The housing bubble wasn’t just a shock but rather a disaster
Raghuram Rajan says, “...the housing bubble that helped bring about the Financial crises was merely a symptom...”
When Raghuram Rajan presented his paper ‘Has Financial Market made the world riskier?’ (Raghuram Rajan-2005), he didn’t think much on it because he had nailed it right. The Financial machinery hasn’t been regulated well and soon is going to break down. Did the Bankers do it? A question he asked and we all would have had our answers if we realized what he was talking about?
He did make sense and effectively presented the declining options for private banks to liquidate their ‘stocks’ which ‘they’-the ‘private’ banks labelled as ‘The Collateralized Debt Obligation’ (CDO). Not only were they insured for this but they also managed to get private investors buy loans given to middle class people whose probability of repaying the amount was KNOWN to be minimal.
In his paper, Rajan describes the incentive structure of the traders and how Investment bankers are actually nailing their boots to the floors and waiting for the boom. When in 2001, the CDO’s were effectively sold out as Sub-Prime mortgages, very few had their eyes open into the future guessing about the bubble burst. Rajan was one of the few and he dared to speak it out.
In 2005, the paper was presented in front of huge galore of widely-recognised listeners. The crowd wasn’t just any other financial-conference crowd but it was a pack of A-Lister’s, the Government know-how’s and the policy makers, who were trying to condemn the idea Rajan was presenting.
Many didn’t want to hear.
In 2006, Banks had started to show the danger signs. Red flags were drawn and economists had already pointed at the high-cost incentive structures and roll outs. Wall Street started to feel the tremors of the bubble burst when few private banks were declining at a faster rate. Some officials from the foreign governments signalled the US finance authorities of the ‘Tsunami’ that was to come. Still many private banks didn’t actually understand the signs until the fall of three major banks and one of them inching to slow death- Lehman brothers was out- Senate hearings have started and many economic evangelists are asked for help.
2008: Institutional grounds on economics remained weak and Rajan saw what he had pictured right in front of him as soon as 2008 started to become more disastrous. Many great banks fell and so was their insurer- AIG was down. World was trembling with losses. Families were shattered and the recession had taken its diabolic face.
Stimulus plans were out. Trillions of dollars were streamlined considering the Keynesian economics yet many still didn’t understand what the housing bubble was? And whether these stimulus plans were actually effective?
Great leaders behind these private banks were asked to step down but it wasn’t for long. The presidency was ending and a new era of change, as promised by the new President-nominee, was starting. But the effect actually never subsided and we saw same people institutionalizing over the dollar, which adds to the decline of value for many currencies around the globe. A second stimulus plan was sanctioned and it did nothing good than worse. The economy was sledge-hammered and Rajan knew the picture he saw is still missing some pieces.
There’s more to the bubble and the burst is yet to happen.