Bubbles they say are evolutionary. They burst suddenly and then give rise to another one. From as early as the tulip mania to that of the housing bubble all were based on too many chasing too few.
Bubbles are formed when euphoria reaches the level of insanity.
The Dotcom burst of the 2001 was no different.
It started with money pumping into the sector after realising its long term potential (Demand-Supply mismatch).Microsoft had come out with an interface after extensive research that would make computers operable by common man. Every business shifted its work on the computer. Internet made data accessible. Websites were set up and wares were put to be sold on the internet.E-commerce took off like hot cakes. Not too long after that everyone started fabricating his business into an IT business just to raise money or realise a higher valuation from the market. Fibre optics were laid down as if there was no tomorrow. There was no concern for the outstripping supply and then it happened in an instant.
They say bubbles burst when the biggest fool refuses to pay the valuation that the market demands and then the market came tumbling down.
The recession was restricted to a particular sector. IT became the dreaded word People lost big money but the hurt was beyond repair for people who joined the bandwagon late. Students on campus who took IT specialisation just because of the hype were left jobless.
The damage was widespread. Businesses went into bankruptcy. Valuations were lowered and sanity was restored.
However there was a blessing in disguise for a country like
India. Outsourcing and call centre business took off because of cheap labour and a huge supply of fibre optics which brought down the prices of calling abroad thus making the business viable and profitable. Once the country solved the Y2K bug problem business started pouring in.
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This was the time when the president of
United States started towing with the idea of housing for the marginalised.
These were the early days of a gradual shift towards housing. They specifically decided to engineer financing of housing which would bring in people who could not have afforded to buy a house till now.
This was the beginning of what would turn out to be the recession of 2008.
“Teaser loans” where rates are kept lowered for an extended period of time were brought in so that people with lower initial income could still afford a loan.
Down payments were reduced to as low as 10% on the price of property.
Credit scores were shoved away under the carpet (credit score being the past payment record of a person showing the ability to pay off loans).Sub-prime crisis was a direct outcome where people who had a lower credit rating were also provided a loan on a higher interest rate. It this was not enough you could mortgage a property and raise a loan to buy another one. It became the order of the day as everyone thought that the property prices would see a perpetual rise.
Though what was happening on the main street was not as sinister as what was happening on the Wall Street. Banks were making a killing out of commissioning products. What became a simple proposition got complex by the day.
The loans that were provided by the banks were stuck in their books which meant that they became illiquid. Banks realising the importance of liquidity started bundling these loans into debt papers which were then sold to the public as bonds so as to convert their holdings into cash. That money again went into providing loans for property thus creating a spiral effect of leveraging up to as much as 100 times. Even credit card debt was bundled and sold off as unsecured bonds.
Fancy products became the talk of the town even when no one knew their functioning.
Collateralized debt obligations (CDO)-were the loans bundled backed by an asset.
Collateralized Mortgage obligations (CMO)-were the loans backed by a mortgage property.
CMBO-Commercial mortgage backed obligations which are bonds backed by a pool of commercial mortgage loans.
They all depended on the payment by the final consumer holding the loan.
If that was not enough people in the insurance industry brought out derivatives on these underlying which started trading on the exchange.
CDS-Credit default swaps are the obligation on the insurance company when there is default by the borrower of the loan. People also used it to speculate on the default by the borrower.
Every industry became interconnected out of the interlinked products. That is when the sceptics started to warn the industry to reform or face a blown out recession. But no one was listening as the party was growing louder.
It did last for a while as the markets tend to remain insane for an extended period of time and that is why the hurt was also bigger.
Meanwhile the teaser rates on loans started to lapse and interest rates started to rise. The default rates started rising. This is when the prospect of a slowdown hit the shores.
Even though the default was the reason what brought the recession into the market it was not the main one.
The loans that were bundled and sold off were clustered and not differentiated as prime and sub prime. When people started defaulting no one was able to classify the value of the portfolio as the papers containing these sub-prime mortgage loans were clubbed together with prime loans and the default was mainly in sub-prime loans.
The market panicked. When no one was able to value the price of the underlying the insurance company providing insurance on these underlyings came under pressure because the portfolio held by these co’s was humongous.AIG came under distress. Suddenly there was a crisis of confidence. Bear Stearns and Lehman Brothers were the ones who came under massive bear hammering. Citibank also faced similar terrain. Every investment bank and every bank was holding the same paper securities and they had leveraged it over and over again.
