The Wall Street Crash...............Its Aftermath

A lot has been written about the ongoing financial crisis in the United States, the heated deliberations in the Congress on what is the effective bailout funds required, FBI enquiry into the real reason for the fall of Institutions and the real culprits behind it etc etc. Those sitting outside the US and seeing the drama unfold cannot but speculate what is the aftermath of this huge financial disaster. The questions raised can be - (1) Will there be a protracted financial crisis in the US dragging the world along with it or will the clean up act and confidence building measures from the Fed in terms of fund flows, policies, stabilize the US market and consequently the world economy? (2) Will the US be able to retain its position as the premier financial hub for management of investments or will that activity take place somewhere else? (3) Will foreign investors now invest in US securities as before? (4) Will the world financial economy be less US centric than it was before? and finally (5) Is this event a harbinger to a shift of economic power from US to emerging markets like Brazil, Russia, India and China?
While it is hard to find answers to these questions at the present, some clues present themselves from a variety of comments, information available by in various blogs, articles and comments from which a prognosis can be made
Comments / Views

• As per Jeffrey Garten, in his analysis in FT.com, "The US’s dependence on massive inflows of foreign capital, roughly $3bn (€2bn, £1.6bn) a day, will surely increase now as Uncle Sam acquires $1,000bn in new obligations from current bail-outs. For years to come, Wall Street and Washington will be unable to manage without strong co-operation from other markets".
• Garten's analysis also states "Globalisation will now also create a clash of philosophies. Most governments and investors outside the US never shared the American system of cowboy capitalism. Now they have good reason to demand that some fundamental changes be made in the way the US manages its financial institutions. This can happen with a conscious, negotiated modification in the US financial model, or it could result from foreign investors shifting their funds elsewhere".
• Economist Paul Krugman in his article in New York Times, Banks Gone Wild states 'This slump was both predictable and predicted. “These days,” I wrote in August 2005, “Americans make a living selling each other houses, paid for with money borrowed from the Chinese. Somehow, that doesn’t seem like a sustainable lifestyle.” It wasn’t.'
• FBI is investigating four major US financial institutions (Fannie Mae, Freddie Mac, AIG and Lehman Brothers) whose collapse helped trigger a US$ 700 billion bailout plan by Bush administration - Economic Times India, Thursday, September 25, 2008
• Those who followed the US led free market principles especially countries like China are now shunning the same - read "China Shuns Paulson's free market push as meltdown burns US" in Economic Times India, Thursday, September 25, 2008
• An senior US Economist Robert J Samuelson in his article titled "The Great Confidence Game" in the Economic Times India, Thursday, September 25, 2008 succintly states "People have to believe that Institutions that they deal will perform as expected. We are in a crisis because financial managers - the people who run banks, investment banks, hedge funds - have lost that trust". Similar sentiments were echoed by Robert Reich an US public policy expert in his article titled "In the aftermath, a loss of trust"
• A loss of trust as seen in Morgan Stanley as it "lost close to a third of assets in its prime brokerage last week, amounting to hundreds of billions of dollars, as hedge funds fled after the collapse of Lehman Brothers and moved to rival banks." (read FT.com Morgan Stanley suffers cash flight, James Mackintosh in London, September 25 2008)

The Prognosis
It is very much evident that there is a huge loss of investor trust. The Fed bailout, Warren Buffet investments is to bring confidence back to the investors. However, trust is built over large periods of time takes a long time rebuilding once lost. Human memory maybe short but certain events linger in the memory for long. In India the power fiasco over Enron virtually derailed all investments into the power sector even after 10 years - consequence of a negative impact on investors and government. The repercussion of what has happened in Wall Street will be etched in our memories for long. The 1930s market crash is still being reflected today so also will the Wall Street Crash be an object of study far into the future.
Cowboy capitalism as practiced by Wall Street should become history. Asian and emerging markets will be learning some powerful lessons from the US experience. China has already shunned the free market practices propounded by the US model. Regulation and tighter controls should be the norm of the future. Will all this impact money flows into US? - it certainly would. With US$ 3 billion or more required by US everyday from foreign investors to sustain its market bailout this kind of sustained investment should considerably dry up in future, leading to severe recession and possible contracting of its GDP. The dollar may weaken significantly and lose its standing in the basket of international currencies. Capital flows would then head towards safer growth economies - in all probability the BRIC countries. This would be a paradigm shift and therefore impact should be felt across the globe.
Will the US recession drag the world economy? - very much, as it accounts for 40% of the world's economic activity. However, world's GDP should bounce back fairly quickly with emerging economies benefiting heavily from the bounce back.
Will US still remain the premier hub of money management? This is a difficult answer. The brains trust of the capital markets is in the US and these very people who have failed at Wall Street will try and figure out what went wrong and make corrective action. Corrective action will come about if US changes its market model and gets itself regulated by a global regulatory authority, as is being proposed, and does so quickly, a shift from US maybe unlikely. The reason being that the financial and market systems in the US are robust and well spread as well as hard to replicate by other economies in the short and medium run. Huge investments have been deployed on technology and market systems which have been perfected over the years. The flight of capital from US shores might trigger an exodus of investment advisors to places where such capital is being deployed. However, it is unlikely such an exodus might take place with immediate effect.
All this will take a while - while the US tries to resurrect itself it should be business as usual in other emerging economies not overtly dependant on the US. They should and probably will take advantage of the US weakness. Capital flows to emerging markets should increase buoyancy in the crestfallen markets. Management skills will be at a premium may in come with capital.

