ARTICLE PRESENTED BY K.SRIRAM ON KNOWLEDGE SHARING.

Sub-prime lending refers to lending to subordinated borrowers who do not qualify for the best available market rates due to poor credit history. There is an additional risk-premium attached to this rate to cover default risk (incidence of which is greater) to the lending institutions. Sub prime lending is risky for both lenders and borrowers due to the combination of high interest rates, poor credit history, and adverse financial situations usually associated with sub prime applicants.

Now, what happened (in the recent past, from Aug'07) is that the assets (homes, condos etc…) that were used as a mortgage for this sub-prime lending have since fallen in value (due to the bursting of the housing bubble) and therefore have lost substantial value albeit o/s mortgage balance remaining constant (unchanged) i.e. incl higher interest rate due to riskier funding. Therefore, borrowers had defaulted and banks (incl. inv banks) had taken a huge hit on their P&L and even when the bankers wanted to liquidate the mortgages for foreclosure etc, they recovered only a portion of the o/s balance and the remaining UNCOLLECTIBLE (BAD DEBTS).

A few consequences in US economy in light of these incidents:

1.Economic Recession

2 Sliding $$$$$

3.Inflation

4.FedRes printing money to ensure market liquidity in inflationary times (akin to what happened in the 70s), leading to a potential stagflationary economy.

5.This looks like more of a cyclical correction in the middle of a long-term bull market.

6.Investment banks haven't yet recovered on short-positions on certain derivative instruments (CDOs i.e. collateralized debt obligations / CMOs collateralized mortgage obligations)

Knowledge Sharing

Dear Sriram,
A nice and useful presentation in crisp and condensed manner.

While you are right that sub prime lending is closely related to FIs (Banks), lending money to unqualified borrowers (with poor credit history), I have just one? to ask-Why banks tempt and encourage such borrowers with killing rate of interest. In fact its banks that are responsible for such unethical practice and conduct and invite troubles for themselves and to the borrowers.

Just because banks are dumped with money from investors/depositors. Does it mean they will lend it to any Tom, Dick & Harry of unreliable in nature with bad financial/credit history? What a malady of circumstances and situations!!!!

Mind you, it is not only that the banks levy, super premium rate of interest to its borrowers with poor credit history, but also loads the borrowers with unbearable processing, documentation; pre-EMI fees etc. etc. and ultimately end up with bad debts or NPA to reflect in their P&L and B.S. In fact genuine borrowers with clean track record and credit worthiness are also very badly affected and hit as a result of the bank’s this kind of attitude and approach(This ‘am referring to Indian scenario) particularly by foreign banks and banks under the management of private sector .The element of financial burdens passed on to the borrowers in the interest rate is also jacked up with,over riding commission/out of pocket expenses to be passed on to the so called DSA’s/Recovery Agents(comprising of group of thugs) employed by the banks for their unethical role.-Thank God the Reserve Bank of India has now put a ban on such recovery Agents being deployed by the banks for recoveries, as a result of some of the affected ones having approached the court of justice.

There do exist unhealthy competition on the part of the banks to lure the borrowers to lend money with different rate of interest and other charges “fine printed in terms and conditions” more so with more fine printed with “conditions apply”-offering the borrower to wear the noose, on his neck the borrower being unaware of this. The charges levied by banks even for a little delay in payment of EMI by way of penal interest, delayed payment charges etc are indeed murdering like, of the borrowers.

To set right matters in the right perspective and to extend a sigh of relief to borrowers, the Apex Bank (RBI) should come out with strict guide lines to all banks with stringent penalty provisions for defaulting banks and standardise the ROI for all types of lending and nominal other charges (if at all warranted.). Banks on their part should lend money only after thorough credit worthiness verification, financial standing and backgrounds of the borrower instead of merely satisfying with Identity proof and residence proof of the borrowers.

As far as Home loans are concerned, the bank is no way and absolutely at any risk whatsoever , as the lending sum is restricted to 80% of the property value, and the real scenario being the property value is on spiralling escalation and the bank takes the custody of the original property documents towards financial security. Even on home loans, RBI guidelines and restrictions on ROI and other hidden costs needs to be standardised nominally and introduced for compliance by banks and other lending institutions for strict compliance as this too is as of now under the whims and fancies of banks and lending institutions. The floating rate of interest, the fixed rate of interest being offerred by banks and FIs are a mere gimmick to throw mud and dust in the eyes of borrowers to make them blind folded.

