The Big Fat Elephant – All set to Break the Shackles

“One needs to break out of the old order to start anew”

Imagine a big fat elephant standing on one thick leg. For years he had been standing on one leg but never thought of unfurling the other legs. One day suddenly he realized that it is wiser to stand on all four rather than standing on one. Breaking out of old habit was tough and it led to lot of unrest  but it was the need of the hour. And you know who this big elephant is? This big fat elephant is the global economy and the one thick leg is the US economy. The other three legs which are unfurling are Brazil, China and India.

Let us trace back how this realization was made by the elephant.

Last decade saw the whole world enmeshed in the web of globalization. At the threshold of the current century the global landscape was ready to witness a booming economical growth. But suddenly all those corporate houses which were- just a wink ago- bustling with profits went bust with corpulent losses. On a closer look one can find that all this was not something that happened all of a sudden as was perceived but had been taking place for a long time.

With the real estate business growing by leaps and bounds, everybody thought of making hay while the sun was shining. Sub prime borrowers(the people with poor credit history) wanted to take home loans from big banks to buy expensive houses which they otherwise couldn’t  afford. But the big banks refused to give them loans as a result of which they approached small institution investors who were rolling in surplus money. They readily agreed and gave adjusted mortgage loans which are loans with variable interest rates. The real estate prices were soaring due to huge investment in the sector and this splurge proved to be a good time for all. With an increase in the number of sub prime borrowers, these small investors took loans from big banks to cater to the demand so these banks were now indirectly a part of this splurge. Everybody believed that housing market will keep booming and they will benefit. This system was, no doubt, yielding a lot of money. But the problem came when some defaulters started to appear. To maintain liquidity small investors took loans from big institution investors’ world wide in return for the mortgage papers of the borrower’s house.

Now the question to ponder is, why would big investors give loans to people who are risky?

There were two reasons: The business was profitable, because even if the borrowers defaulted their houses could be seized to recover the loan money. The second reason was that, these institutions were converting these mortgage papers into bonds and corporate bills and were getting money in return. Not only that, these bonds were also insured by the insurance companies like AIG as they too thought it to be a low risk and high return investment. But the situation became worse when the loan amount exceeded the total cost of houses. The whole economic set up failed as everyone became a debtor and there was nobody to buy houses now-  the housing bubble finally burst and the financial sector faced a liquidity crunch. Tremors reverberated through the system. Investors lost money, insurance companies went bankrupt, industries couldn’t raise money because of liquidity crunch of the banking sector and finally USA, the biggest consumer in the world was brought down on its knees along with numerous industries in developing countries which had fed and grown on had American market.

The effects of all this were more than disastrous, with the first blow coming on 15th Sept 2008 when no knight in a shining armour came to rescue.  Lehman Brothers  declared its bankruptcy, followed by many financial institutions and exposed Achilles Heel of the US banking system.

Each and every walk of life was affected and terms like credit crunch and recession became the talk of every household  as the perceived booming strongholds of economy came down like a pack of cards. Unemployment reached unparalleled heights with 200 million people becoming unemployed world wide. Finally, the government intervened and took some measures to recover from the recession.

Emergency Economic Stabilization Act 2008 was passed and US government bailout package hit $8.5 trillion representing almost 60% of the nation’s estimated GDP. Partial nationalization of banks was done with strict regulation. All these measures stabilized the economy to some extent and boosted investor confidence. And as a result  the economy now seems to be recovering. But before breathing easy we need to look back and see what have we learned from these turbulent periods and along with it, we need to get ready to tackle the emerging Euro Crisis. To prevent the world financial system from Crisis we need to realize that:

* We need to get back to basics- as fundamentals, don’t lie.
* Trading on stock market momentum is fine but do remember that it is just momentary.
* Life altering changes don’t happen overnight.
* Capitalism cannot be given a free playing field.
* Emergence of new countries in the economic scenario is bound to change the way business works when economy picks up thread and starts anew.
* Sole dependence on the dollar is not right so the world needs an alternative to the dollar.

So, arise and Awake ……now is the time for change with the elephant all set to break the shackles of old order.

Manisha Rana