www.slideshare.net/IIToons                           Copyright © 2011 by Shivaprasad Srikantia. All rights reserved.      ...
IndiaMBA rEFERENCE Library Series. Copyright © 2011 by Shivaprasad Srikantia. All rights       reserved. Croydon Books, EQ...
IndiaMBA rEFERENCE Library Series. Copyright © 2011 by Shivaprasad Srikantia. All rights       reserved. Croydon Books, EQ...
IndiaMBA rEFERENCE Library Series. Copyright © 2011 by Shivaprasad Srikantia. All rights       reserved. Croydon Books, EQ...
IndiaMBA rEFERENCE Library Series. Copyright © 2011 by Shivaprasad Srikantia. All rights       reserved. Croydon Books, EQ...
IndiaMBA rEFERENCE Library Series. Copyright © 2011 by Shivaprasad Srikantia. All rights       reserved. Croydon Books, EQ...
IndiaMBA rEFERENCE Library Series. Copyright © 2011 by Shivaprasad Srikantia. All rights       reserved. Croydon Books, EQ...
IndiaMBA rEFERENCE Library Series. Copyright © 2011 by Shivaprasad Srikantia. All rights        reserved. Croydon Books, E...
IndiaMBA rEFERENCE Library Series. Copyright © 2011 by Shivaprasad Srikantia. All rights       reserved. Croydon Books, EQ...
IndiaMBA rEFERENCE Library Series. Copyright © 2011 by Shivaprasad Srikantia. All rights       reserved. Croydon Books, EQ...
IndiaMBA rEFERENCE Library Series. Copyright © 2011 by Shivaprasad Srikantia. All rightsreserved. Croydon Books, EQUATION ...
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  1. 1. www.slideshare.net/IIToons Copyright © 2011 by Shivaprasad Srikantia. All rights reserved. Croydon Books, EQUATION MERIDIAN (Publishing & Syndication), 10 Hornby Building, 172/174 Second Floor, Dr. D.N. Road, Fort, Mumbai 400 001 INDIA __________________________________________________________________________________FAST MONEY IN WALL STREETClaude Shannon and John Larry Kelly were two street smart mathematicians who had figured out formulasfor securing high returns in the stock markets. While working long hours at the Bell Laboratories, John Kellyhad evolved a set of mathematical formulas for gambling, sports betting, and playing the stocks. By drawingclose parallels between gambling and stock market speculation, Kelly’s formulas intended to turn stones intogold. Word went around that when billionaire Warren Buffett applied Kelly’s theories to his investments, hehad money coming out of his ears. When traders and investors experimenting with Kelly’s techniques beganconsistently making windfall profits, scientific speculation was institutionalized in Wall Street.With a repertoire of Shannon-Kelly formulas, investment bankers in Wall Street began outsmarting worldmarkets. Incidentally, the White House had always remained committed to the idea of enhancingcompetitiveness of American business corporations through less regulatory intervention in Wall Street.Instead of posing as obstinate regulators, Alan Greenspan and his cronies at the Federal Reserve chose todemonstrate playfulness and encourage speculation founded on untested ideas. This playfulness brought afeeling of optimism that benefitted the American economy by making possible an interrupted 18 year bullrun. Richard Fuld ,who has been credited with the collapse of Lehman Brothers, was on the Board ofDirectors of the Federal Reserve Bank of New York.Senior Wall Street executives began whizzing around the world in their Gulfstream corporate jets andclandestinely rigging world markets. By about 1980, speculators using sophisticated mathematical algorithmsbegan controlling the prices of commodities, food, and oil. It was now time for demand supply equations putforward by classical economists to be rebuffed and placed as museum exhibits at the Smithsonian. The worldwas different now, and economies were poised to move along a new growth trajectory. With just a fewkeystrokes on a computer terminal, Wall Street speculators could now swing the price of crude oil from $ 70a barrel to $ 140 a barrel. This not only made Wall Street tycoons wealthier by hundreds of millions ofdollars, but also broke the monopoly of the OPEC cartels. Most interestingly however, it brought a significantchunk of Russia’s oil assets directly under Wall Street’s fold. 1
  2. 2. IndiaMBA rEFERENCE Library Series. Copyright © 2011 by Shivaprasad Srikantia. All rights reserved. Croydon Books, EQUATION MERIDIAN (Publishing & Syndication).Russia was a country that had, with great trepidation, acquiesced to capitalism. Whiffs of Cuban cigar smokestill wafted through the hallways of Kremlin. as stubborn remnants of the old communist nobility stilllingered in the building. By about 2003, these old hats had became increasingly suspicious of Wall Streetcartels, and rightly so. In 1998, when Russia had to default on her national debt, communists blamed WallStreet investment banks for having drawn them into such a quagmire. Soon thereafter, alarm bells startedringing when Russian officials discovered that Wall Street executives were consorting with Russian oilmagnates suspected of harboring political ambitions. It all seemed like a sinister capitalistic plot to furtherdilute the power of the Kremlin. Therefore, Vladimir Putin decided to take a few intelligent measures. Asa first measure, Wall Street executives were to be denied permission to fly their swanky corporate jets overRussian airspace. As a second measure, and until the