Coming Out of Subprime- the New Economic Challenge

It’s time again for the US policy makers for another economic recovery program, on the aftermath of the financial crisis triggered by the Subprime mortgage market collapse. The Fed, Central Banks and the Bush administration are up in arms to contain the current housing crisis which spread like a contagion effect across the global capital markets. As a lender of last resort, the Fed (Ben Bernanke) has proved itself (himself) credible enough in tackling the current crisis, according to analysts, though it cost the Central Banks around $350 billion to buffer the credit squeeze as a result of the subprime effect.

The lenders, the borrowers and the credit originators might have learnt lesson well from the current financial turmoil that wiped out $2.5 trillion from the global equity markets. One could wonder how 'uncle sam' -the US economy, by far still the largest with $ 13.5 trillion economy could really come out of this trouble, as the subprime is not yet over and the banks and lenders exposure's to such is much under purview. Global investment banks and NBFC's have been reporting mounting losses tagged to subprime bonds (MBS-mortgage backed securities) traded in the US and elsewhere which investors have started dumping due to high default rates.

It has now been one of the prime agenda of the Bush administration as how to tackle the current subprime mess as well as safeguarding the borrowers’ interests. In fact, US have been through several economic crises before in the last three decades well backed up by ambitious recovery programs. One such has been during Ronald Reagan’s tenure, when, the situation was not far off-better than the current subprime. It was during the 1981 the US economy was facing a tough challenge with Inflation rate as high as 12% and unemployment rate around 7.2%. The present scenario doesn't look the same since the nature of financial crisis has changed with the times. US Inflation is now within the Fed's comfort zone-2% and unemployment rate well contained. The few options Reagan had at that time were cutting government spending, managing federal deficit, cuts in domestic spending and income taxes. Perhaps, Bush might have fewer options at present as the USA is confronted with huge trade deficits with China, much larger defense budgeting, likelihood of an economic slowdown, and the falling housing prices and rising home loan foreclosures.

One likely option could be opening of an outright 'subprime-only exchange' where the remaining ABS-MBS bonds could be traded freely among the investors after re-pricing those loans. Subprime bonds could be sold in 'auctions' as it might open a creative channel to diversify the default risks of the borrowers. However it might be, financial statecraft should be sound in dealing with a crisis of this magnitude, which due to its contagion effects might spread the infection and make it more pandemic in the financial markets.

One might say, "never put an actor on stage before the show starts’’; while it is equally true to "put a stage before the actor performs". As with the financial markets, it is not immune and the stage should always be there to put down the right man at the right time as markets have become more interdependent and highly integrated in nature-albeit more “sensual”.


References: Bloomberg, Reuters’s, Economic Times
Books: Reagan, God and the Bomb- F H Knelman