Meghnad Desai’s view of risk and risk takers


Six
months ago when the first signs of the financial crisis appeared many were taken
by surprise. It was predictable in principle that after years of cheap liquidity
and a lot of new risk vehicles in which people were investing, sooner or later
something would give way.


The
difficulty with economics is that while one can predict an event is likely to
happen given the various related phenomena, one cannot forecast the date and
time when it will happen. Economists are not astrologers; they aspire to be more
like astronomers. They observe remote movements in markets and map their
dynamics. It is an imperfect science, yet it has some lessons to
teach.


Also at that time last
summer, many were saying that somehow the emerging economies – especially China
and India – had decoupled themselves from the developed country markets and so
India would be spared the worst of the crisis. We know better now. Financial
markets, much more so than real economies, are interlinked by fast flowing funds
which can come and go. This is not worrying because these flows move Sensex and
other indices up and down, but the speed and volatility by themselves insulate
the real economy against these fluctuations. Of course, this assumes that
monetary policy is sound and financial regulation
works.


The financial economy is
global and fast moving; the real economies are integrated only through traded
goods and services which leave a lot of the economy in each country to
experience such shocks with some delay. The 1973 oil price rise was different
because it was a direct shock to the real economy and not via financial markets.
What we have seen is that while there has been turmoil in financial markets it
has had little impact on the real
side.


Those who buy and sell in
the stock markets should know that volatility is the name of the game; indeed
great stock market players like George Soros make their fortunes by being one
step ahead of volatility. If you make losses by the same token that is your
problem. There is no need to rescue rich losers on the stock markets. What we
are seeing on Wall Street now is that when large losses are made somehow the
believers in free markets rush to the government for help. Thus they are
socialists when they make losses and free market fundamentalists in good
times.


The rescue of Bear
Stearns by the Federal Reserve was a prime example of this whereby J P Morgan
got the assets at a throwaway price (even after the recent upping of the bid
from $2 to $10 a share). The Fed has taken a possible loss of up to $25 to $30
billion while J P Morgan only loses at most $5 to $6 billion but then will
profit from its acquisition. This under a government which believes in free
markets! Ben Bernanke has devised a generous injection of liquidity which will
come back to haunt the American
economy.


The Bank of England is
more independent compared to the Fed. Mervyn King, the bank governor, has taken
the correct view that if banks make foolish deals they should pay for any help
he can give them to get them out of trouble. He has been much criticised since
the powerful lobby of the rich players in financial markets and their apologists
in the media and parliament are howling with rage that the bank is not doling
out cheap money.


Northern Rock
was a smaller mortgage lender than Bear Stearns, which was an investment bank,
and when it was in trouble the first step was to assure the depositors that
their money was safe. But after that, instead of giving it to a private firm to
profit from this rescue, the government took Northern Rock over. When it has
paid


off its support loan of
£25 billion it will be denationalised. In the meantime, the shareholders
are likely to get what their shares were truly worth when the firm was rescued,
i.e. zero.


I wish governments
enforced market logic more rigorously rather than helping out risk takers. A lot
of these hedge funds or banks have made money by borrowing a large multiple of
what their paid-up capital is. In the case of Carlyle Corporation, this was up
to 30 times. Leveraging, as this is called, is financed by short-term loans.
While the investments keep going up, the company is happy as are its lenders.


But then suddenly even triple
A securities issued by the US government-backed housing finance companies, Fanny
Mae and Freddy Mack, found that their shares declined massively. Firms, which
had borrowed 30 times, found their value collapsing and their lenders demanding
money on the dot. So a multi-billion company like Carlyle went bust.


Sensex has had its gyrations,
going down to below 15,000 and now struggling back up. This is as it should be.
Stock markets are for grown-ups. As President Truman said in the context of
politics, one can say about stock markets: “If you can’t stand the heat, get out
of the kitchen”. In any case one hopes the government does not give any help to
the losers. It is one thing to help farmers who are in debt, but another to help
financiers who thrive on debt. Let them pay the
price.


The above article has been written by Meghnad Desai – The writer is a member
of the British House of Lords and it only affirms what I have written in my earlier article “Kindly Bear with me”!!!!!

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