One of the constant criticisms emerging from recent credit crises is that financial engineering does not do any good to the society. To dismiss the whole work stream merely as jugglery that provides intellectual satisfaction to the brainy and a nightmare to the general public is kind of unfair. It’s like saying anything related to Nuclear reactor is bad. It depends on what you using nuclear reactor for. If it’s for power generation then it’s extremely clean and over the extended period of time costs less but if you are to build weapon then kaa-boom.
The securitization phenomenon – the root cause of the whole crises – is relatively new. It was crystallized in 1960’s and picked up the pace in late 80’s and 90’s. The concept is quite simple and intuitive at the core. If you have $100 to lend then you can loan it only to one person (considering the need is $100) or you can create a security out of it and free up the capital. Once you loan $100 at 10% per annum, the expectation is that you will receive $110 at the end of one year. Instead of waiting for one year, you can sale that loan to a third party for $102. You make $2 immediately while the third party makes $8 over the period of one year. Now you have $102 for loaning out. The cycle continues. This is the base logic. Now add thousands of loans together and then sell that product to the third party. The risk is transferred to third party at certain cost and more money is available for business. Securitization is primarily used in mortgages business, where the loans are given for non-liquid assets like buying houses or cars. The type of securitization I explained above is the simplest format and more complex products are built based on customer needs as well as market conditions. This phenomenon has potential to raise huge amount of capital. It also seamlessly matches people who have money with people who need money making debt a tradable liquid asset. The point to note here is that these assets are not as liquid as stock market or bond market. There is no centralized exchange to
So far so good!
The problem actually started when money raised through investor was single handedly diverted towards housing market. The supply of money was far more than actually needed. In short money became cheap. So, folks started building houses or buying houses in the hope the prices will keep going up and there will always be a buyer. That’s when law of gravity started working. I mean, literally! Home is an illiquid asset. You can’t flip it the way you can play with stock market. In the stock market the maximum loss is the amount of money invested. On the other hand, home keeps exhausting money in the form of maintenance cost and property taxes. So, if you failed to sale the house in time then you are pretty much screwed. Obviously default rates rose sharply. This alone shouldn’t have precipitated into a perfect storm. Both the regulators as well as banks knew that this bubble is bound to burst but they kept playing the game till the end. Bankers kept buying, structuring and servicing extremely complex, highly illiquid securitization products. Rating agencies kept their ratings for such products intact. CDS – Credit Default Swap is insurance in the finance world. As the name suggests, in case of default the seller of CDS pays you the money. AIG kept selling such CDS to practically everyone. The concentration risk became very high for most of the bank and yet the risk management departments in any of the banks failed to raise alarm. Regulators refused to even acknowledge that there is any bubble till the end. The economy, specially the size of US, is very hard to handle in short term. But if problem was identified and measures were taken to divert the flow of money into other sectors like renewable energy then that could have averted the disaster.
It is worth noting that not that all the criticism heaped on financial engineering is wrong. When huge amount of money started finding its way into housing market, size of this work stream vis-à-vis others started growing rapidly. It did not employ that many people nor did create any infrastructure. It was basically castles in the air that still created real gains to the investors rational enough to cash out in time. So when the whole thing crumbled there was nothing left and yet it created disproportionately large ripples across the whole economy. All though the whole housing market is valued in tune of couple of trillion dollars, in a typical fashion everyone wanted to get out at once. The result was that the stock market lost staggering 11 trillions worth of value. With short-term debt notes practically ceasing to exists, it all most brought down many companies to halt. New investment froze and new business floundered. The job loss that started in the banking sector soon engulfed all other sectors. People lost their retirement benefits, pension benefits and of course their investment. Wall Street for all practical purposes ceased to exist as three of the five investment banks either went bankrupt or were bought out. It was chaos for sure.
In the end lot of things went wrong at the same time for such a disaster. And I hope that the field of financial engineering is not made into a scapegoat.
Thursday, December 17, 2009
Thursday, December 10, 2009
'Grand'ulkar
I know I know I was the one who wrote “Endulkar” blog some time ago. Call me a hypocrite or anything but at least I am ready to stand up to my fault. One lesson I learned is that no matter what, one should never write off a Champion. Champions are rarest of rare breed and hard to recognize but then Sachin's case is no secret. All though for what ever it's worth I must say that even in my last blog on him I expressed my admiration and respect for him. The reason for my recent epiphany was his blasting against Aussie in recent One Day international. I think it will be huge injustice to him if we see him only through the prism of statistics. Not that he comes out any less in that department. The staggering amount of runs he accumulated puts him in a rarefied air that’s usually reserved for grand masters of any trade. In fact, he doesn’t even have any other company or competition there. There are good players, there are great players and then there is Sachin Tendulkar.
