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Tuesday, August 14, 2007

Subprime Concerns


Subprime. I don't remember any other word that a whole lot of stock market types had to learn so quickly about. And it's not even a real word. By now most people who read newspapers and watch TV know about subprime. They have some idea about what subprime is and have heard that something called The Subprime Crisis is causing stock markets around the world including India to jump up and down violently. But the connection sounds a bit tenuous. So there were all these people in America who were given housing loans even though it looked unlikely that they could pay their installments. And when many such people found that they really couldn't pay up, then stock markets around the world fell. As we say in Sanskrit, Vasudhaiv Kutumbkam. The world is but one family. EMI cheques in America bounce and Dalal Street catches a cold. I can bet that a lot of Dalal Street types would like to personally lay their hands on an actual subprime borrower, grab him by the collar, give him a tight slap and ask him why exactly he bought a house that he can't afford to pay for

Anyhow, one can't blame the borrowers too much either when the business methods of the lenders were so bizarre. Apparently, you didn't actually have to give in any documents for these so-called 'self-certified' loans. Self-certified means that the borrower can certify himself as having the capacity to repay. There were even self-certified loans with zero down payment and a honeymoon period of up to two years during which no repayments had to be made. The exact implications of a loan facility like this are left as an exercise for the reader. But the part that matters to us is how, if at all, this is connected to us in India. The tightest explanation one can find that the subprime failures will impact many of the same investors whose money is also flowing into Indian (and other emerging) stock markets. As things get shaky in one part of their investments, they'll pull money out of their other investments and that will shake up the foreign fund flows that are known to be a major driver of the stock market boom. There's another, more touchy-feely and broader version of these explanations, which is that the subprime crisis has led to the rise of a general aversion to risk of all kinds and a desire in lenders as well as investors to get there money back safely regardless of opportunity lost.

Does this really have anything to do with India? As I'd said in my Global Cues article a couple of weeks ago, there's a huge and growing disconnect between what drives stocks in the short-term and what drives them in the long-term. American hedge-fund manager-turned-TV personality Jim Cramer says that the stock markets are like a fashion show. In the audience, the amateurs watch the models but the professionals watch other professionals. What Cramer means is that what happens to the companies doesn't matter, what matters is what other investors think of what is happening to the companies. There's a lot of this attitude around, and this is what leads to this obsession with global cues and subprimes. In the medium and long-term, this is utterly irrelevant. Even in America, the actual proportion of outstanding housing loans that are in trouble is 0.6 per cent. The fundamental numbers and trends of the Indian economy and stocks are as robust as ever. It's what's actually happening in the economy and the corporate that matters. If others think something else, well then they'll just have to change their thinking sooner or later. The moral of the story is that when you go to a fashion show, take the long-term view and keep your eyes fixed on the models.