Friday, November 07, 2008

Stick to the basics

I'm not big on writing about stuff I'm not an expert on, but that's not stopped me in the past.

This time it's the bank and credit meltdown. I was observing the rise and rise of real estate for the better part of two years and one thing struck me last year: this isn't making sense. I'm not talking about the subprime loans, credit default swaps or collateralized debt obligations et al. The basic business itself wasn't making sense. How can a sensible businessman even assume that real estate prices will keep going up forever? Were incomes going up at the rate real estate was? How long before people could simply not afford to buy homes anymore? In the Seattle area, it'd reached the point where buying an affordable single-family unit close to Microsoft was well nigh impossible for a single-income family. You had to move farther away or move into a smaller place. How many banks realized this and yet did nothing to reduce risk or exposure to mortgages?

This American Life had an illuminating episode on this. Link here. They say that the system made it such that no one had any incentive to be realistic about the kind of risks they were taking. Risk kept getting transferring from the lending institutions to banks, then to investment banks and so on till you had no idea where your debts were really owed. Then of course, everything went haywire.

However, I still wonder about banks and the people who run them. Didn't they at some point wonder - "This person didn't put down a single cent of his own money to borrow half a million from the bank. Is s/he ever going to be in a position to return all of this? What if some of these people are unable to repay?"

There's a saying in Kannada my mother loves to quote about money (which may partly explain why I'm hard-nosed about it). The saying means that you should stretch your feet only as much as your bed allows you to. Sleeping with your feet hanging off the bed leads to much grief, including $700 billion bailouts.

1 comment:

Arpana Sanjay said...

Ha!! Only stretch your legs as far as your bed allows you...and only have as many children as you can sustain. :-))