Cheques and balances

This is verily the Autumn of Discontent for American Financial Capitalism if not for America itself.

This is verily the Autumn of Discontent for American Financial Capitalism if not for America itself. A crisis not witnessed in seventy-five plus years, a country and an economy on the edge of the awful vertiginous precipice of a possible Great Depression 8212; one can easily ask the question, Quo Vadis America.

I happen to be visiting the US giving me an 8220;insiders8221; view. Guess what, I have written three articles and have had to discard each of them as events seem to make them irrelevant. Lehman was followed by Merrill, which was followed by AIG and is now followed by Washington Mutual. The pride of America: its Financial Services Industry, its high wage, high return, high profile answer to departing manufacturing to China and departing services to India is now under assault. And the assault is not from external competitors. The malignancy seems to be inside. Mountains of debt, endless chains of leverage, incomprehensible algorithms of mathematical finance and, above, all the sheer size of the problem leave you wordless and flabbergasted. Millions are a rounding error; billions are the basic unit of accounting; hundreds of billions are a matter of easy discussion; and now trillions are being mentioned in a perfectly natural way.

Let us get back to basics if only to help set the framework. Booms are part of the business cycles of modern capitalism. Booms turn into bubbles when interest rates are low for a prolonged period of time and money and debt become plentiful. Bubbles result in excesses and frenzies, when despite all the lessons of history, people start believing that inflated good times can and will go on for ever. When bubbles burst, those who have borrowed indiscreetly and that8217;s a lot of people, for that is what happens in a bubble are unable to repay their debt. A chain reaction develops as their creditors again a lot of people in turn are unable to repay their loans. It takes some time before the downward spiral which is a mirror image of the earlier upward spiral comes to an end. And this adjustment is painful as economic activity invariably slows down, sometimes shrinks described as a recession and once in a while shrinks a lot described as a depression. We know all this and yet we are for some reason unable to steer a course that reduces volatility. This is pretty much what has happened now. How come the highly regarded pundits of academia and their highly paid counterparts in business could not or did not anticipate all this and ensure a less precipitous outcome?

The fact is that many people did see this coming in general terms. The truth is also that no one could predict exactly what would happen in any granular detail or what the sequence of events would be. This is why economists begin to resemble my friendly astrologer in Chennai who once told me that even in bad times good things could happen and vice versa. This 8220;wise8221; prediction was not very useful to me, but at that time sounded vaguely reassuring. Many people knew that the bubble was unsustainable and that when it bursts the cost of the transition in the post-bubble world would be loss of wealth and real economic pain. All of this knowledge of the cunning corridors of history has been of limited use.

Now that the bubble has burst and as each day, each week many sub-bubbles are bursting, what are we to do about all this? The chairman of the Federal Reserve, Ben Bernanke, is an economist who has done a lot of research on the Great Depression. His biggest concern is to ensure that through action or inaction the present situation does not result in a repeat of the grim thirties. It is with this in mind that he has saved Bear Stearns, Fannie Mae, Freddie Mac and AIG while encouraging shot-gun marriages for Merrill and Washington Mutual. Many are puzzled as to why he did not save Lehman. I am not. There was plenty of notice with respect to Lehman so that creditors and counter-parties to transactions with them had considerable time to make adjustments. And there is some evidence that Lehman could have had voluntary recapitalisation but chose not to go ahead. In these circumstances, drawing a line as to where the Fed will intervene and where it will not is a good signalling mechanism.

As the Federal Reserve itself started looking short of capital, Bernanke has turned to the US government. Treasury Secretary Paulson tried to push through with some celerity a 700 billion proposal whose contours can charitably be described as vague. The 8220;cheques8221; and balances of a democratic order were set in motion as the parliamentary procedures of the US Congress took over. And all of this happens with the media exposing every detail of the negotiation almost in real time. One must admire the workings of a democratic system. It may not get everything right. But the fact that these matters are required to be discussed openly and need different institutions to agree

reduces the risk of bad decisions while admittedly not eliminating them altogether. A democracy is like a biological organism that can adapt and evolve, not like a machine which once broken cannot be repaired.

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I sit back and think of the UTI problem some years ago in India and how despite the tremendous pressures in Parliament and the media or was it because of these pressures? the Government of India did a first rate job. Middle-class investors were reassured. Potential market panics were contained. And over time the government actually made a profit on the transaction. Messy democratic processes did work and we should be proud of that. I like to bask a little bit in reflected glory by telling anyone who will listen that Damodaran the architect of the UTI success was my senior in college. Dear Reader: At least I went to the right college. Don8217;t you agree?

The writer divides his time between Mumbai, Lonavla and Bangalore jerry.raoexpressindia.com