Russian economy recovered, vulgar display of WallStreet wealth in full public view was to be prohibited. As a third measure, Russian oil company executiveswere to be imprisoned and challenged. Mikhail Khodonkovsky, a Russian oligarch and owner of the YukosOil company became an overnight celebrity when he was whisked away and locked up in a prison cell. TheRussian administration insisted that Mikhail Khodonkovsky had assiduously laundered money and broughtdisgrace to a great nation.In the first phase of evolution, America had moved from an agriculture-centric economy to a manufacturing-centric economy. In the next phase it had moved into a service- centric economy. When this happened,thousands of factories were closed down in America. While capitalizing on the discovery of scientificformulas and the psychological art of mass deception, the nation later moved into a financial-centriceconomy. In the new American economy founded on the Shannon-Kelly model , nearly 50 percent of whatwas perceived as profit from business was actually illusionary, and was derived from the financial sector. Theretail and manufacturing sectors contributed significantly less.American President Calvin Coolidge had remarked that the business of America was business. That statementnot only set the tone for American idealism, but also assigned a greater political role in a capitalistic societyfor the American multinational corporation. In the American democracy, business enterprise cartels havebecome more powerful than the democratic state. Today, powerful banking cartels wished to control thesupply of money through a new generation of financial instruments known as derivatives. The financial worthof these derivatives was rather conjectural. Their worth and merit was often based on monetary illusionsfashioned from a set of assumptions. Though these assumptions might have be outlandish and debatable froman economic standpoint, they were not exactly illegal, illicit, or unlawful. This explains why those responsiblefor the recent financial meltdown in Wall Street could not be prosecuted in an American court of law. Makingbad business decisions or risky investments could not be hastily equated with white collar crime. Meanwhile,with the sudden proliferation of financial derivatives, the Federal Reserve’s role as a regulator had beendiluted. The Federal Reserve could not have possibly exerted, exercised, or asserted control over a financialspace swarming with flamboyant derivatives. Unless, financial derivatives were outrightly banned, WallStreet could not be effectively policed either by the Federal Reserve or the American Treasury. However,financial derivatives were a novel innovation that could protect money lenders from defaults and help cushioninterest rate risks. Furthermore, derivatives could pave the path for making loans more affordable to society.So, financial derivatives were here to stay. It was left to the ingenuity of emerging economies around the tostart experimenting with this American practice.Insurance companies, and corporate pension fund entities in America have plenty of money available forspeculative investments. In a positive spirit, American Federal regulations generously allow nearly 10 percentof holdings from insurance premiums and pension funds to be invested in risky instruments. In the Americancontext, this 10 percent actually works out to billions of dollars available for speculative investments. Onefaction in Wall Street is trying to mobilize these funds for investments in new businesses and startups.Therefore billions of dollars from Insurance company premiums and retirement pension funds are readily 2
  3. 3. IndiaMBA rEFERENCE Library Series. Copyright © 2011 by Shivaprasad Srikantia. All rights reserved. Croydon Books, EQUATION MERIDIAN (Publishing & Syndication).available to entrepreneurs who wish to explore risky businesses. This is what makes the American economyso colorful, vibrant, and exciting. Therefore, emerging economies of the world might want to study and adoptthe American model for economic growth.America’s economic and political achievements are better understood if the American nation is pictured asa colossal cartel of multinational corporations. American national and foreign policies, usually suggest aneconomic motive that could potentially benefit America’s corporate business fraternity. Furthermore,business corporations operating on American soil were promised a safe haven and a political climate thatwould relentlessly favor business enterprises. In fact, the American government had even vowed to guaranteebusiness corporations complete protection from unruly labor unions, socialists, and communists. Meanwhile,European societies which were trying to practice a lifeless form of capitalism while stubbornly clinging toantiquated socialistic principles were unwittingly alienating business enterprise. This explains why manyEuropean pharmaceutical majors who wished to guard their lucrative drug molecule patents from menacingsocialists moved their primary activities to America. Since then, this exodus of European pharmaceuticalcompanies has greatly benefitted the economies of New Jersey and New York. 3
