The Present Scinario

You may have never bought the bonds of Lehman Brothers or the shares of AIG, but your stocks get battered when these hallowed US financial institutions failed. Your investments, be it in equities or mutual funds or even gold, are getting eroded every time there is some bad news in the US. This is the irony of being part of a global financial system. Post liberalisation, world economies are more intricately connected, which means any development, good or bad, in one country will directly or indirectly affect your investments. The sub-prime mortgage crisis in the US has snowballed into a global credit crunch. The result: asset prices across categories and countries are biting the dust, and so is your personal wealth. However, there is a lesson to learn from the financial debacle in the US, which is a fallout of economic mismanagement at an individual level. It is, therefore, important to understand the genesis of the crisis so that you can manage your personal finances better. Crisis begins Let us first understand what happened in the US and why it took such a bad turn? Between 1953 and 2003, the US faced 10 big and small economic recessions. The recession intensified since 1970 after a steep hike in crude prices by the Organisation of the Petroleum Exporting Countries and the Vietnam war. The 85-month period between 1974 and 1981 in the US economic history is known as “stagflation” — a period of high inflation and stagnation in production — caused primarily because of high crude oil prices. To decrease the money supply and put a check on inflation, the US Federal Reserve increased interest rates steeply between 1979 and 1983. Many savings and loan associations took advantage of high interest rates and lent far in excess of prudent limits. The tight monetary policy in early 1980s inflicted a recession in the US real estate market and by the end of the decade, 2,412 out of 3,600 savings and loan associations became insolvent. The economic recession cooled inflation. After coming to power in 1982, US president Ronald Reagan followed an easy money policy, known as Reaganomics, characterised by sharp cuts in personal and other taxes, to boost domestic consumption and production to overcome stagflation. Though these measure improved GDP and employment growth, the Cold War led to a massive budgetary deficit. In the 1980s, the US government became the world’s largest international borrower. Around this time, the savings and loan associations started declaring themselves insolvent one after the other (Savings and Loan crisis), resulting in the great stock market crash in 1987. Problem deepens Throughout the 1990s, the US government followed an easy monetary policy and the Federal Reserve brought down its benchmark lending rate to 1 per cent in June 2000 — the lowest in 45 years — from 8 per cent in June 1990. With thinning spreads between their lending and deposit rates, banks and financial institutions resorted heavily to mortgage and other forms of lending ignoring the credit worthiness of consumers. Cheap availability of credit lured every US citizen to take a housing loan. This led to sub-prime (low or no credit worthiness) mortgage in the US. According to US census data, per capita disposable personal income (net of taxes) was $30,418 in 2005 but average annual expenditure rose to $46,409 in the same year. This means, people in the US borrowed more than what they earned to foot their consumption bills. From companies to investment banks, all drew up big expenditure plans on borrowed funds. In October 2004, the US securities market regulator suspended the restriction of net capital requirement to borrowed capital for Goldman Sachs, Merrill Lynch, Lehman Brothers, Bear Stearns and Morgan Stanley. Freed from restriction on debt, these five investment bankers borrowed as much as 40 times of their net owned capital. Dollar started flowing freely into securities and real estate markets of developing countries from investment bankers, asset management companies and hedge funds. Meanwhile, to disown the risks associated with their “unsound” mortgage and consumer lending, banks and mortgage lending institutions innovated debt securitisation and debt swaps that could be traded. These securitised debts and swaps were also insured by mortgage and credit insurance companies for the satisfaction of buyers. Seeds of a potential catastrophe were sown then and and the crisis deepened when the Federal Reserve kept on raising its benchmark fund rate from 2004 onwards to 5.25 per cent by June 2006. With rising interest rates, sub-prime borrowers started defaulting on loan repayments. Buyers of securitised mortgage debts suffered huge losses and some big investment bankers went bust while others had to be bailed out. Insurance companies also went belly up. Banks began to distrust each other with loans. The credit crisis followed. Taking stock So, what is there for the common man to learn from the whole credit saga. Excessive borrowing is a curse. Understand the interest rate risk first before borrowing money. Don’t just consider the EMI amount while taking a loan. When the interest rate goes up, your EMI will also rise, reducing your disposable income to the extent that you may be forced to use credit cards more often to meet your other expenditures. Use credit cards only in emergency and pay the bill during the free-credit period. Don’t roll over the credit or you will be caught in a debt trap. Don’t buy exotic investment products that you don’t understand clearly. Even debt and bond investments are not safe. In a crisis situation, debt and bond papers become very illiquid and you may not be able to sell those. Bond and debt investment requires a well-developed corporate bond market, which is absent in India. When it comes to investments, don’t follow the herd. Determine a return rate that will help you reach your financial goals. Once your investments generate the desired return, sell that investment and put the proceeds in some other instruments. Stock prices may surge further after you sell your holdings. But you won’t lose money when the stocks crash. Instead, you can buy some other good stocks at a much cheaper price. The current crisis may have come as a rude shock for many investors, but it will also help them to stay away from future financial misadventures.

Astrology

Ganesha had predicted on October 06, 2008 that circuit prices may prevail in the market. Relying on this prediction, those who finalized the deals accordingly must be rejoicing. This is the benefit of taking the astrologer's prediction into consideration before taking any action in the stock market. Till the last day of October the opening of Nifty will not be favorable, views Ganesha. Do not take any action till the day on which the opening of Nifty is positive. Mail me at dharmesh.joshi@ganeshaspeaks.com and order your reading now. Ganesha views firing crackers from the opening till 10:08. So do not be hasty and just wait and watch. Selling price may be around the circuit price. From 10:08 to 12:45 if Nifty is at the down fall then it may rise during this phase. From 12:45 to 14:45, in comparison to the previous phase, Nifty may fall. From 14:45 to 15:30, profit booking in heavy weight scrips is envisaged.