Everyone started deleveraging in the market. Money suddenly went off equities and properties from all over the world.
Cash became the king in the market. Countries holding chunks of cash were being scouted by major American investment banks to help them deleverage and put off liquidation.NOMURA was said to have shown interest in Lehman brothers but had sidestepped at the last moment.
When the market could not value the underlying securities it could not put a bottom to the prices of those securities. Once there was a crisis of confidence there was a run on the banks. Lehman brothers which was trading at 60 dollars a share two months back came down to 3.When it could not raise the necessary capital it went into bankruptcy.
Everyone started predicting the end of the world. Money started drying up in the markets.
The secular fall in the market and a run on the banks became too much to ignore for American Federal Reserve. This is when it stepped in and provided a bottom thus restoring sanity into the market (bailed them out by providing capital). By this time some of the most reputed investment banks had gone down under. Federal Reserve brought down rates to as low as 0% and gave out money to anyone who could return it back. Banks started deleveraging out of that money and save themselves from default.
The talk of a “V” shape recovery had made its way into the market. Analysts with major investment banks had seen the bottom and started putting money back in what would turn out to be the easiest way of making money in the market.” Go long” was the anthem on the Wall Street with an occasional one or two companies falling into default now and then. The money sitting on the sidelines made its way back into beaten down stocks.
Back here in
India, developing countries were also facing the axe. There was no crisis of confidence as the market was not highly leveraged. But as developed countries were deleveraging they started taking out their portfolio from developing nations. Stocks and properties started to tumble. As the markets started falling stocks got hammered to an extent that they became so attractive they became hard to resist. Property prices also became attractive because they became undervalued.
A similar “V” shaped recovery was predicted by technical analysts. Most of the money that was available with investment banks came back into
India as they found out the economy to be resilient and not dependent on the export sector. A country like
India where everything was undervalued and had an inflationary economy, the money went back into commodities, property and equities.
Once I saw the opportunity I put my clients on it and made money by simply investing in for the long term.
Property prices doubled up and stock prices quadrupled thus bringing handsome profits to my clients.
2010 and beyond
With every recession the president of
United States has changed priorities. This time President has been propagating Energy revolution and energy efficiency in sectors like gas guzzling automotive sector. Solar photovoltaics have also got the necessary limelight. Major impetus has been given to the electric vehicles.
Various countries have also taken the cue and started working on these fields. Major R&D has been set up into these sectors which could revolutionise the industry and change the way we consume.
Manufacturing is back and going green is the new status symbol.
Toyota prius has been the trendsetter and many concept vehicles are being showcased in auto expos around the world.
Alternative fuel sources are being scouted and major investment sources are betting on the sector. Shale gas has become a huge opportunity and major investment is tapping into that source.
The industry might look different from what it is today as new sources are being discovered every day but the momentum has been turned on.
Gradually we are reaching a point where the system will stabilise and interest rates will be raised by the Federal Reserve which will take back excess liquidity from the system. Will it lead to a “W” shape fall?
We can only look into the possible scenarios. Federal Reserve will increase rates when they see growth in the system. Deflationary economy is not the point when they will take the risk of increasing interest rate in the system.
Developing economies have been major beneficiaries of the liquidity. Are they the ones who will face the music when the tide turns? Will it lead to another recession?
Stock market has been a barometer for the state of the economy. A new normal has been established in the system which signals that the market will find a support far higher than the low seen in the last recession. This would end up as a point which could become the support for a new benchmark.
Developing countries are also facing inflationary pressures in the economy. When money is abundant it is put into commodities. Gold and oil prices are hitting the roof. Gold is a hedge against inflation and a sign of safety. When there is a risk of default in the system gold becomes the best bet. Oil prices are also flared up with any crisis in oil exporting nations. With a major amount of import being oil it is bound to affect inflation in any country.
Inflation is a tax on the poor. A developing country like
India where major spend is into food and transportation it affects the standard of living of its population. Governments have been trying to grapple with excessive liquidity by increasing interest rates now and then but to no avail.It is yet to be seen what happens when American Federal Reserve starts increasing interest rates.
Excessive liquidity in commodities should be sucked out so as to restore normalcy into the system or it could act as a harbinger of an impending collapse in the system. This time the hurt could be far more damaging.
