The other day I was reading Ashani Sanket, a novel by Bibhutibhushan Banerjee, which dealt with the atrocities of undivided Bengal during the time of famine. I was moved to read that despite plentiful rains and good harvest, rice, the staple food there, had become unaffordable by thousands of people. The price rise made the situation even worse.
What all is happening in the financial world in the emerging economies is similar to the plot of the story. Not only has the financial sector in the west been trampled underfoot with economy crashes all over, it has had its fair share of impact on the Asian markets as well, with India also getting a fair amount of shocks, and the most surprising fact is the ferocity and swiftness of the impact.
A few years back, Fed Bank in the United States was following a monetary policy where the govt was offering plenty of credit at affordable rates. As it happened, the property prices rose, even those who could not afford to buy got enticed by the predatory lending practices and bought properties. However, it so happened that with the rising interest rates, declining property prices and a slowing economy, people resorted to defaults while repaying back.
It was mainly the institutions that had significant investments in mortgage backed securities created on a pool of assets that were hurt most. Moreover, institutions that had sold credit derivatives started incurring huge losses as credit worthiness of the real estate sector went into a turmoil. Lastly, the very fact that institutions had financed their positions through high leverage in the form of short term borrowing added to the already existing financial chaos. This move forced them to follow a policy of refinancing their positions frequently. However, as asset prices fell, these institutions found it hard to do the same. Eventually, the cost of funding start going up but a point was reached when it became impossible to make the funds available.
This contagion which began in United States is gradually making a headway towards Europe and is threatening to eat up the rest of the world. The question is- Where to take refuge? Who is going to help? And even as governments from all over the world try their level best to restore order in their respective financial industries, what is actually needed is some sort of a new world order that can at least minimise, if not isolate, the adverse impact of one country on the global economy. Impossible? Probably. But all the more essential.
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