Effect of Blind Capitalism

November 29, 2008

The worst recession

The US economy is in doldrums and its having a pinch in the Indian IT industry as well. What has caused it. This has exposed the drawbacks of unprincipled capitalism.

The current global recession is the worst recession in the history even worser than the 1930′s. The current economic crisis has left behind lessons to learn at both the micro and macroeconomic levels. The present day financial markets can be punishing and reversal of fortunes can be dramatic. What compounds the problems are strange accounting practices and high-risk nature of the loans and investments. Please read below the details to get a rough idea of the events that led to today’s economic chaos in USA and the other parts of the world.

The cause and effect

The US government reduced the interest rates for more people to take loans on interest and when it exceeded a limit. The Banks started to feel a pinch and started increasing the rates again and the defaulters who had already invested all the money in thier buissness enterprise, real estate couldn’t pay back. And hence this quagmire.

What is a sub-prime loan?

•In the US, borrowers are rated either as ‘prime’ – indicating that they have a good credit rating based on their track record – or as ‘sub-prime’, meaning their track record in repaying loans has been below par.
•Loans given to sub-prime borrowers, something banks would normally be reluctant to do, are categorized as sub-prime loans. Typically, it is the poor and the young who form the bulk of sub-prime borrowers.

Why loans were given?

•In roughly five years leading up to 2007, many banks started giving loans to sub-prime borrowers, typically through subsidiaries. They did so because they believed that the real estate boom, which had more than doubled home prices in the US since 1997, would allow even people with dodgy credit backgrounds to repay on the loans they were taking to buy or build homes. •Government also encouraged lenders to lend to sub-prime borrowers, arguing that this would help even the poor and young to buy houses. •With stock markets booming and the system flush with liquidity, many big fund investors like hedge funds and mutual funds saw sub-prime loan portfolios as attractive investment opportunities. Hence, they bought such portfolios from the original lenders. This in turn meant the lenders had fresh funds to lend. The subprime loan market thus became a fast growing segment.

What was the interest rate on sub-prime loans?

•Since the risk of default on such loans was higher, the interest rate charged on sub-prime loans was typically about two percentage points higher than the interest on prime loans. This, of course, only added to the risk of sub-prime borrowers defaulting. •The repayment capacity of sub-prime borrowers was in any case doubtful. The higher interest rate additionally meant substantially higher EMIs than for prime borrowers, further raising the risk of default. •Further, lenders devised new instruments to reach out to more sub-prime borrowers. Being flush with funds they were willing to compromise on prudential norms. •In one of the instruments they devised, they asked the borrowers to pay only the interest portion to begin with. The repayment of the principal portion was to start after two years.

How did this turn into a crisis?

•The housing boom in the US started petering out in 2007. One major reason was that the boom had led to a massive increase in the supply of housing. Thus house prices started falling. This increased the default rate among subprime borrowers, many of whom were no longer able or willing to pay through their nose to buy a house that was declining in value. •Since in home loans in the US, the collateral is typically the home being bought, this increased the supply of houses for sale while lowering the demand, thereby lowering prices even further and setting off a vicious cycle. •That this coincided with a slowdown in the US economy only made matters worse. Estimates are that US housing prices have dropped by almost 50% from their peak in 2006 in some cases. The declining value of the collateral means that lenders are left with less than the value of their loans and hence have to book losses.

How did this become a systemic crisis?

•One major reason is that the original lenders had further sold their portfolios to other players in the market. There were also complex derivatives developed based on the loan portfolios, which were also sold to other players, some of whom then sold it on further and so on. •As a result, nobody is absolutely sure what the size of the losses will be when the dust ultimately settles down. Nobody is also very sure exactly who will take how much of a hit. It is also important to realize that the crisis has not affected only reckless lenders. •For instance, Freddie Mac and Fannie Mae, which owned or guaranteed more than half of the roughly $12 trillion outstanding in home mortgages in the US, were widely perceived as being more prudent than most in their lending practices. However, the housing bust meant that they too had to suffer losses — $14 billion combined in the last four quarters – because of declining prices for their collateral and increased default rates. •The forced retreat of these two mortgage giants from the market, of course, only adds to every other player’s woes.

What has been the impact of the crisis?

•Global banks and brokerages have had to write off an estimated $512 billion in sub-prime losses so far, with the largest hits taken by Citigroup ($55.1 bn) and Merrill Lynch ($52.2 bn). A little more than half of these losses, or $260 bn, have been suffered by US-based firms, $227 billion by European firms and a relatively modest $24 bn by Asian ones. Despite efforts by the US Federal Reserve to offer some financial assistance to the beleaguered financial sector, it has led to the collapse of Bear Sterns, one of the world’s largest investment banks and securities trading firm. Bear Sterns was bought out by JP Morgan Chase with some help from the Fedral Govt.