  4. 4. IndiaMBA rEFERENCE Library Series. Copyright © 2011 by Shivaprasad Srikantia. All rights reserved. Croydon Books, EQUATION MERIDIAN (Publishing & Syndication).THE LUCRATIVE BUSINESS OFMILITARY WARFAREThe most interesting American precept that grew out of Calvin Coolidge’s philosophy was that politicalcalamities, and social upheavals in other countries open up new economic opportunities. For instance, AdolfHitler coming to power in Germany was a calamity that presented an economic opportunity. Looking backin history, there was an intelligent plan behind America’s involvement in World War II. This was not just awar that resolved European conflicts and drove Adolf Hitler to suicide. It was a war that weakened Europeanglobal power. In one of the greatest political maneuvers of the twentieth century, American bankinginstitutions readily provided venture capital to finance wars in Europe. Money was poured into Europe toencourage nations to fight each other to the point of total destruction. Finally, World War II demolished theEuropean economies and allowed America to emerge as the most dominant economic power in the world.Communist uprisings in North Vietnam presented yet another opportunity. America’s involvement inVietnam would not only help seize mineral reserves and rubber from South East Asia, but would also containEurope’s influence in this region. The communist uprisings in North Vietnam was a political calamity thathelped the White House and the business cartels justify an American invasion. By 1960, European nationshad lost their political clout in the global arena. Later, the Vietnam War removed the last traces of Frenchcolonization in South East Asia. The Vietnam War helped drive out European economic domination in Asiaand lay the foundation for American business domination.In recent years, Saddam Hussein’s belligerence presented a another magnificent business opportunity forAmerican oil companies. The Iraqi invasion not only strengthened and stabilized America’s oil supplies forthe next 50 years, but also lessened Russia’s political influence in the region. A few years after the invasionof Iraq, the New York Times reported that the American State Department had a group of advisers assist Iraqiofficials draw up major business contracts between Iraq and 5 Western oil companies. Multinationalcorporations such as Exxon Mobil, British Petroleum, Shell, and Chevron were expected to benefit from thesenew business contracts. Meanwhile , many diehard communists in China and Russia might interpret this as 4
  5. 5. IndiaMBA rEFERENCE Library Series. Copyright © 2011 by Shivaprasad Srikantia. All rights reserved. Croydon Books, EQUATION MERIDIAN (Publishing & Syndication).an example of Western imperialism. Incidentally, Henry Kissinger, had repeatedly advocated the policy ofcontrolling the world’s oil supplies for American domination in international affairs.In the post colonial era, instead of the American government taking part directly in wealth acquisitions,American multinational corporations were encouraged by the White House administration to exploit weakernations through clever business contracts. Many American companies cannot survive in business unless theyout source high skill jobs or industrial production to low wage countries. In fact, American business modelsare not fully sustainable with wages currently prevailing in America. Essentially therefore, the businessframework of the American multinational corporation allows direct accesses to materials and manpower inlower cost regions of the world. Many American technology companies have been doing high wage scientificresearch work in low wage countries such as India. They have set up off shore research hubs in the low wagecountries. Incidentally, it may not be immediately apparent to most American citizens that outsourcing highpay work to a low wage nation with the intent of under compensating a foreign worker is technically thesame as embezzling money from a low wage nation. In other words, American business corporations canutilize prevailing global wage dynamics to legally embezzle millions of dollars from third world nations. Inan earlier period in history, American farmers in the southern states had embezzled money by undercompensating slaves.After World War II, the subdued political leadership in Europe was willing to be guided by the iron hand ofthe White House. After the war, while nations in Europe were recuperating from the wave of destruction,America utilized the available window of opportunity to gain political and economic prominence. Europeannations that were once formidable colonial powers had become politically pliable and economically fragile.Soon thereafter, these debt ridden European economies became parasitic economies counting on the liberalityand magnanimity of American economy for their sustenance. In fact, after World War II, European nationsmeekly surrendered to America. They came instantly under America’s political and economic fold.Incidentally, the G-7 club was created to serve as a face saver for those nations whose political and economicclout had diminished so suddenly. Thereafter, the other 6 industrialized nations of the world looked up toAmerica to build their economies. Meanwhile, nations in Europe are unable to obtain adequate quantities ofraw materials for their technology industries. In fact, Europe is expected to face a raw materials crisis thatwill eventually stifle local industry. 5
