crisis MANAGEMENT
Insights from the Recent Financial Crisis We have just witnessed a financial crisis which was historic not only in proportions but also in its implications. Here is an analysis of the same for Financial Planners so that they are able to draw the right insights.
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crisis MANAGEMENT
V. Sreekant, CFPCM Proprietor, Money Care Solutions
T
he financial world currently looks much brighter as compared to the utter gloom that prevailed about one or two years ago, when even the mightiest of the financial institutions were not sure of surviving the next day. Quick and synchronized actions adopted by the leading world economies helped the world extricate itself from this abyss. However, the question which still remains unanswered is that whether the underlying problems that caused the crisis been truly resolved? Or have they been just brushed aside for the moment? Only time can answer this. However having been fortunate (or unfortunate?) enough to have experienced a “black swan” event, we are in a position to learn from this experience. Here’s a dissection of the crisis with an eye on the future.
is an excellent example of the same. In addition, European countries like Greece are stark reminders of the weak financial health prevailing worldwide.
The aftermath: Looming risks & possibility of next crisis
Here’s an analysis of what worked and what did not, in the recent past.
The world economy and financial system still faces considerable risks that could tip us into the next crisis. Some of these risks, which are in fact legacies of the recent past, are:
1. Possible asset bubbles:
4. Trade issues: The savings and consumption patterns prevailing in different parts of the world are skewed in such a way that causes imbalances on the global economy. There is a need to find a sustainable equilibrium for a balanced growth across the world. Protectionist measures, early withdrawal of stimulus and currency distortions could tip the world economy into a double dip recession with consequences on employment, bad debts etc. causing a domino effect on the financial sector.
Looking back: Insights from the crisis
Concepts questioned An unintended benefit from this great crisis has been the testing of a few financial concepts which had crept into the financial glossary recently. They are:
The enormous liquidity pumped into the global financial system recently may well inflate the next bubble. Peculiarly, the very crisis caused by liquidity has been dealt with more liquidity. Quantitative easing and continuing ultra-low interest rates in major economies encourage risky financial behaviour and huge currency carry trades, sudden and simultaneous unwinding of which has the potential to cripple world financial markets.
1. Decoupling:
2. Inappropriately timed stimulus exit:
Unconcealed capitalism was somehow expected to be self correcting and self punishing. Strangely, without government bailouts, many of the giants of the global finance and automobile industry would have been extinct today. World economy, no doubt functions as a combination of capitalism, socialism and communism.
It was relatively easy for the G20 countries to co-ordinate the stimulus measures. However, the untimely withdrawal of such measures has posed a huge challenge considering the varied pace of recovery of the different economies. No wonder the RBI governor calls it a “Chakravyuha”, which means easy to enter but a challenge to exit.
3. Large government debt: The huge debts that governments have taken up to provide stimulus, now poses huge challenges to the stability of these economies and the global financial system. The recent episode of the failure of the Dubai government to repay debt
In today’s interconnected, interdependent and globalized world, it would be irrational to expect individual economies to function as isolated chambers unaffected by each other. Economic performance may be relatively less correlated, but financial markets are highly correlated which in turn influences the real economy.
2. Free markets:
Points which favoured India None would dispute the fact that India was relatively less impacted by this crisis as compared to the other developed nations. Here is a brief analysis of the factors which helped India fare better.
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crisis MANAGEMENT 1.Balanced economy: None of the constituents of our economy namely, private consumption, investment, government expenditure or exports exert an overwhelming influence on our economy thus making it a balanced one.
2.Measured reforms: The pace and extent of our economic reforms is very slow however, it proved to be beneficial to us in the recent crisis.
3.Prudent regulation: We are fortunate to have visionary experts at the helm of our central bank and other regulatory bodies. They could sense the trouble ahead and position our country strategically to the best extent possible. Even at the height of the crisis, our financial system functioned flawlessly. No wonder they have earned accolades world over.
remained fairly stable in the recent past, investor sentiment and perception have moved the market wildly. Such high volatility may further deter the already reluctant Indian retail investor from entering the stock market with conviction, apart from impacting foreign trade due to sharp currency fluctuations.
2. Poor transmission of monetary policy: The huge interest rate cuts and liquidity injected by our central bank during the crisis did not fully percolate to the end users and hence failed to achieve its objective of improving credit flow. What Helped India?
What did not?
Balanced economy
Volatile capital flows
Measured reforms
Poor transmission of monetary policy
Prudent regulation Boring banking
4.Boring banking: Prudent business and lending practices of Indian banks has hugely helped maintain financial stability. Real banking needs to be boring.
5.Indian conservatism:
Indian conservatism
Important lessons for Financial Planners and their clients
We Indians do have a tinge of conservatism in our DNA that naturally makes us spurn risky and innovative financial behaviour. Accumulating wealth for future generations is part of our national culture and ethos. This conservative behaviour has helped us face the current financial crisis in a much more efficient manner as compared to the other developed countries.
Points which did not favour India Though the above factors minimized impact on India, we also had a few areas of concern as below:
1.Volatile capital flows: The Indian capital market of late has a high correlation with FII activity (see chart 1). Though Indian fundamentals have Chart 1: FII Activity in Equity Market
This crisis has certainly reinforced a few important pieces of financial wisdom which can be used by the financial planners and their clients to logically stay away from the crisis in their financial lives. Some of them are:
1. Do not count notional gains: Increasing expenses or borrowings based on bloated market value of your stock portfolio is a sure way to disaster. Investors in the developed economies have learnt this lesson the hard way. We really need to differentiate between realised and unrealised gains. In simple words ”Don’t count your chickens before they hatch”.
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CriSiS MANAGEMENT 2. Financial discipline is not out of fashion: The value of savings and financial discipline is more evident in bad times. A person who has lost his job and is struggling to find another will repent on not following a financial discipline rather than a person currently working. .
3. Be wary of cheap credit: Teaser rates and fancy loan products may tempt us into borrowing more. But leverage is a double edged weapon which needs to be used very carefully. Financial prudence states that we borrow to finance assets that provides enduring value and not for daily consumption and thus we should be more careful while taking loans.
4. Nothing goes up infinitely: Nothing can keep going up infinitely, including the prices of shares, real estate, gold etc. Betting on one way movement is a courting disaster which is surely going to impact severely in the long term.
5. Investing basics are still valid: Basic doctrines of sound investing like diversification, asset allocation, rebalancing etc are immortal concepts that holds true over centuries even when the market is filled with financial innovation.
6. Market timing is a futile exercise: Trying to time the market is not worth the effort and risk, though it’s not totally impossible. Even professional fund managers of large institutions have experienced the problem of timing in the last couple of years. We would do well by sticking to a systematic investment program solely focussed on our financial goals.
7. Use your own judgement: The herd may not be always right. Just because everyone is buying a house expecting the price to double, we need not join them. Unquestioningly following the credit ratings, buying investments that sound “too good” to be true are some of the pitfalls to watch out for. It always helps to step back and think for a moment and then pick up a stock in a rational manner.
8. Keep it simple: Stay away from fancy, opaque and complicated financial products which hide the real picture.
Conclusion History will, in all likelihood, repeat itself. But the way we act in anticipation and in reaction to these crises need not be the same every time, provided we have learnt from the past. Hope we are now better prepared to face the next crisis, when and if there is one. moneycaresolutions@gmail.com
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