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September 07, 2007
Subprime Lessons
If you take subprime lessons from Michael Lewis in MINT, you'll learn that it is easy to blame others ( the poor in particular) for a crisis of your own creation. Shorn of rhetoric, Lewis essentially makes the following points:
1. Finance is one thing you should never engage in with the poor.
2. To quote M Lewis :
At the time I bought the subprime portfolio, I thought: This is sort of like my way of giving something back. I didn’t expect a profile in Philanthropy Today or anything like that. I mean, I bought at a discount. But, I thought people would admire the Wall Street big shot who found a way to help the little guy. Sort of like a money doctor helping a sick person. Then the little guy wheels around and gives me this financial enema. And I’m the one who gets crap in the papers!
Link to the article
3."Poor people don’t respect other people’s money in the way money deserves to be respected."
4.To quote from the article again "I think it’s time we all become more realistic about letting the poor anywhere near Wall Street.
Lending money to poor countries was a bad idea: Does it make any more sense to lend money to poor people? They don’t even have mineral rights!'
It's difficult to accept even a single argument of Lewis. Here is the counter-argument:
1. You can bank with the poor, and in fact ,quite successfully
As Sai Sireesh's recent blog shows once more, poor are bankable. Md. Yunus has shown that. The Microfinance movement in India has demonstrated it. Financial inclusion is the way to growth and prosperity.
2.The problem that underlies the subprime crisis lies not with the culture of the poor, but with the risk culture of financial institutions.
In times of competition, you go flat out to achive higher returns and fail to balance greed and fear. The failure also arises, as Chris Whalen's very insightful blog on the Credit derivatives tells us inappropriate risk management and poor governance structures. Add to this the inability to conduct macro stress testing, and it becomes clear that it pays to have improved risk management practices.
2.Poor countries are "hot" destinations of advanced economy funds
In a situation when Foreign investors make a beeline to invest in India ( and remain heavily invested in China), the argument "lending to poor countries was a bad idea" falls flat on its face. The fact is that money is chasing profits, through trial and error it finds better pastures. subprime crisis is about investing in risky business, you rely too heavily on projected income of the poor that it dependent on macroeconomic growth. Any slowdown affects such calculations. Once again, the key is not shutting the door to the poor, ( that's not good for the poor and that's bad economics for wall Strret as well). The best strategy is to apply caution, use robust risk management systems, look beyond VaR, have excellent stress testing and early warning systems and look at the new business models that are flexible in times of rising default risks.
Posted by sunandoroy at September 7, 2007 08:51 AM
I think the Sub-prime crisis,has once again highlighted, that no matter how sophisticated our systems become, our models become robust,there would always be RISKy animal lurking nearby, which simply cannot be tamed.
Posted by: vivek at September 8, 2007 06:27 AM
Hi Sunondo
Remember, I spoke to you in Decemeber, 2006 from Chennai. Now I am in Virginia, USA and attending the Washington Chapter meetings.
How is the Mumbai chapter doing. Let me know if there is anything that I can work on from here. Also, I'm looking at Functional Consultants who can create the Op Risk Database for US banks. We are developing a Op Risk Framework for US Banks. Also, is there any scope to market it in India?
let's be in touch.
Regards
Praful Mayekar
Posted by: Praful Mayekar at September 8, 2007 06:32 PM
the sub-prime crisis once again highlights the risk-return trade-off.if one plays for high stakes one must be prepared to face the risks also.
Even if you have sophisticated risk management systems and mathematical models there is no substitute for plain common sense..S/P crisis is no different..rememeber LTCM?it had all top guns of the Financial world but look what happened.
Have sophisticated systems by all means but apply common sense when you are not sure.
Posted by: gangadharan mani at September 9, 2007 01:48 PM
Well there is nothing wrong with models or any other calculation. The only issue here is there is (and was) competition for good clients/customer and some businesses wanted to make money from this untapped market. They knew what they are doing, they did not expect (using using their intutions) falling apart so quick. This was result of just an optimist thinking.
Thanks
Posted by: Aftab Anwar at September 12, 2007 09:12 PM
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