Easy money blamed for home loan fiasco

Global slowdown amid rising inflation creates uncertainties

The Bank for International Settlements (BIS), located at Basel, Switzerland, is the bank for all central banks and is the oldest global financial institution.. Its views on the global financial crisis, incorporated in its annual report, are worth noting as they also provide an insight into when it will end.

The BIS has for long warned of the dangers of unrestrained credit growth and asset price inflation. It says, “the current market turmoil in the world’s main financial centres is without a precedent in the post-war period.” Along with the resurgent inflation, there are fears that the world economy might be at some kind “of tipping point”.

Why did the crisis happen? The report says, “Loans of increasingly poor quality have been made and then sold to the gullible and the greedy, the latter often relying on leverage and short-term funding to further increase their profits. This alone is a source of vulnerability. Worse, the opacity of the process implies that the ultimate location of the exposure is not always evident.”

Exposure limit not clear

Obviously both internal audit and external regulation failed. Through securitisation, these problem loans were sold far and wide. So much so it is not clear in many cases as to who owns them and how much they are worth. The BIS attributes the long period of easy money and lax supervision as being the principal reasons for the crisis. Many others hold the view that adventurous financial engineering has been the main contributor. The risks emanating from the crisis continue till today. The world economy is at a crossroads. Rich countries are facing deflationary pressures from housing and financial sector collapse. Simultaneously, there is a resurgence of inflation everywhere. There are huge uncertainties even a year after the crisis became global. How long will the boom in commodity prices last? How serious will be the impact of a U.S. slowdown on emerging economies? What is the outlook for the global equity markets, now that a massive exercise at repricing risks is going on? These are other uncertainties linger partly because some or all the underlying problems are unprecedented. Certainly, a global slowdown in the context of high inflation creates uncertainties on a massive scale.

A tradeoff

Official policies geared to meet the risks face a tradeoff between containing inflation and sustaining growth. In the BIS view a general global slowdown is preferable to a sharp inflationary surge. Altogether “macro prudential policies” that will focus on eliminating systemic risks rather than on massive failures at specific institutions are to be emphasised.

The BIS report has plenty of messages for India. The developments in the U.S. financial markets obviously influence the emerging markets. The stock markets in India are the prime example but even commodity markets demonstrate a high degree of linkages across the world. That is why the seriousness of the U.S. financial crisis can never be downplayed in India and other emerging markets.

The financial sector, especially being at the centre of the storm, is grappling with plenty of uncertainties. In the U.S., inter-bank lines of credit have all but disappeared as banks are wary of lending to one another. Capital flows out of U.S. have already started seeking safer sanctuaries. Emerging markets, including India, do not rank high in the list of preferred destinations. Coping with the consequences of the ongoing repricing of risks is one of the biggest challenges in India and other developing countries.

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