The Hindu Business Line : A high-speed discussion on slowdown

Scene: Chennai airport passenger’s lounge. The Air India flight 172 to London has been delayed for another hour, so passengers are moving around and chatting with each other.

Mrs Spendthrift, a pleasant, matronly young woman in an over-wrought maroon churidar is on her way back to the US after visiting her parents. As she settles down, a chubby man in an expensive business suit, Mr India-bull, rushes in to the lounge.

“Has Air India flight 172 left yet?” he calls out to no one in particular.

“No, delayed an hour.”

“Oh, thank God!”

He wipes his forehead and plonks down beside Mrs Spendthrift.

“Every road that taxi-wallah came through seems to have been blocked. How do people get anywhere on time or do anything?

Crash fears dispelled

“It must be all the new construction. So many foreign companies want to set up an office here. Of course, that’s better than all the lay-offs and downsizing in the US. My husband is always worrying about his contract.”

“What does he do?” asks Mr India-bull glancing with some self-satisfaction at the sight of her three meek cloth-bags wilting against the understated gloss of his leather briefcase.

“Software salesman. If they terminate his contract, I don’t know how we’re going to manage with our two little girls in school. Now I hear there’s going to be a recession next year, not only in the US but everywhere.” It’s clear that Mrs Spendthrift’s knowledge of “everywhere” is rather limited but nonetheless laced with intense anxiety.

“Oh, tell him not to worry.”

Mr India-bull dusts off a mythical piece of lint from his coat with a plump, be-ringed finger. “The doom-and-gloomers have been predicting another great depression in the US for the last 20 years or more. But has anything happened? The only depression we’ll see is the one in store for people who miss making their fortunes now. And here in India, it’s more than a boom — it’s a new age. A new economy. A new par-a-digm” He draws out the three syllables lovingly.

“People were warning me that Asian markets were going to crash when I bought land in Bangalore in 2003. Crash? The prices have gone into orbit. If your husband loses his job, he should just come back to India. Or better yet, try London. My company just opened an office there. We’ll be needing new people as we grow.” He chuckles.

The newspaper next to them descends abruptly and a thatch of white hair, a pair of round wire-rimmed glasses, and a long bony nose emerge, attached to a sharp voice. It’s old Professor Contrarian.

Contrarian view

“I hope this young lady is not being given this as serious advice,” he says testily.

“The property market in the UK will soon be on its way down. Down, not up. The requirements for borrowing money are tightening. A few of their banks — like Northern Rock — have actually gone under. This so-called boom of yours is a fraud. It’s a house built on sand — in this case, housing built on bubbles.... of borrowed money. Bubbles that are in the process of deflating. Central banks print money and cut the interest rates. People borrow more and more. At first houses don’t keep up with the new money and their prices go up. Later, when the interest rates tighten, the boom ends.”

He shakes his head at Mrs Spendthrift, “I hope you didn’t buy a house in the last two years. If you did, I assure you, in most major cities in the US, UK and Europe and many in Asia, the price will come down over the next few years.”

Mrs Spendthrift, clutches her cloth-bags a little closer, but India-bull is unimpressed.

Some gas-bag professor who’d probably never set a foot outside his miserable hovel. He’d put him in his place.

“Pish. Tush. Don’t believe it. Property, especially in India, hasn’t anywhere to go but up. The reason is not more and more money but more and more people. Land is a limited commodity. It goes up. Small supply,” he brings his palms together. “Big demand,” he spreads them. “That means up, not down,” his hand shoots up excitedly.

“Down,” says Prof. Contrarian, from inside the paper.

“Up, up, I tell you!” Mr India-bull gesticulates so wildly that Mrs Spendthrift glances out at the runway half-expecting him to take off.

“And even if house prices stall a bit in the US, so what?” he continues, “As long as the American consumer keeps on spending, the economy is going to ride along nicely and the housing market will go back up!”

He glares at the professor.

“Down” repeats the professor dreamily, tapping his pencil. “Eleven letters. Second letter ‘p.’ Clue: One guesses it could be risky.”

Mrs Spendthrift giggles nervously.

“Well, I must say our house has gone up in price. It was very expensive when we bought it up, but now it’s gone up almost half the price. Even if it comes down a bit, it will sell for more than what we paid.”

“There you are. That’s how you get rich.”

Overspending worries

“Well, it certainly feels nice. We were able to borrow against the house to pay for a new car. And rich or not, we’re actually spending more. To tell the truth, I sometimes get worried about that. Do you think we should be?”

Mr India-bull opens his mouth, but Professor Contrarian has lowered his paper again.

