For quite some time I had been thinking to put up something on the topic. I am sure there wouldn’t be a person who hasn’t heard of the term by now. It has been a year since the buzz has been around. It has only *peaked* a couple of weeks ago with the collapse of the BIG financial giants. I’ve grown up hearing that United State’s economy being one of the most stable in the world only to find this sudden fiasco.
I tried to search for the term on Google and the definition itself spells doom!
“A type of loan that is offered at a rate above prime to individuals who do not qualify for prime rate loans. Quite often, subprime borrowers are often turned away from traditional lenders because of their low credit ratings or other factors that suggest that they have a reasonable chance of defaulting on the debt repayment.”
To cut it short subprime lending is lending money to subprime borrowers (borrowers with a not-so-good credit history). To risk of default is accommodated through a higher than average interest rate.
That’s ok! But why did it result in such a big fiasco?
Well, fortunately I got an opportunity to get through a short course in financial instruments. I was amazed by the sheer complications of the various instruments floating in the markets! I guess the more complicacies one introduces, the higher is the respect in the financial community. Look at the following terms:
– ‘derivatives of derivatives’
– ‘reverse mortgage’
– ‘collateralized debt obligations’ (CODs)
Don’t they sound cool?
So tons of ultra-complicated financial instruments were made whose base was subprime loans. The complications grew so much, that no one could actually estimate the actual worth underlying these instruments. And when the borrowers started to default, everything started ripping apart like a castle of cards. Since the base of all the *exotic* instruments was these sub-prime debts, when the foundation collapsed, no one could have done anything to stop this.
What is money?
I never understand the fact that the Fractional Reserve Banking allows banks to print money by just keeping aside a meager percentage of deposits and lending out the rest. So the injection of currency is actually based on debts!!!!! The more indebted the citizens are, the more money gets injected into the country’s economy. Anyways, I am too naïve to comment further on this. There must be some rationale which I still have to understand. The following video is a MUST WATCH for anyone who wants to understand money:
How is India impacted?
Fortunately, Indian bank’s exposure to such instruments is almost nil. So no direct concerns over there. However, with the US economy slowing down, some impact can’t be ruled out. I guess the whole world will have to slow down a bit. India seems to have definitely lost it’s shine as is evident through the Indian stock markets and general perception as well.
Why has everything to be so complicated? Why can’t things be simple? I guess the reason is human nature. We constantly look to challenge ourselves and in the process introduce complications. I hope things will settle down soon and people will be careful for a while. But I am sure all this will definitely manifest again in some or the other way in our own lifetimes!
It has happened twice now. Yes, both the times the Indian Markets have crashed in the last six months, I sold off all my stocks just about a week before the fall. So that’s great news. Luckily I got rid of the stocks at the right time. Some instinct allowed me to time the market by exiting at the right time. Continue reading
Date: Wednesday, 17th October 2007
Time: Around 10:30 AM
I logged into my trading account to view my portfolio. Couldn’t believe what I saw! My portfolio (though it’s meager) was down 20% from what it was last night. I looked at the market flash only to know that the trading had been halted for an hour as the Sensex shed around 1500 points within minutes of opening, thereby ripping through the lower circuit. I was not able to figure out what was going on.
Anyway all that passed away like a dream and things were back to normal the very same day, once the markets reopened.
But why the hell did this happen?
Well by now everyone knows that it was because of SEBI’s proposed ban on P Notes with immediate effect. I interacted with people around me who had some interest in the markets, and everyone suggested to stay away from active investing as the markets are volatile because of SEBI’s recent proposal on P Notes.
So far so good, the moment I asked what a P Note is, I got blank faces or some weird explanation which I couldn’t comprehend.
To be precise, a P Note (Participatory Note) is a financial instrument through which a foreign individual or institution can take a position in the Indian equity market without being registered as a ‘Foreign Institutional Investor’ (FII). So the FIIs who are already registered in India become the medium for such individuals/institutions to take a pie in India’s promising growth story by issuing them P Notes.
So what’s wrong?
Well if the money flowing in through such instruments becomes significant; it can make any regulator uncomfortable, as it becomes impossible to track as to where the money is coming from. I am not going to explain any further. If you would like you know more the following could be helpful:
The point I want to make is not the whole P Note issue. I wanted to highlight the significance of the all powerful ‘Market Sentiment’. I have read a number of times that the Market Sentiment is so powerful that it can sometimes defy all logic. I believe that in any market there are only a few people (few in nos. but holding the major chunk of the market.) who understand the intricacies of it and a majority are mere dummy observers.
Let me summarize what I learnt from the P Note episode:
All this provides some decent opportunities for a well informed investor, to buy/sell stocks and make a quick gain.
Happy investing 🙂