The financial crisis of 2008

The financial crisis of 2008 was uncompromising in its destruction of reputations and unsparing in its treatment of investors, many of whom were blown on the rocks by the forces that ripped through markets.

Across the world, people felt the pain of plunging stock markets through stock market portfolios or pension funds, but several incidents of bad luck, poor timing or financial stupidity stand out among the wreckage.

The scandal surrounding Bernard Madoff, a former scion of Wall Street, is a fitting end to a catastrophic year for the financial sector with an alleged pyramid investment scheme apparently duping billionaires out of millions.

The world’s leading banks, richest investors and even a Steven Spielberg charitable foundation are among the victims of what could end up as a 50-billion-dollar fraud.

Among other notable losers of the year, British billionaire investor and football club owner Joe Lewis was caught conspicuously taking a punt on Bear Stearns shortly before the now-defunct US bank collapsed.

Having made millions betting successfully on the collapse of the British pound and the Mexican peso, Lewis reportedly spent more than 800 million dollars building a stake in Bear Stearns at more than 100 dollars a share.

Bear Stearns was eventually rescued by JPMorgan Chase which paid 10 dollars a share — less than the estimated value of the group’s Manhattan office building.

In Germany, Adolf Merckle, formerly owner of the world’s 94th biggest fortune according to Forbes magazine, lost a reported one billion euros through speculation on shares in car maker Volkswagen.

In Asia and the Middle East, the managers of state investment funds spent the year watching the value of their ill-timed investments in Western banks in late 2007 and early 2008 — estimated at 50-60 billion dollars — turn from bad to worse.

They stepped forward to help recapitalise European and US banks that had been hit by early subprime loan and securities losses, but following further problems many have since been part-nationalised.

A review of the banks that received cash injections from wealthy Asia and Middle Eastern investment funds reads like a rollcall of the hardest-hit lenders.

China Investment Corp (CIC), China’s sovereign wealth fund, bought a 9.9 per cent stake in Morgan Stanley last December.

The Government of Singapore Investment Corp (GIC) invested in Swiss bank UBS and US bank Citigroup. The city-state’s Temasek Holdings pumped billions into the former US investment bank Merrill Lynch.

Abu Dhabi Investment Authority made an investment of 7.5 billion dollars in Citigroup — to name but a few.

Acknowledging the huge falls in the value of Singapore’s investments, Prime Minister Lee Hsien Loong told journalists in early December that the returns would come in the end.

“The situation looks a lot gloomier now than when they went in but these are long-term investments so we will see. It looks under water now but the situation can change,” he said.

The famous US investment banking sector disintegrated, with the bulls on Wall Street humbled and the party of the last few years coming to an abrupt stop.

Goldman Sachs and Morgan Stanley scraped through by turning themselves into deposit-taking banks, Bear Stearns and Merrill Lynch were rescued by takeovers, while Lehman Brothers — the ultimate failure of 2008 — went to the wall.

Former Lehman Brothers chief Richard Fuld suffered the indignity of having his pay packet (300 million dollars since 2000) revealed at a US congressional hearing and suffered a mauling from angry lawmakers.

“While Mr Fuld and other Lehman executives were getting rich, they were steering Lehman Brothers and our economy toward a precipice,” said the committee chairman, Henry Waxman.

There were other examples of bad banking.

French bank Societe Generale revealed staggering losses on derivatives trading of 4.9 billion euros (7.1 billion dollars) in January which were blamed on a rogue trader — the now infamous Jerome Kerviel who has been charged.

In Germany, executives dubbed “Germany’s stupidest bankers” by the press were fired from state bank KfW after authorising transfers of more than 300 million euros to Lehman Brothers shortly before it went bankrupt.

In China, Citic Pacific, the mainland’s biggest state-owned investment company, reported realised and potential losses from unauthorized foreign exchange contracts of 18.6 billion Hong Kong dollars (2.38 billion US) at the end of November.

The real estate market, which has been rising steeply for years in economies such as Britain, Ireland, Spain or the US, also gave investors a hard lesson in economic realities: what goes up, comes down.

In May last year, Spanish property group Metrovacesa reached a deal with HSBC to buy its London headquarters for 1.09 billion pounds only to sell it back to the banking group in December for 250 million pounds less.