•The crisis has also seen Lehman Brothers – the fourth largest investment bank in the US – file for bankruptcy. Merrill Lynch has been bought out by Bank of America. Freddie Mac and Fannie Mae have effectively been nationalized to prevent them from going under. •Reports suggest that insurance major AIG (American Insurance Group) is also under severe pressure and has asked for a $40 bn bridge loan to tide over the crisis. If AIG also collapses, that would really test the entire financial sector.

How is the rest of the world affected?

•Apart from the fact that banks based in other parts of the world also suffered losses from the subprime market, there are two major ways in which the effect is felt across the globe. First, the US is the biggest borrower in the world since most countries hold their foreign exchange reserves in dollars and invest them in US securities. •Thus, any crisis in the US has a direct bearing on other countries, particularly those with large reserves like Japan, China and – to a lesser extent – India. Also, since global equity markets are closely interlinked through institutional investors, any crisis affecting these investors sees a contagion effect throughout the world.

Vedic Observer

What caused the chaos?

Blind greed for amassing wealth is the culprit for the whole damage. In an overly ambitious venture, the banks lent huge money to people whose financial credibility is questionable. To add to the problem, the value of houses collapsed and the payments were defaulted leading to huge losses that resulted in the insolvency of many financial giants like Lehman Brothers, Merrill Lynch, and Bear Sterns etc. The Vedic way of monetary transactions.

In the Vedic system, wealth was measured in terms of gold, food grains, land and livestock which are substantial assets. The cultivable land was fertile enriched with minerals obtained from natural manure such as cow dung etc. unlike the modern day toxic fertilizers. The land provided human society with nutritious food and the cows provided milk which can be used to prepare hundreds of nutritious and delicious foods.

The vaishyas or the mercantile class of men took care of cultivation of land, cow protection, commerce etc. this is mentioned in the Bhagavad Gita (BG 18.44)
”krÌ£sÌ£i-go-raksÌ£ya-vānÌ£ijyaḿ / vaiÅ›ya-karma svabhāva-jam
paricaryātmakaḿ karma / śūdrasyāpi svabhāva-jam”
Farming, cow protection and business are the natural work for the vaisyas, and for the sudras there is labor and service to others.

There wasn’t much borrowing as everyone was satisfied with whatever he got from his land and cows. The kshatriyas collected taxes and ruled the state under the able guidance of qualified brahmanas who did not accumulate wealth at all. Vaishyas cultivated the land, took care of cows and engaged in commerce while the Shudras served the above three classes (varnas) for which they were paid remuneration. Thus the whole society was self sufficient and happy. As all the classes of the society were satisfied, the whole population was making substantial spiritual progress as only in a content state of mind can spirituality flourish.

There were many scientific ways to builds houses using natural ingredients like stones and mortar etc. In fact the monuments and structures built previously are better planned, stronger, long lasting, and artistic than the modern day ones. In this way all the basic necessities of life like food, clothing, shelter was taken care of. In addition to this we also had the banking system. The excess money was deposited with the local banker. Those who needed wealth used to borrow and pay back with some interest. The borrowing was very rare and only for emergency purposes as the system was self sufficient and took care of the needs of all classes of the society. But it was never like paying huge amounts to “sub-prime borrowers”.

Yes, at times we do need to lend and borrow money, but it is the responsibility on the part of the lender and the borrower to make sure that the borrower is lent money within his limitation and avoid the today like situation. Wealth or money is only a part of our requirement. It is not the “all in all” of human life. If one gets too much engrossed in accumulating wealth, he is likely to miss out on the actual goal of life, which is Self-realisation.

What do we learn from this? Simple Living, High Thinking
The great economic advisors of yesteryears like Canakya Pandita have warned us against borrowing excessive and unnecessary loans. Human life is a rare opportunity provided to the living entity to attain that which he could not attain in other life forms i.e. liberation from material conditioning altogether and reviving our original position as servitors of the Supreme Lord. The Lord has provided enough for the sustenance of all.

As mentioned in the Isopanishad
”īśāvāsyam idam sarvaṁ / yat kiñca jagatyāṁ jagat
tena tyaktena bhuñjÄ«thā / mā gá¹›dhaḥ kasya svid dhanam”
“Everything animate or inanimate that is within the universe is controlled and owned by the Lord. One should therefore accept only those things necessary for himself, which are set aside as his quota, and one should not accept other things, knowing well to whom they belong.”

We should just take what we need to sustain ourselves and invest the rest of our time to make steady progress in Krishna consciousness.When one is caught in financial turmoil due to miscalculated investments or borrowings, his life becomes stressful and miserable. Thus he loses his focus on the actual goal of life.


The golden rule is “Simple living, high thinking”.

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Prescribed duties should never be renounced. If one gives up his prescribed duties because of illusion, such renunciation is said to be in the mode of ignorance.

by Gita 18.7

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