nd had to slash rates by 75 basis points.
And the contagion is spreading. All those countries that depend on the US to fuel their economy would soon start feeling the ill effects of the turmoil. In fact they are already. India, in the post liberalization era too cannot stay immune from global economic upheavals.
Subprime loans
All of this of course, started with the Subprime crisis. For a long time the US economy was fuelled by the housing boom. It was during this period that a great many loans were given to borrowers who in normal circumstances would not have been eligible. These were people with lower incomes or bad credit history. Loans to such borrowers were termed ‘subprime’, which is actually quite self explanatory.
The housing boom was fuelling the economy, so the then Fed Chairman Alan Greenspan looked the other way as a bubble developed (and then looked set to burst) in the housing market. Buyers bought houses at high prices – made possible only because loans were cheap and easily available – on the hope that they would be able to resell or remortgage the house for a still higher price.
This was the idea, as it turns out, behind an alarmingly high number of house purchases. At a certain point prices ceased to climb further. Those who owned houses at that point were left without the option to resell it and they had no way of paying back the loan with which the house had been bought. Banks had to foreclose and sell the houses on the market to recover loans. But house prices were falling and banks were unable to recover their money. They lost money and so did the hapless buyers who had entered the market late.
This is one part of the story.
The other part is the story of what happened to the loans that were taken to buy these houses. The banks did not keep the loans in their hands. They sold it to third parties as mortgage-backed securities (MBS). It is was here that rating agencies, like the Moody’s played a part. They certified these highly risky bonds as ‘AAA’ which was to say, they were safe to invest in. As a result losses were spread far and wide. The loans were sliced, diced mixed with other loans, made into a package deal of the sort that investment banks salivate at, and sold.
With the result that now nobody knows exactly how much exposure investment firms have had to the toxic loans. Investment funds have disclosed billions in losses. Heads have rolled including those of the CEOs of Citigroup and Merrill Lynch.
All this in itself is pretty bad. But the really worry is that it hides something much deeper and sinister than the present crisis, which bad as it might be would pass away given time.
If it turns out that the housing bubble was created specifically to prevent the market from slumping when the tech bubble burst, and contributed to keeping share prices artificially high, then the ‘correction’ could well see stocks fall so low that it would be something histroric.
