Monday, October 20, 2008

Getting over Lehman

To many this post may sound a little late, but for the past few weeks there have been a spate of shows in the media on current financial crisis. Mostly the shows interview/seek opinions from morons but occassionally an expert pops in with same I-blame-Lehman punditry that I am sick of by now. These experts are misguiding the people.
So I want to rant on one of their two main arguments. First is Lehman is dead because of excessive leverge and financial stupidity and thank god for it. Then these people go on to rant upon how the business model is flawed.
Lehman problem is a little different - the business model is built on high leverage and Lehman's ability to manage it. The leverage was 32 times its equity at the time of default. Lehman underestimated the size of bets - money betting for a fall in its share price. If they would have correctly anticipated this then they would be out of trouble.

Before the recession, it was John Peirrepont Morgan who (with similar model) helped US wrest the development initiative from Britain and France. This business model in general and particularly Lehman gave the US - silicon valley, factory based manufacturing, organised retail industry after 1930 recession. These are the very institutions that have helped the US keep up, nay lead the economic development of the world. Without Lehman, and its ability to manage this leverage US would have fallen before the rise of Japan in 1980. US also owes the latest "best decade" (time around Clinton era) to capital sourced from this very model. The excesses during that era - spawned biggest bubble ever - its still inflating in other parts of the world. This bubble pushed the innovation envelope beyond the regulatory scope and therein lies the problem. US has lot that it owes to this model.

There is a lot of blame-game and political gibberish that surrounds demise of Lehman and current financial crisis. Ordinary citizens will do well to not heed any media and rather read up on opinions of unbiased professors from top educational institutes. My reading leads me to believe that both Obama and McCain have misunderstood the problem. Obama has good economic research support - but his speeches do not communicate the understanding of his team. But I would bet on Obama (just purely based on his team).

Fundamentally, average US Joe and Jane are equally to blame for the current crisis. The average Joe and Jane spent more than they earn or could earn in the near future. The number of clothes, toys, electronics, etc that people have bought are actually lower. The most people spent was on housing. At a very fundamental level, its not their fault as well -as human emotions are wired differntly and if there is nothing perceptible (like own money) to loose people tend to take risk - thats what people did with housing. But people should have known better - afterall even though it wasnt perceptible it was still their money. People dont realise what costly mistake they have done. It will impact their economic well-being for next decade. Unfortunately ignorance is not an excuse - so the blame and misery is compounded. So everyone has skeletons in their cupboards.

For average US citizen to survive the crisis, it will take boot strapping. But bootstrapping will happen when the current debt is paid off. And its going to take a really long time to work through it. Prof. Elizabeth Warren has amazing work in this field. She is also trying to protect average Joe /Jane from transactions where housing companies duped the citizens. Further she is trying to protect them from credit card bills as well. It would be great if people support her.

Lastly, the ability to ride out of this current crisis rises out of capability and opportunity to innovate and create new sources of value addition. This happens through new businesses, SME and related job creation. With Lehman's and demise of high risk capital - US has lost its main recovery financier. It is thus that US will cede its economic supremacy to others unless US fixes the system. Does it have the political comprehension and will to do so? Its for US citizens to decide.