Saturday, October 18, 2008

Will India have a sub-prime crisis situation ?

Looking out this is what I see from my window ... an apartment complex which was being constructed at record speed until 2 months ago ... suddenly all deserted and abandoned. There are many such half-finished projects in Mumbai ... and completed apartment complexes which are not finding any buyers.

The real-estate market in Mumbai is in a state of suspended animation ... potential sellers not willing to bring down prices and prospective buyers waiting with bated breath for the inevitable price correction ... obviously no one wants to make the first move. 

Eventually however owners and builders who are holding on to apartments will succumb and the prices should come down by at least 30%. Thats why builders have lost interest in completing constructions or starting new projects.

So yes, there will be a Real Estate price correction in Mumbai and even more so in the rest of India. This is your usual demand-supply game in which the spanner of global recession, liquidity crunch and negative sentiments has been thrown in. 

However this is nothing remotely like the sub-prime crisis in the US ... and India will definitely not have a "sub-prime" crisis ... and for this we need to be thankful to multiple stakeholders ... the Indian banks, builders, the Government and finally ourselves :-)

First of course the Indian Banks who had the foresight to disburse home loans based on the income / earning potential of the individual and not the projected future value of the house that was being purchased !!! This is in sharp contrast to US Home mortgage agencies Fannie Mae / Freddie Mac ... whose sole reason for existance was to dole out mortgages to any jobless / homeless tom, dick, harry or even their grannies if they wanted it !!!

Freddie & Fannie actually got banks to dish out the loans. The Banks knew what they were getting into so to cover their asses they got the "smart-alec" i-banks into the act. These dudes created AAA rated securities with these mortgages as collateral and sold them to institutional investors ... insurance companies, banks etc thus spreading the shit far and wide ... the base assumption was that since house prices would keep rising the shit would never blow up in their faces. That assumption unfortunately was terribly wrong ... none of this will of course happen in India coz ...

Our government never had the time to dabble in mundane things like housing for the masses ( the roti, kapda, makaan rhetoric was thankfully only for election speeches and never implemented ). So India never had the equivalent of a Fannie or Freddie or any of their clones which the US Govt created post the great-depression ... thank god for that !!! 

Ironically the very same institutions which helped the US economy to come out of the Great Depression has now propelled US into the next mega recession !!!

Our builders mostly smalltime shrewd marwaris know the supply - demand paradigm better than any of those now jobless i-bankers ( ie. Goldman Sachs, Lehmann Brothers et al ). They never constructed or released enough houses to meet even a fraction of the pent-up demand of millions of Indians who still dont own a home. This ensured that they were able to price whatever they did construct astronomically so in any case most Indians were not able to afford houses !!! So thanks to the millions of citizens of our great nation for not being able to afford homes in the first place ... where there are no homes there is no crisis :-) 

India is also a nation of "savers" which also goes a long way in "saving" us from a crisis like situation ... the perils of "aamdani athanni kharcha rupaiya" is something we truly understand ... unlike our american bros who go to the extent of taking out a second mortgage on an existing mortgaged house to pay off credit card dues which was used to clear previous credit card dues ... I may be exaggarating a bit but you get the idea.

So net net of course we are feeling the ripple effects of the US recession and will continue to do so over the next many months ... thats the pitfall of open markets and our exposure to the global economy the extent of which remains to be seen. One thing for sure : there is no possibility of an "indian sub-prime" crisis triggered by murky real-estate mortgages to aggravate the situation in India.


  1. did not know you also dabbled in finance but agree with you. sub-prime hi nahin to crisis kahan se hoga ?

  2. That should explain the following:

    > Strength in US dollar lately
    > More banks nationalized in EU than in the US
    > More countries making bigger bailouts (% of GDP) than US
    > Leverage ratios in US investment banks were 1:30 (dumb) but EU countries had 1:80 (dumber?)
    > The concept of sub-prime does not exist in India because there aren't any credit rating agencies to rate people in the first place. Secondly India does not have the hire & fire approach, Indians might not default on credit or declare bankrupties. That is the main reason India is insulated not because of smart bankers.

    Just because the cancer was first detected in US, should not imply other countries were/are clean.

  3. Well, many of the things that you said have contributed to the crisis. Some more than others. This is my take on the problem. At the heart of the problem lies the AAA bonds that you mentioned in your blog. This bond was a not a Wall Street invention. Local governments in states and cities have been selling bonds for many years to raise money for public works projects. But the problem lies in the fact that I-banks who originally wrote the debt-bond started passing the debt liability to Hedge funds in exchange of paying a yearly fee. All that Hedge funds had to promise was to pay the I-banks the entire sum of debt in case of a default to debt payment (this is aka credit default swap). For hedge funds these was a great way of making quick money. Imagine a hedge fund that has $100 million, and went into this agreement with an I-bank for a credit-default-swap agreement for $1 billion. Hedge fund would get 5% i.e. $50 million a year. Fund manager probably thought if he continue this agreement for 5 years, he can easily make $250. So, it was a easy money for them and as a result became very popular. All I-banks opened over-the-counter desk to sell them in a frenzy. Two years ago, anyone on Wall Street would laugh at the idea that debt would ever be dafaulted. Well, finally we know what happened. People defaulted on making payment. So, now the Hedge fund with only $100 million cannot pay $1 billion in default payment, starting a casecading effect in the financial lending system.

    So the real reason of the crisis is not that people wanted to buy more than they can afford, it is the government's lack of regulation that allowed this credit-swap agreement to roll freely. I think the ironic lesson from this crisis is that free market principles are good, but it cannot be really free. Oversight and regulation is what is needed for a smooth functioning of a free market.

    Rajdeep Das