Monetary priorities- RBI

Subir Gokarn: Monetary priorities Subir Gokarn / New Delhi September 08, 2008, 0:00 IST The new RBI Governor should articulate policy as soon as possible. Also Read News Now Paper Specials - Mamata ends stir, farmers to get land - Lobbying begins for the last lap of nuclear deal - Capex spends may drop by 30% in FY09 - RBI may agree on release of inflation data on monthly basis - Rising interest rates to eat into infra firms’ profit - Alembic seeks allies in US to double sales More Also Read News Now Paper Specials - Monsoon watch : Will the rains be adequate this year? - Fighting Inflation : Inflation at a 13-year high - Your Money : Personal finance - Credit Policy : RBI’s monetary policy review - Tracking the downturn : Economic slowdown and its impact - Time Out : food, travel, sports, health… More Dr Y V Reddy’s recently concluded five-year term as the Governor of the Reserve Bank of India (RBI) coincided with India’s growth surge and its increasing global significance. Not surprisingly, then, the period has also been one of very fundamental changes in the domestic macroeconomic environment. Dr Subbarao’s assumption of office is an appropriate time to take stock of the how the previous regime dealt with them and what this means as far as what the priorities of the new regime should be. The most immediate priority is, of course, the management of the business cycle, whose downturn phase the economy is clearly in right now. The dynamics of the cycle have become quite complicated with the inflationary pressures that became visible earlier this year. When the RBI began to seriously clamp down on liquidity towards the end of 2006, the compulsions were quite different. The economy was seen to be overheating and, therefore, amenable to policy actions that would bring inflation under control by reining in inflation. In fact, around the world, 2007 was supposed to see a peaking of the cycle and central banks were getting ready to move to a neutral stance, or even begin reducing policy rates, in 2008. The massive rise in oil prices, accompanied by sharp increases in the prices of other commodities, changed that outlook rather abruptly. With the exception of the US, where the Federal Reserve had to cut rates sharply at the beginning of 2008, other central banks were compelled by the inflation surge to prolong the tightening phase of their interest rate cycles. That compulsion has not abated as yet. Its impact on growth has become increasingly visible, even as the inflation rate remains uncomfortably, even dangerously, high. This rather undesirable combination of slowing growth and high inflation can be seen as a failure of the policy approach, inducing the new regime to change its stance. There are significant lessons to draw from recent experience when making this decision. The ability of relatively small, calibrated policy measures to significantly influence demand and, consequently, GDP growth, has been amply demonstrated over the past year. This attests to the efficiency of the mechanisms by which policy measures impact economic activity. The more efficient these mechanisms, the less drastic policy measures need to be and, consequently, the lower the risks of making the wrong moves. The course of action that the RBI chose does have both an analytical underpinning and an unavoidable trajectory. The paradigm supporting the policy stance is, quite clearly, one that requires the central bank to keep its focus on the medium-term rate of inflation, not just the immediate. This, in turn, requires a predictable policy response every time the inflation deviates from a benchmark — call it the target rate, the comfort zone, the neutral zone or whatever. Failure to respond in the manner predicted will confuse investors and consumers, perhaps enough to influence their long-term decisions in ways that are adverse to the economy. On the other hand, making the predicted response will re-assure the same groups that the deviation is very likely to be temporary. Predictability is the key word here. Having followed the monetary actions of the RBI relatively closely over the past five years, I saw improvements in the ability of people to forecast its policy actions. While central bankers may derive some satisfaction in their ability to surprise markets and Dr Reddy was sometimes characterised by the media as one such, I think that, over the five years, the RBI’s monetary policy announcements, with maybe a couple of recent exceptions, were both increasingly predictable and consistent with the behaviour of macroeconomic indicators. This is where the trajectory comes into play. Once a course of action has been selected, even if one disagreed with it to begin with, changing course mid-stream can often do more damage than following the path to its logical conclusion. From this perspective, Dr Subbarao’s statement that he would put priority on anchoring inflationary expectations is significant. It can be interpreted as a signal that he will continue with the current stance, reversing the interest rate cycle when the inflation rate appears to be converging with the benchmark. Let us turn to a second set of milestones, which were in sharp contrast to the predictability that I attributed to the monetary management regime. These are with respect to the exchange rate. For the first three and a half years of Dr Reddy’s term, the stance towards the rupee was one of robust resistance against the pressures of appreciation that resulted from India’s emergence as an attractive investment destination. Accumulating foreign exchange reserves and sterilising them to prevent an explosion of domestic liquidity was something that all our neighbourhood emerging economies did and that perhaps provided some justification for us doing the same thing. Whether this was an efficient way of dealing with the situation, particularly when the drivers of growth were primarily domestic is a legitimate question. However, that is in the past and we should focus on the developments during 2007 and 2008. First, with a significant reduction in intervention levels, the rupee appreciated sharply, evoking both howls of protest and cries of joy. Then, just when it seemed to have stabilised, the impact of the global financial turbulence on capital flows into emerging markets caused the rupee to depreciate sharply. It is now lower than it was when the gyrations began last March. The problem essentially is that the stated position of the RBI — that it manages volatility but not the level of the exchange rate — is at odds with what the markets believe that it does. Massive reserve accumulation and the movement of the rate within a narrow band for such a long period tell their own story as to what the actual policy position is. If the movements of the past year and a half are to be interpreted as an abandonment of the previous regime, no one should have any problems with that, particularly now that the availability of currency futures provides a means to hedge against two-way price risks. But, the most important requirement for a policy to be effective is that it needs to be clearly articulated. That, I believe, has not been done and it should be the priority of the new Governor to do it as soon as possible. The writer is Chief Economist, Standard & Poor’s Asia-Pacific. The views are personal