Saturday, October 11, 2008

How will we overcome 1800 points drop?

(Dow Jones Industrial Index dropped 1800 points during this week – its worst ever – along with most markets all around the world. It is truly a global shock triggered by Wall Street. Financial fear is unprecedented and like most folks, my friends expressed the anxiety too. During an email exchange about this calamity some questions were raised – is it just one more disaster perpetuated by Bush Administration and will Indian economy be insulated? Below is my response to these questions.)

Blaming Bush is easy, that does not make our 401K any better. Culpability of Democrats is not zero too. However, mainly it is a disaster brought by the 'ideological blindness' - the market theocracy of Neo-Conservatives; market is always right and 'starve the beast called Government' by cutting taxes so that it will not have wherewithal to intervene in Market. Obama is unlikely to be able to solve these problems well, at least in short term. It is only that McCain has potential to continue the same 'market theocracy' or create more mess. (So guys vote Obama!). Now that the politics of this crisis is behind; let us have a look at these problems as adults.

First two quick reactions:

1. No, I do not believe India (and even China for that matter) is in better shape. There are at least 2 reasons for that. The first is books of banks in these countries are not that transparent so it is more of an issue what they are hiding. Already ICICI is blaming why only they are signaled out. Remember the earlier 'loan waver' by Congress government of the tune of $16 Billion (quite a big number for India) for farmers. Even though the Central Gov. is expected to reimburse banks for that, it is hard to believe that process will work through well. For example, most Co-operative banks in Maharashtra are totally bogus (the infamous 'topiwale' sugar factory politics). Point is I am very skeptical that bank books are good. In China, in last few years obscene amount of lending has happened - to construction projects, steel mill, car factories and so on. Can you think of hundreds of Car companies surviving in any economy at any given time? That is the lending reality in China. That is the second issue - equally indiscriminate lending in those countries.

Sure, it is not politically correct to say that Western Banks are bit more transparent than rest of the world; but unfortunately that is the reality. Most countries in the world are hiding this problem. Can you imagine Russian Bank books are any transparent? Question is will those countries open those problems or will be able to ride out problems due to high intervention of their governments. To the extent banking system of those countries is linked to Western Banks; those problems will come in open and that may not be necessarily a pretty picture even if it will be a partial view only.

2. Economically, finally the 'de-coupling' theory is debunked. Many in America (especially the pervert Conservatives) take the pleasure in validation of saying that 'when America sneezes, rest of the world catches the cold'. Asian economies are fundamentally dependent on American and European market for their export and that captive market for sure has dried. Hence precipitous drop in Asian markets. Unlike die hard Conservative, I am not that sanguine about 'agenda setting' power of Western Economies. Because this means to ignore the dependency on debt financing in American made possible by Asia. As a consequence, there will be no more CDOs financed by Japan, China and S. Korea etc.; meaning the ATM of 'home equity' has stopped working for Joe-Six-Pack on Main street. But as mentioned earlier, Asian Main street will be also coming down because of all this.

In short, it is all global and very, very unlikely that any country will be left without any impact.

What does it mean in medium to long term?

At first, I also got the reaction that this is 'end of the world'. But as I think more of it, here is where I am:

- Still it is bit of 'financial issue' rather than complete reflection on real economy. As one currency expert pointed out (Mark Chandler on; it is 'financial recession' rather than 'business recession'. In business recession, first it is the excess supply and then drop in demand. Here, it is drop in finance which otherwise would have supported the real demand. Housing prices would not have collapsed so much when there are so many genuine buyers with real needs if only normal mortgages were available in regular ways.
- But Real Economy will not be that far. It will or already started to get impacted. The saving grace is there is a time lag between Financial Market and Real Economy and that is the window for policy makers to make the eventual impact less severe i.e. to make it into a recession instead of depression.
- So then the question is - are 'policy makers' awake? Until Hank Paulson was saying Economy is fine (and McCain babbling 'fundamentals of economy are strong'); these policy makers were at sleep. Now they have woken up. Congress eventually passed $700 Billion bill and many more measures are taken. Even Paulson has started to talk about 'equity in banks' rather than simply buying toxic loans at premium. Britain and Gordon Brown are showing true leadership here. May be being Chancellor of Exchequer for a decade has helped British PM to understand the true nature of the crisis here. Besides, Britain is aware how perilously they are dependent on saving Banking Industry in London since that being the only competitive ticket left for Britain in today’s world. Further, Gordon Brown has a unique chance to blunt the political challenge of the young rookie called David Cameron in their coming electoral battle. And on and on; I digressed from the main point - British recovery and bailout plans are superior.
- Assuming policy makers continue on this path of surgery and the new Administration in White House does not screw it up further; America and rest of the world can avoid the 'depression' - 25% of unemployment. Recession - that is for sure.
- Beyond that, we all know it is the end of 'gilded age' of Post-Modern High Finance when six Investment Bankers from Wall Street roamed around the globe as White Knights. There will be more regulations (for example 60 Trillion market of Credit Swaps, the insurance of credits to each other); banks will start keeping loans on their books and S&P, Moody and Fitch of the world getting more regulated and have more competition to their rating business.
- It is fairly clear that American Supremacy of Financial World will go away. Rest of the world will not take American word at face value. Meaning, political ground work is created for the world to start working on a global structure. So far Trade and Global Warming were the only two issues which propelled more global co-operation; but now wide spread realization of need to strengthen global financial security will also make countries to come together more.

We will see how it develops. Interesting times indeed.

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