A very simple concept that contains solution to the problem is “Let a man live he will not run away, attempt to kill a man he will run away to escape-the attitude and approach by the banks and FIs are of latter in nature which has got to be eliminated under the control and guidelines of Government/Reserve Bank. If the Government and Finance Ministry is not able to work on this small issue effectively and efficiently how can they look forward to have a growing and efficient overall economy of our country?

Please take note that “Bad debts” are created by banks due to their own “bad” actions and approach and make the bank weak, and we do have instances to our knowledge that such weaker banks merging with stronger banks by way of M&A.Let not the history repeat again as “Self survival is the best survival.”

As far as USA is concerned, all said and done, China just started opening its wide mouth to swallow and gulp USA economically and its symptoms are already visible, it may not happen overnight, but will sooner than later.

Of the US consequences referred to by at No.4, it is highly dangerous and will add to the economical agony of US and put them in peril. The main source of revenue to US by way of sale of arms and nuclear products will also bear set back as their monopoly on these will also be put to constrain.

I think it would be appropriate for me to add an article posted by me in my blog titled “OTHER THINGS BEING EQUAL” with comments from readers as it relates to Economics and ‘am sure you will find it interesting to read.


“The other things being equal” - A good old Economics clause.

My economics teacher used to apply the above clause, ampty number of occasions while conducting Economics class. Those days, being an immature lad with the lack of grasping power added with inadequacy in command over English language, I hardly could understand anything out of his class lecturers.

Later after entering into commercial activities and own business, I started reading books on Economics and articles related to Economics, I started knowing little more about it and have come to a conclusion that “ THE OTHER THING BEING EQUAL” being used in economics seems to have become “THE OTHER THINGS ARE NEVER QUITE EQUAL”. Observe the contrast.

In the present global scenario trade negotiations by countries, by and large looks more like a barter relationship rather than being modern market transactions. Countries are up to mischievous stand to exert as much as they can to extract in the form of not only concessions and advantages but also in the form of information unconnected with the trade negotiations (an unethical conduct). They make short-term alliance and agreements of short while existence to suit and accommodate their convenience. They even conceal relevant information, instead reveal irrelevant information and the end result looks more like a “modus vivendi” burying the principles of “modus operandi”to be based on the logic of economics and trade justice.

There appears to exist uncertainty on agreements arrived at (as I have read in the press reports recently) over the recently held Hong Kong ministerial summit. Please take note that developing countries are no longer going to be succumbed into bartering their interests, leading to economic imperfection and such a situation can either delay or defer decisions, creating economic imbalance. The need of the hour is to make a viable, acceptable trading system by all countries. The existing market solutions will not fit into all cases mainly as a result of power relationship amongst the countries and lack of symmetric of information and this impede the clean flow of simple economic models envisage. It’s now evident that “THE OTHER THINGS BEING EQUAL” will not work out.
While open trade by all countries should be a welcome concept, may place some developed countries into unacceptable position and this can further impede the infrastructure development, Industrial policies connected with economic development and growth of developing countries. As one size may not fit and suit all, what exactly will fit and suit to which country, will continue to remain a matter of intense debate. As open trading system is mostly a good thing and an acceptable solution for economic development, the barter relationship by countries, existing in the present trade negotiations must be put an end and instead countries should commit themselves to provide free market access in all goods to all developing countries keeping in mind -as the saying goes-You have a right to be protected against the rich and not against the poor. Hence it’s for all countries to keep their fair trade options open within the framework of ethical negotiations keeping in mind “LIVE AND LET LIVE” concept.
Look…. In to-days business scenario anything and everything depends on various policies of the countries, viz economic policy, financial policy, Trade policy, commerce policy, industrial policy, bilateral policy so on and so forth. Therefore its essential for countries policy makers to bear in mind all considerations favourable to developing countries are taken care of and to ensure fair policies are compiled and framed for compliance. Let’s work together to achieve global economy wherein every country will participate and once the global economy is brought to rich, individual economy automatically comes within the reach of richness in economy.
J.KANNAN
Posted by J.KANNAN at 9:23 PM

2 comments:

Anonymous said...

An article very well written and presented. I only wish that countries give a serious though in open trade transaction in the suggested manner to make desired end to meet for benefit of all economically developing countries
a policies and plan in mind to make should done within the frame work suggested and nothing is bad by making a good effort to achieve the end results acceptable and useful to the majority of the human society and ultimately to the benefit of world nations.

Anonymous said...

you can make an excellent comments provided you go through the entire topic written patiently, absorb revel at portions ultimately I hv to agree in total with the presenter Let me go through the post entirely and send my detailed comments The topic needs to read well before offering comments.

PS: Looking forward to comments/feedback for improvement.

J.K