Should you be worried? The question appeals to him. It’s almost philosophical. It deserves his favourite answer.

“That depends,” he says, stretching out his thin legs and settling back.

“If you put down a big down payment and your house mortgage and interest payments are not too high, you should be fine. And even if the payments are high, if your income matches them, you’re fine. And, if you bought in an area that has not become overvalued, you’re also fine. You see, a bubble might exist overall in the economy, but it may not exist in some areas. For instance, prices are not high in smaller cities or in the countryside. And where they are high, each area has its own bubble, with its own rhythm. These things are cyclical. Like most things in nature.”

He gives a sigh of pure satisfaction.

“But tell me, where did you buy?”

“We bought a house in Philadelphia. With 5 per cent down.”

The professor shakes his head. “That’s not good. At least tell me that you didn’t take out one of those adjustable rate mortgages (ARMs) that start out with a low rate and then go up sharply? I will be very unhappy if you said you did.”

“Oh no. We have a fixed rate. But many of our friends did get ARMs which are going to readjust next year. Are you telling me they have a serious problem?”

“Are their salaries also adjusting upwards? Of course, they’ll have problems. Especially if they’re addicted to plastic.”

“You mean credit cards? Who isn’t? In the US you can’t get away from them. Credit card companies send them out to people all the time. And you need them. We couldn’t have bought a house if we didn’t have a record of borrowing. In fact, we would have to pay a penalty if we paid off our loan too fast.”

Luring borrowers

“It sounds like your banks want to lend more than you need to borrow. What they’re doing is luring borrowers in with cheap loans. Then they pull up the prices later on. The idea is to keep you addicted to debt for your life. And if you can’t pay, then the banks will come for your house. You know there are more foreclosures on houses now than at any time in the US since the Great Depression in 1929. And the banks which made the bad loans are also collapsing.”

Mr India-bull finally manages to get a word in.

“Oh Jeremiah, sir, banks folded in the 1980s too. It was called the Savings and Loans crisis. America did not collapse, the globe did not stop spinning. In fact the stock market boom began just after that.”

“Ah, but we’re not talking about just a few banks here. We’re talking about some of the biggest banks — like Citigroup — being downgraded. What if a large bank or fund collapses, as Long Term Capital Management did in 1998, even though it was run by Nobel laureates? It almost set off a global crisis. Today, the situation is even worse because of the growth of derivatives.”

Mrs Spendthrift, “Derri-what?”

Mr India-bull: “You see? He doesn’t even speak English!”

“Derivatives. Securities whose prices are derived — often in a very complicated way — from an asset. That asset could be anything from concrete things like gold to abstractions like the difference between two interest rates. Derivatives are so complicated often no one knows the level of risk involved. Worse yet, they are usually purchased with money borrowed against other derivatives. Think of it like villagers making their living by doing each other’s washing. In fact, with the derivative market, the investors are only exchanging promises to do each other’s washing. In some cases there aren’t even any real clothes.”

Mr India-bull snorts. “Even if your laundry fairy-tale is right, why should anyone here worry about the US? Indians are healthy savers. Our middle class is growing and consuming. Our dhobis are not making any promises they can’t keep.”

“Yes, but different markets are very connected these days. And a lot of the investment money flowing into the Sensex is coming from abroad, from funds that have their own investments that are affected by the US economy. Investors are fleeing the US market and moving into Asia. Later, if they move out as fast, it could cause serious problems here, especially if their own value is based on junk investments.

There’s another problem. The middle class here might have more purchasing power, but if Americans stop buying, it will affect Asia too. Why? Because a number of transactions between Asian countries that go through China ultimately reach the US.

Then there’s the exchange rate. If the American economy weakens and the dollar goes down against the rupee, Indian exports will become more expensive and that will hit the exporters and the companies that deal with them here.”

“You’re making things far too complicated, Professor-ji. Let me ask you a simple question. If more money is invested in more businesses, isn’t that the definition of growth?”

Prof. Contrarian gives another sigh of satisfaction and strokes his chin. Really, this was almost as good as his old seminars.

“Again, it depends. You see, productive investment is very different from what we have now. When money is being thrown at every hare-brained get-rich-quick scheme, that is not growth. That is not a boom, but the prelude to a depression. A bust. That’s what you get when everyone and the taxi-wallah is using their money to...” he breaks off sharply and dives back into the paper.

“Of course! Nine letters. “One guesses it could be risky”....why didn’t I think of it?”

“Huh?” say the other two together.

“Speculate!”

Racy@TheHindu.co.in

http://Racycases.blogspot.com