After the flood

Manmohan Singh told the world to keep an eye on the post-global economic crisis scenario at the G-20 summit in Toronto. This was not only for the purpose of picking up the pieces but also to ensure that another storm doesn’t arrive, writes Jyoti Trehan.

Manmohan Singh told the world to keep an eye on the post-global economic crisis scenario at the G-20 summit in Toronto. This was not only for the purpose of picking up the pieces but also to ensure that another storm doesn’t arrive. The 2008 crises that collectively made up the ‘meltdown’ were precipitated by profligacy, fuelled by greed, rampant in the United States when interest rates, following 9/11 and the Iraq war, had come down to zero. The underlying reason for reducing interest rates in America was to fund anti-terrorist programmes and to mitigate the pangs of the Iraq war. But in a minimally regulated and free-market economy like the US, the zero interest rate regime was abused in the real estate sector, where, while extending loans, even due diligence procedures were not followed. Banks and other financial entities that had been financing the real estate sector at zero interest, taking advantage of highly complex ‘derivative instruments’ into which this debt was packaged, traded it internationally at a profit.

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Of course, to trade them at a profit, many false projections were carried out through marketing strategies supported largely by credit rating agencies. In a sense, in the globalised world, junk was being traded at a profit. As a result, the world was made to pay indirectly for America’s increased spending on countering terrorism and fighting the Iraq war. The US was able to get away with duping the world because of the dollar being the ‘currency of choice’.

The resultant unscrupulous trade practices the US investment banks indulged in worldwide were the now infamous ‘sub-prime crises’. The recent case where the US Securities and Exchange Commission charged Goldman Sachs with fraudulent practices in sub-prime crises reinforces what’s been stated so far regarding the questionable role of investment banks.

But this American strategy of selling junk as valuable security boomeranged due to consequent defaults. A spate of bankruptcies of investment banks or their takeover followed, plunging the US into the economic depression. The rest of the world was also sucked into the depression as a result, with the poorest nations being the worst victims.

And how was the financial world taken for a ride? The simple answer: a lack of transparency in the way the global financial system is structured. Financial havens that dot the world have certain features like tax breaks, banking secrecy, shell banks, shell companies, shell corporations and electronic transfer of money that make financial transactions opaque. Since these financial havens with in-built opacity were extensively used in the run-up to the crises, even economic experts and financial analysts were clueless about the impending economic doom. When the slide into the economic depression had begun, no one could indicate the extent of these crises. Due to the lack of information about the extent of toxic assets, economic analysts kept hoping right till the end that the economic meltdown was not all that serious. Only when the economic bubble, generated by sub-prime lending in the US, burst with the bankruptcy of Lehman Brothers, it became clear that the world was hurtling towards a 30s Great Depression scenario.

Four G-20 summits have taken place since the crisis began. The emphasis in all has been on the need for coordinated action to pull the world out of depression. Steps have also been taken to ensure effective regulation of markets and transparency to prevent a repeat of the manipulations. The Keynesian prescription of stimulating demand by way of injecting liquidity into the financial system has been the strategy for recovery. So far, according to International Monetary Fund estimates, $11.9 trillion have been pumped into the world system. To arrest the onset of runaway inflation, world leaders have also provided an exit strategy to reduce liquidity.

The world economy is still struggling despite occasional, contradictory reports. To what extent the strategy of putting the world on the path of recovery will succeed may be determined by how much we are willing to retread the past and learn from our mistakes.

Jyoti Trehan is Director General of Police, Punjab. He is on the advisory board of the Journal of Financial Crime, UK

The views expressed by the author are personal