Tag Archive: AIG

With G-20 reigning in on banks to curb executive pay, they seem to have lost focus. The trouble never started because of excessive pay, but because of failed regulation. The crisis began with the mortgage market and more specifically with what is called a Credit Default Swap(CDS) or in simple terms an insurance that protects the loan (principle/interest or both) from default.

The basic assumption being- Home prices will never fall led to several large players (Lehman, AIG etc) writing (Guaranteeing) CDSs without assesing the risk properly. It’s simple, even if one amongst the competition feels that home prices will never fall, he will start to undermine the risk in writing a CDS (Hence underprice it) and as opposed to his product the ones provided by other peers would seem overpriced, although they might be the ones who assess the risk in a proper way. As a result, all the CDS business comes to just one firm (the one that underestimates the risk). Hence the situation forces all firms to go out of business, either in the beginning (by not underpricing the risk and therefore losing out on competition) or later (like in the case of Lehman and AIG). The problem was that none of the regulators noticed this anomaly nor did the industry practice any self regulation. The case for self regulation doesn’t exist becuase it just takes one rogue company to prevent the industry from acting responsibly. What the G-20 really needs to do is ensure and promote good risk management through a regulator and self regulation.

As a result, you have a housing bubble that would’ve otherwise harmlessly corrected itself and not caused the biggest recession since WW II. The timebomb that ticked on for 7 years could have been dealt with long ago, just that the authorities were in denial and so were the so called “giants” of wall street.

So who is to blame? The regulators or excessive pay? It’s time to find a sustainable and logical solution, reducing pay won’t make the game less riskier. If at all it might create a situation where executives will take to riskier ways of making money for their organization and personal bank accounts.

It’s been almost a year now. The domino effect of the sub-prime crisis shattered the global economy. It first started with the fall of Lehmann Brothers. Bank of America gobbled up Merrill Lynch in a desperate fire sale. Fannie Mae and Freddie Mac had to be bailed out. And if that wasn’t enough, even the financials giants like Citigroup and AIG were resurrected from what seemed like certain death.

The waves of this financial tsunami swept through the entire developed world. Even developing countries India weren’t spared of the consequences. So from the highs of 9% + levels, the GDP came crashing down to 6% levels.

To tackle this slowdown, the Govt. of India and the RBI came out together in full force. Acting in unison with the other central banks, the RBI pumped in massive amount of funds into the system. It ensured that the lending rates to borrowers were lowered substantially to prime up the demand. The Indian govt too played its part. As a part of the demand boosting measures, it unleashed a series of fiscal stimuli. These steps have reduced the pace of the downfall and ensured a soft landing for the Indian economy. However recent economic data suggests that we may soon turn the corner or have actually done it!

After 5 consecutive months of decline, the IIP (Index of Industrial Production) numbers entered the positive territory for the 1st time in May 2009. Industries in core sectors like automobile, cement, etc have posted a stellar set of numbers. Consider this. The sales of the top 4 automakers in India went up by a whopping 33 % compared to a year ago. The country’s second-largest carmaker, Hyundai Motor India, reported a 53.94% jump in sales. Not to be left behind, even the cement sector has been one of the outstanding performers of India Inc. While the profits of the overall sector shot up by 36%, individual companies like ACC almost doubled its net profit. Even the I.T industry – in spite of it’s over dependence on the US economy has managed to post extremely healthy set of numbers. Companies like Infosys and TCS – the poster boys of the Indian I.T industry have expressed a strong confidence of riding out the global slowdown.

But you may ask how is all this going to affect us? In a substantial way! With the placement season round the corner, this piece of news only bodes well for all of us.

Abhinandan Nardekar

BITS – Pilani

Panic is feeding on itself. It’s not just investors, but also the authorities who are panicking. What’s more, after Lehman Brothers Holdings Inc.’s bankruptcy, the financial industry’s spirit has been crushed. Add in a further twist of de-leveraging and one can see why the American International Group Inc. (AIG) bailout hasn’t steadied nerves.

The initial reaction to AIG’s rescue was positive. But the feel-good factor lasted a nanosecond. The authorities were caught between the devil and the deep blue sea. If AIG had gone bust, there would have been mayhem. As it is, the US authorities have looked desperate. As Wednesday wore on, Uncle Sam looked more and more like a tired sheriff who was running out of bullets to shoot the bad guys. The US treasury even had to “bail out” the Federal Reserve by giving it extra cash.

What’s more, the consequences of the last week’s events are only just becoming apparent. The initial reaction to Lehman’s liquidation and Merrill Lynch and Co. Inc.’s takeover was shock. But there are also multiple other effects.

For a start, there are perhaps more than $100 billion (Rs4.67 trillion) of losses on Lehman’s debt. That has caused some money market funds, which investors believe are as good as bank deposits, to “break the buck”. It means investors may not get back the money they put in. That realization has helped accelerate the flight to safety — a rush to buy US treasury bills.

The overall risk aversion, meanwhile, has drained cash from money markets as everybody tries to hoard cash. Banks don’t want to lend to each other. They are also wary of lending to funds, and vice versa. Hence, the central banks’ decision on Thursday morning to flood the market with liquidity that, at least temporarily, stopped the downward spiral.

In addition to money market turmoil, the week’s events have also given another twist to the de-leveraging ratchet. Lehman, Merrill Lynch, AIG and Halifax Bank of Scotland each had huge balance sheets. These haven’t entirely disappeared. But they are all now, to a greater or lesser extent, likely to shrink.

Then there’s the impact on capital raising. The financial system needs more long-term capital. But after Lehman and AIG shareholders were wiped out, it is even harder to raise it.

There are a few lifeboats out there. Merrill clambered aboard Bank of America Corp. and HBOS Plc. has huddled together with Lloyds TSB Group. But even these deals don’t provide new capital. Indeed, the enlarged groups may need further capital to steady their ships. And there aren’t many other strong rescuers out there. Reports that Morgan Stanley has engaged in merger talks with Wachovia Corp., a bank with its own share of troubles, hint at desperation.

Finally, there’s the psychological impact of Lehman’s failure and Merrill’s takeover. It’s bad enough if institutions are cutting jobs; it’s another matter if they go under or lose their independence. This has led to a pervasive sense of gloom among those who make their livelihood in the industry. There are precious few optimists left.

Of course, the darkest hour is before dawn. But when the light starts to shine, the financial landscape will be very different from the one on which it set.

Pranay Jain

BITS – Pilani