—Contributed by Vasant Prabhu

Come to think of it, Finance & economics is not for the faint hearted, especially in the current turmoil ridden times. The exotic derivative products ,which nobody understood but many bought in India or the Sub prime crisis in the US may be common words in vogue today, but are certain manifestations of the dark underbelly of the Global economic & financial system.

Let’s start with the US housing collapse story & the subsequent spin off into global financial crisis. Who would think that a 3 trillion dollar or so Industry would come crashing down like a pack of cards? The US Federal Reserve officials nor the regulators certainly didn’t see it coming. The wise men managing the greenback at the Central Bank (and so were their counterparts in Japan i.e., Bank of Japan) held the price of money to such ridiculously low levels or say unrealistic levels that money was just available for picking. These extraordinarily low interest rates meant that the Financial Industry just borrowed heavily and invested like there was no tomorrow. Low interest rates were also the reason that people went on a house buying spree regardless of whether they could afford or not . The Housing Industry & the Banks lending to the Industry made merry in the process. The latter threw all caution to wind while lending to all kinds of people, giving rise to a new class of borrowers called NINJA (No Income No Job profiles). Predatory lending by banks was one of the sign of the mayhem that was to unfold. But nobody saw. Whether the Central Banks knowingly or unknowingly created the Asset (read Housing) bubble or the huge build up of debt is matter of debate or conjecture.

On the other side of what I call, Mass Ignorance Spectrum are Banks & Pvt companies especially MSMEs with regard to derivative products & its underlying risk & volatility in India. Derivatives are generally used to hedge but can also be used for speculative purposes also. Since these are contracts, practically anything can be used as an underlying asset to execute them. For small Indian companies, these derivatives were struck to cut costs, hedge currency risks and even make a quick gain. Leveraged options, complex swap and 2 way derivative bets were some of the heady mix that Banks prepared & offered to these companies who could not fully grasp the nature of these products. Nobody is sure including the experts & finance block mandarins about the exact nature of derivative exposure of Indian Banks & companies. One conservative estimate pegs the losses arising out of these derivative products at roughly 20,000 Crores mostly emanating from small and medium enterprises many of whom are not even listed in the public market. The clean up act has begun though; new accounting standards like AS30 are now being discovered to ensure that these losses are accounted in the financial books in the year they are audited. The chartered accountants fraternity & the auditors are eager to see that this mess does not engulf them. The clean up act may also mean that these companies will renegotiate the terms of contract (as per law they cannot) and defer the payments. However one thing is certain, part 2 of the drama will unfold in the courts where the Banks that sold these exotic derivative products & the gullible companies that bought them will slug it out. Call it the IDL (Indian derivative League) and the line up looks impressive (no fancy names though); Sundaram MultiPap Vs ICICI Bank, Rajshree sugars Vs Axis Bank, Karur Vs ICICI Bank. Sit back & enjoy.

Warren buffet was prompted to call these products financial weapons of mass destruction. Unlike their military namesakes used widely in the US-Iraq war, for a change these were actually uncovered.

All said & done, Modern economic & financial theories & markets are sure to make Adam smith & John Maynard Keynes turn in their graves.