The phrase coined in “1984”, a satirical novel on totalitarianism, masterfully written by George Orwell, has its origins in the World War II era. In recent times, it has, however, been associated with the way the US government monitors what its citizens are doing. It is therefore an irony that the same ‘Big brother’ failed to keep an eye out for the biggest punch to the economy. Now, the US government is nursing a whopping shiner, while wondering “Where oh where did we go wrong?”
Well, it all began with the sub-prime crisis, which was in culmination of a number of complex relations made on tricky grounds in the US financial markets. The USA mortgages (i.e. loans given on the condition of keeping an asset, typically a house, as a security) had been made to many subprime borrowers (those borrowers who are judged to have lesser ability to repay the loan based on various criteria.)
When USA house prices started to decline, mortgage delinquencies rose, resulting in the securities that were backed by these mortgages, which were widely held by financial firms like investment banks (including Lehman Brothers) depreciated. This led to a decline in the capital of banks and tightened the credit, in other words, getting loans became difficult. This has led to the collapse or merger of many names that had so far been considered rock steady.
The reasons for this sub-prime crisis can be finally be narrowed down to some main decisions that went wrong; the lending decisions taken by banks and government sponsored enterprises, rating agencies, government’s enthusiasm in pushing low cost housing, the reliance on mortgage backed security and the borrowing decisions taken by individuals or households.
Now, the banks are supposed to be the institution that you can bank upon for finance related decisions. Traditionally, loans were given to only those people who, in normal circumstances, would be able to repay it. The US banks decided to give out loans to subprime borrowers, believing that the house prices would rise in the future, hence hedging whatever risk they were undertaking regarding the inability of the borrowers to repay the loans. The reverse happened, which should have been a foreseen circumstance, as the law of demand and supply governs almost every commodity.
The fall of giants like the Lehman Brothers, Merril Lynch, WalMu, HBOS and many others has been attributed to a much-debated topic: regulation of finance and markets by the government. The new buzzwords for the 21st century economy have been globalization, liberalization and privatization. In fact, the Indian economy has opened considerably since the year 1991, and has benefited from applying these three concepts. But the recent financial crisis has forced every country to reconsider any step that results in deregulation. This involves a paradigm shift of another kind; the one in which pure capitalist economies with a totally deregulated financial set-up are increasing the state ownership and decision making powers, where they had previously scorned at any kind of control over the working of a free market economy.
One of the major lessons learned is that not all globalization and liberalization is always good. If India had not had such a stringently controlled financial system, with bodies like the Reserve Bank of India, Insurance Regulatory and Development Authority and the Securities and Exchange Board of India, today we would probably be in a worse position than Japan’s economy (which is dependent majorly on its exports to US).
The reason why we have the capability to weather the worst economic storm, since the Great Depression of the 1930’s in the US, is that we have regulations that require banks and major financial institutions to maintain transparency and accountability in practices of lending, borrowing and investing. So, in future we must remember that even if the world becomes flat, there are certain best practices that we should not abandon. And while the Big Brother has woken up from sleep and finally started watching the right things, we are to learn from the mistakes and never let down our vigilance.