Ten years of Global Financial Crisis – 3/3: Back from the brink?

The global tsunami

• Developed economies were more affected since their banks were more integrated in the US system. PIGS - their heavily indebted southern European cousins – Portugal, Italy, Greece and Spain – were also affected. They needed to be bailed out by the European Union – mainly, Germany. Greece and France experienced riots on the streets.
• A rich country like Iceland declared bankruptcy.
• Dubai – whose extravagant real estate projects were finance by borrowed money - had to be bailed out by Abu Dhabi.
• 30 million became unemployed - half of which in the Western world. Many exports-dependent Chinese factories were closed leaving 15 mio Unemployed. Chinese too went on the streets. Not surprisingly, the news did not get much publicity.
• Major companies were affected – with liquidity crisis, new capital investments came to a halt.
• World trade reduced and commodity prices crashed
• Homelessness, inequality, poverty increased. A lot of money which could have been used for fighting poverty and diseases, handling environmental causes - was used to bail out irresponsible banks and corporates.

How India fared during the crisis?

BSE Sensex crashed from 21000 to 8000 points. FIIs (Foreign Institutional Investors) pulled their money out of the financial markets. Indian Government too had to pump in equivalent of USD 4.5 billion in the economy.

India was affected, however not as much as many other countries. Prudent Reserve Bank of India policies and regulations of – not-so-easy cash, and not-so-cheap credit helped us control the damage better. Our dependence on domestic economy rather than the export markets insulated us to an extent.

What caused the crisis?

• Excessive deregulation: Neo-liberal belief that “markets will self-regulate”.
• Competition between London and New York for control over financial markets. This led to accelerated deregulation in order to attract the bankers.
• Conflict of interest – Investment Banks, Rating agencies, Insurance companies.
• Lack of transparency: Excessively complex financial instruments led to a loss of visibility in the risks, let alone manage those.
• Prevalent Accounting standards: “Mark to market” valuations which let you count your chickens before they hatch.
• Recklessness: Banks operated as casinos – gambled with other people’s money.

Peter J. Wallison, Financial expert, Author, and Adviser to the US Government put it very bluntly – “U.S. housing policies are the root cause of the current financial crisis. Other players-- greedy investment bankers; foolish investors; imprudent bankers; incompetent rating agencies; irresponsible housing speculators; short sighted homeowners; and predatory mortgage brokers, lenders, and borrowers--all played a part, but they were only following the economic incentives that government policy laid out for them.”

The Recovery

The recovery was slow and painful. Incomes stagnated. It took almost six years for the world to recover substantially. Banks are more resilient and better regulated today. Some major reforms were introduced to not to let such disaster happen again.

As immediate measures – capital injections were introduced by the Governments, and stress tests were performed on the larger banks. Down payments and income verification were re-introduced. Certain anti-speculation regulations got strengthened, certain curbs on bankers’ bonuses were imposed, and regulation of derivatives was expanded. Independence of Central Banks in enforcing monetary and regulatory policies increased. Improvements in accounting and reporting standards were brought in.

Can such a crisis recur?

Certainly “yes”! So long as “greed and fear” exist, unscrupulousness and naivety exist, herd mentality exists - such a crisis in a different form can occur again. Since early 17th century “Tulip Mania” until 21st century “dot-com” bubble – we have seen many bubbles so far. Will excessive use of credit cards and digital money, hype about the new technologies, hysteria about the crypto-currencies like Bitcoin trigger a crisis in the future? Only time will tell.

Lehman Brothers though, have taught us some lessons: to be on the watch-out for the symptoms of bubbles, to control complexities in financial instruments/processes/systems, monitor and, where possible, eliminate conflicts of interest, beware of schemes which are “too good to be true”, and don’t let a spillover of “Wall Street” (financial markets) on the “Main Street” (real economy).

Interested to know more about Global Financial Crisis? Here are two highly exciting documentaries – “Meltdown” by Al Jazeera, and “The Last Days of Lehman Brothers” by BBC.

(Thanks to Investopedia, Wikipedia, BBC, Al Jazeera, WSJ, LinkedIn, EduCBA, MSNBC, youtube)

Part 1: How the crisis evolved?

Part 2: Cash crunch and the Domino effect