Statistics is just one aspect of his grand career. To get obsessed by it is like getting lost in the woods and missing out the jungle. He started at the tender age of 17 when most of the kids are busy in doing nothing. Most of the kids are obsessed with some sort of sport or some sort of hobby but that’s the extent it goes it. Particularly in India the focus on education is so intense that if by any chance a kid is gifted with skills in certain sport then he or she is surely won’t be using them. But Sachin was one of millions. His early exploits in his school days were legendary by any standards. The way he scored runs and the way he would hit kids of his age around the ground is part of folklore. Of course he was lucky to be born in the city of Mumbai where Cricket has fanatical following. The city has produced numerous cricketing luminaries of international fame. At one point 80% percent of Indian team would hail from Mumbai alone. This helped Sachin in a sense that he was spotted early and was put on fast-track for Indian team. Still to debut against Pakistan in Pakistan was something. Not only you need talent to face Imran, Wasim and Waqar (it was Waqar Younis’s debut series too) but you need balls to stand against the these fiercest rivals. He had first one in ample and he showed second part quite successfully. Thus a star was truly born. But that still doesn’t truly capture his greatness.
The true greatness lies in his consistency. In recently ODI match against Australia it was fascinating to see him batting with Ravindra Jadeja who was born in 1988, merely a year before Sachin made his debut. For last twenty years he is scoring runs in every corner of the world and against every opponent possible. The sheer amount of travel and preparation would bring down mightiest of travelers. Then add the controversies surrounding game, internal team politics and generational change in the cricketing fraternity and the true character of a warrior starts to emerge. Oh and did I mention the burden of hundreds of millions of people for whom anything less than a century is a failure? The tremendous love showered on him by public comes at a very steep price.
His endurance, his all most religious zeal to score run and hunger to win for India over the span of twenty years truly makes him the greatest. Yes he scored runs but that’s merely a by product. It only shows that he knows his trade well. He is humble and never makes fuss about his status. He still talks in Marathi and still mingles with commoner whenever it’s feasible. Your truly was fortunate to see him up close twice. He was serene, focused and without an iota of attitude. He still carried his own kit and practiced with local kids (who are certain to tell the tale to their grandkids) telling them to throw ball at him as fast as possible. It was quite surprising to see how he remains firmly rooted in ground in such a limelight for twenty years.
I think he deserves Bharat-Ratna. And it shouldn’t be conferred to him when he is too old to walk but right now when he is still thrilling millions with his skills. I feel fortunate that I was part of the generation that witnessed the legend as it happened.
Statistics is just one aspect of his grand career. To get obsessed by it is like getting lost in the woods and missing out the jungle. He started at the tender age of 17 when most of the kids are busy in doing nothing. Most of the kids are obsessed with some sort of sport or some sort of hobby but that’s the extent it goes it. Particularly in India the focus on education is so intense that if by any chance a kid is gifted with skills in certain sport then he or she is surely won’t be using them. But Sachin was one of millions. His early exploits in his school days were legendary by any standards. The way he scored runs and the way he would hit kids of his age around the ground is part of folklore. Of course he was lucky to be born in the city of Mumbai where Cricket has fanatical following. The city has produced numerous cricketing luminaries of international fame. At one point 80% percent of Indian team would hail from Mumbai alone. This helped Sachin in a sense that he was spotted early and was put on fast-track for Indian team. Still to debut against Pakistan in Pakistan was something. Not only you need talent to face Imran, Wasim and Waqar (it was Waqar Younis’s debut series too) but you need balls to stand against the these fiercest rivals. He had first one in ample and he showed second part quite successfully. Thus a star was truly born. But that still doesn’t truly capture his greatness.
The true greatness lies in his consistency. In recently ODI match against Australia it was fascinating to see him batting with Ravindra Jadeja who was born in 1988, merely a year before Sachin made his debut. For last twenty years he is scoring runs in every corner of the world and against every opponent possible. The sheer amount of travel and preparation would bring down mightiest of travelers. Then add the controversies surrounding game, internal team politics and generational change in the cricketing fraternity and the true character of a warrior starts to emerge. Oh and did I mention the burden of hundreds of millions of people for whom anything less than a century is a failure? The tremendous love showered on him by public comes at a very steep price.
His endurance, his all most religious zeal to score run and hunger to win for India over the span of twenty years truly makes him the greatest. Yes he scored runs but that’s merely a by product. It only shows that he knows his trade well. He is humble and never makes fuss about his status. He still talks in Marathi and still mingles with commoner whenever it’s feasible. Your truly was fortunate to see him up close twice. He was serene, focused and without an iota of attitude. He still carried his own kit and practiced with local kids (who are certain to tell the tale to their grandkids) telling them to throw ball at him as fast as possible. It was quite surprising to see how he remains firmly rooted in ground in such a limelight for twenty years.
I think he deserves Bharat-Ratna. And it shouldn’t be conferred to him when he is too old to walk but right now when he is still thrilling millions with his skills. I feel fortunate that I was part of the generation that witnessed the legend as it happened.
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