Welcome to the brave new world of credit derivatives driven collapses ( AIG being the first victim). A world that is far more dangerous than the world of subprime mortgage derivatives. A complex world that because of its sheer size can potentially cause more damage in a matter of days than the subprime mortgage derivatives caused in their first year in the headlines.
Compare this figure: Global economy: 55 trillion dollars
Credit Derivatives: 65 trillion dollars
Subprime derivatives: 7 trillion dollars
Now you would imagine the results if further trend continues.
Leveraging positions was found as best way to manage risk for say against variation in prices , interest rates etc... Good idea to hedge.
But what took over was a naked greed and unviable risks, unbeleivable competetion, interlinked markets ... all boons of free and globalized economy.
Proponents point out to figures as to how they have contributed to growth of overall markets and economy while shielding the risks... They claim for tighter regulation, better management as opposed to altogther ban.
But i do not think free economy has such tools to do that. Thus i am firm proponent of banning them. I am firm beleiver in "value investing" school subscribed by Warren Buffet. Sound financial advises by him are worth reading. No point in trading positions and creating artificial wealth and taking in calculable risks...
Maybe our Indian mentality of savings, averse to loans out of self respecting notions, prundent sense of value investing can be assets for us which were ridiclued as " hindu rate of growth".
Much details on this thread later..
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2 comments:
Hi Gautam,
Let me take the privilege of being among the firsts to post a comment on your blog. Fortunately this happens to be a topic close to my heart.
The root causes of this problem are more generic. I feel that there are three core problems
1. Corporate culture that encourages bending of rules to make profits
2. Political interference and compulsions
3. Mentality that if asset prices are rising it is good.
To briefly elaborate on above
1. This psyche we see everywhere. Even in hospitals patients are held longer and operated upon to ensure occupancy! In finance it is slightly easier to do this without hurting your conscience. So there is a tendency to hide bad loans and to manipulate credit worthiness of your customers.
2. The focus of the incumbent government is to have economic growth to create jobs. The easiest way of doing this is to increase the credit and print more money. Of course leads to higher inflation and slower economic growth later. But that could be somebody else’s problem if you are not reelected. This thinking we can see in India as well where the present government has given loan waivers, increased salaries to govt. employees, lower taxes etc in an election year.
3. When asset prices are increasing everyone is happy and people want to make quick buck without fully understanding the risks involved. Nobody asks is the price rise sustainable, how is it being financed etc.
To sum up these sorts of problems will tend to crop up time and again as long as we continue to focus on money and not morals, today and not tomorrow.
Thanks Girish for your comments.
I can understand all three points made by you.
Greed, bad governance and individual mindset.
One point i would ask if you think credit derivatives are financial innovation or a frankenstein?
tell me more about defence entrance blog you are running
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