The great fall in Wall Street and its implications

With the conversion of the two last standing Investment Banking stalwarts in Wall Street - Goldman Sachs and Morgan Stanley into full fledged Banks as opposed to the erstwhile identity of pure Investment Banks, an era has passed. The huge risk taking appetite of these Institutions and their investment products that lured investors from world over to high profits is now history. These Institutions will now on be more regulated, and this would lead to lesser profits and therefore lesser risk to investors.
The latest news shows that bond holders in beleaguered Lehman Brothers are set to lose USD 110 billion - in effect a dollar bond of Lehman trades at 18 cents. Bonds are usually secure debt instrument with underlying assets. However, severe mortgage losses have wiped out most assets of Lehman Brothers which would include, I presume, assets underlying debt instruments.
Risk Management
The big question that one should ask now - what about risk management processes within these venerable Institutions? The failure of Bear Stearns, Lehman and the huge write-offs in other Banks like Citibank, JP Morgan points clearly to a failed system of checks and controls. Whether this was a systemic failure or done purposefully should be a matter of investigation and study. Whilst these Banks / Financial Institutions were primarily answerable to their own investors, the larger picture should have been made available to the Federal Reserve. Obviously, the external auditors to these Institutions were not in a capacity to let off early warning systems of an impending collapse. Therefore all this begs another question - did not Wall Street / Federal Reserve learn from the Enron / Arthur Andersen scandal some years ago? Or, were they (Investment Banks) perceived separately from a Power Company whose business is not risk taking but power production? In any case both resulted in huge destruction of assets of their investors. All this leads to one conclusion - investor protection is nothing but a sham and auditors and risk management systems to oversee investor protection a greater sham.
The real sufferers
If you read the man the once predicted this debacle - "Dr Doom" or the economist Nouriel Roubini, he states that foreign investors who so long trusted the might, wisdom, technology and experience of the "American System" of Investment Banks / Financial Institutions have been badly let down. Their trust would have been severely eroded of the system, having invested heavily into these Institutions. I suppose the Fed bailout would help the perpetrators of this default- management within these Institutions and the mortgage home owners who may now get a reprieve on their home loans!
Lessons learnt and opportunities for India
This has some very pertinent lessons for the Indian investors and Indian Regulators - it is time to abandon the American style thinking on profits. Most of our youngsters who were fresh MBAs from IIMs have been lured in the likes of Lehman Brothers, Goldman Sachs in the past with huge salaries, incentives etc need to understand is that they imbibe the whole culture of reckless abuse of investor funds which is highly dangerous. I believe investors would have become more circumspect of higher profit and the whole nature and attitude of their advisors. This would definitely spawn a new generation of advisors and Institutions who would have to pay a higher premium for use of investor funds. Larger liabilities could befall on those fund managers who have not been circumspect with investor funds. Risk management processes will surely strengthen and investors would want a larger global footprint to invest their hard earned money.
Emerging markets would certainly benefit and more so stable ones. India should profit heavily when once again investor interest gets aroused. Having been singed by their American experience, big time funds from Saudi Arabia, Japan and Europe will seek more Indian funds and Indian investments. However, success will come only if we play the game well - bring more transparency into our investment process and provide a stable platform for investors to put in their money. The Risk Management processes should be defined and audit process more robust. This would bring in higher investor confidence. India requires huge investments in the infrastructure sector and foreign funds would be most welcome to invest into the same provided they invest on long term basis with a hope of stable returns. Indian infrastructure could offer stable returns in response to long term funds - a potential win-win situation. Some guarantees could in thrown in to assuage investor confidence.