Author : Jaishri Jayakar

The 2008 Financial crisis rocked the world and much was written and talked about it. More than that, the lives of billions of people were affected. Financial institutions with hundreds of years of lineage collapsed overnight. New York’s Wall Street was in shock. And pre-World War II old timers pictured the Great Depression of 1939 in the modern age. Household names such as Lehman Brothers, Bear Sterns Corporation and A.I.G turned into nightmares of the American people and government.

While many of us have heard of the term “sub-prime”, in relation to mortgages, a simple Indian retired teacher like me would find it hard to relate to the actual meaning of the term. So let me put it in the simplest term that could be understood by one and all as to what exactly happened that year and about the global repercussions of simple and dirty greed.

A home loan in America is known as a mortgage. Unlike India, America has hundreds, if not thousands of local community based banks. Traditionally these banks would lend money to its customers to buy a house. Based on the credit limit of a customer, the bank would lend upto 80% of the value of that house. Also, as is the case with everyone I know, if you lend someone “x” amount of money it is your obligation to collect the same with interest over a period of time. A few New York Wall Street financial geniuses came up with the Derivative market which is not subject to the stringent regulatory controls of the Securities Exchange Commission’, which is the same as the India’s ‘SEBI’.

Now the derivative market is sort of like the boys we see standing by the railway tracks and betting on who can throw the stone farthest. Owing to the limited controls set by the government regulators, in the derivative market you can bet on anything such as the weather, currency fluctuations and the date you expect the markets to crash. The aforementioned financial geniuses came up with the idea to buy many loans from the community banks, combine them together and created what is known as “Collateralized Debt Obligation” [CDO]. They, in turn would sell the CDOs to their investors promising them great returns at virtually no risks owing to the CDOs being backed by physical assets.

As the onus was no longer on the community banks to collect the money they had lent, they started giving loans to anyone who came to the bank, sometimes as much as the 99% of the home value. They also started giving such loans to people, especially from the poorer financial backgrounds, so that they could charge more interest from these customers. These poorer customers were called “Sub-Prime” as they didn’t have good credit backgrounds.

Now imagine a situation, where in a colony of 100 houses, each house has a market value of Rs. 100,000. If one family, under distressing conditions sells their house for Rs. 60,000, suddenly the market value of all the hundred houses comes down to 60,000. Imagine one of the those houses was owned by a construction worker who paid only Rs. 1,000 as a down payment and received the other Rs. 99,000 from the bank. He would have lived in that house for six months and can no longer pay his monthly EMI of Rs. 700. As he has little equity invested in the house, he decides to stop paying his EMI and moves to a rented house, allowing the bank to repossess that house. The bank now, to recover a portion of their capital auctions the house in a foreclosure auction that may fetch as low as Rs. 30,000. Suddenly the colony which was worth Rs. 100,000 per home becomes valued at Rs. 30,000 per home. Very distressing indeed!

As this phenomenon spread nationwide CDOs became useless and the small banks who had loaned the money out to un-creditworthy clients started collapsing! In turn those Investment Banking companies hawking the CDOs and those companies that had CDOs worth billions of dollars realized that in reality, those CDOs were nothing but just pieces of paper!

The financial wild fire spread, burning everything in its path. In simple words, this toppling of the house of cards is the 2008 financial crisis, also known as the Sub-Prime crisis.

Why wasn’t India affected?

As any home owner or prospective home buyer in India would attest to, the fact remains that India has a large and substantial black market. Purchasing a house in an Indian city constitutes dealing in this market in different ways.

Now, imagine that same colony of a 100 houses was in India and you wanted to buy a house in that colony. The market value of that house is Rs. 100,000. The seller of that property, over a cup of coffee would dictate his terms which would invariably include “ratio”, such as 50:50, 60:40, 70:30 etc. To the uninitiated this means that he wants half through the bank; colloquially speaking “white” and the other half in cash, “black”.

This practice, while highly illegal is wide spread and pervasive. The objective is the owner pays income tax / capital gains tax and other taxes only on Rs. 50,000 and the purchaser pays for registration and stamp duty only on the declared value i.e. Rs. 50,000. Hence, he may take a home loan for up to Rs. 40,000 (up to 80% of the property value). He has therefore invested close to 60% of the value of his home and is therefore highly vested equity-wise, in the property.

Even if his neighbour sells allows the bank to foreclose on their house and auction it for Rs. 30,000, you would continue to pay your EMI to the bank as you have already invested so much money into that home. This ensures the banks are highly solvent and loan defaults in India are extremely low compared to the US or UK.

In conclusion this perverse, corrupt and illegal practice has not only saved our largely service oriented Urban Indian economy from total collapse but has in fact cushioned our budding property market against the pitfalls of the global recession!

Who so ever said, “Cheaters never prosper!”?