  6. 6. IndiaMBA rEFERENCE Library Series. Copyright © 2011 by Shivaprasad Srikantia. All rights reserved. Croydon Books, EQUATION MERIDIAN (Publishing & Syndication).GLOBAL ECONOMY AND WALL STREETIt is common knowledge that the global economy is often influenced by what happens in Wall Street and theWhite House. In the American way of doing business, corporate business and international politics are closecousins. The best way to raise money in Wall Street has been by hypothetically altering public perception bybuilding consumer confidence. Everyday business in Wall Street seems to revolve around the fundamentalidea of playing the stock markets intelligently. Modern economies seem to run on imaginary money andfinancial illusions. Business tycoons, politicians, and bureaucrats seem to be working overtime tomastermind these illusions, and help create a feeling of prosperity and political stability.In the world of politics, power is sometimes derived from illusions. During the cold war, the theatrics at theWhite House and the accompanying rhetoric were all meticulously conceived and created to impress theSoviet communists. Lavish Presidential fanfares at the White House, the opulent theatrics at state sponsoreddinners, the American President’s large entourage, and the majestic appearances of Air Force One have allbeen contrived to create an illusion of American might, prosperity, and economic power. Incidentally, theexecutives at Enron Corporation had created an illusion of prosperity and economic power just beforedeclaring a financial collapse .By the way, billionaire George Soros has written a book titled The Bubble ofAmerican Supremacy - Correcting the misuse of American power.Though America has the world’s largest economic and military resources, these resources are not largeenough to support the imposition of American values globally. When President Ronald Regan’s financialpolicies ran up huge budget deficits, America became the world’s largest debtor nation in dire need of foreigncapital to run the economy. Due to lack of funds, even America’s high school systems were in a frightfulmess. However, by merely consuming 20 percent of the world’s industrial output on credit, America was ableto masquerade as an economic superpower. This was the American way, and it seems to have workedwonderfully.The American nation’s willingness to consume goods, while conveniently disregarding trade deficits or fiscaldeficits, was later finding way into an interesting political equation. After World War II, political leadersin many Asian and European nations were under pressure from voters to ensure uninterrupted economic 6
  7. 7. IndiaMBA rEFERENCE Library Series. Copyright © 2011 by Shivaprasad Srikantia. All rights reserved. Croydon Books, EQUATION MERIDIAN (Publishing & Syndication).growth in their native economies. Political leaders and policy makers across the world were conscious of thefact that economic growth in their home constituencies hinged precariously on American consumerism. Insuch a predicament, Asian and European political leaders never dared to raise the issue of America’sfinancial worthiness or credit worthiness to pay for all the imports. However, the political leaders wereslightly suspicious of America’s credit worthiness. Therefore, they had to collectively figure out a way ofconstantly funneling money into America. This way, new money funneled in could be used to service debton the older money that was funneled in. With no end in sight to the funneling, the idea was to completelyobscure America’s debt obligations in the international arena. In this strategy, where trillions of dollars werefunneled into the American economy, the Federal Reserve choose to look the other way. Americans couldbe guaranteed a good life as long as their consumption was being financed by money pouring in from othercountries. In this game, as long as Americans were consuming, politicians in Asia and Europe could keeptheir economies growing. A track record of good economic growth would allow a manipulative politicalleader to stay in power and get reelected.To ensure that America kept buying, nations that exported goods to America began lending her money to buymore goods from them. Japan became the leader of the pack. Japan pumped staggering amounts of moneyinto American coffers and lured the nation to buy Japanese cars and electronic appliances. Later, the Chineselearned a few tricks from Japan. Vast amounts of Chinese money was steadily pumped into America throughthe purchase of U.S. treasury bills and government bonds. The American economy willingly utilized thismoney to buy more shiploads of clothing, lingerie, and electronic toys from China. Over the years, trillionsof dollars have flown into the American economy through this credit arrangement. Incidentally, this issomewhat like General Motors Acceptance Corporation (GMAC) providing finance to buy GM cars andcreating a revolving life cycle. Though this ingenious arrangement baffles economists, it seems to be bringingbenefits to society on an unprecedented scale.In all fairness, European and Asian nations that were economically and politically benefitting by Americanconsumerism ought to be willing to put out a helping hand in the event of financial catastrophes. In allfairness, the European and Asian economies were morally obligated to absorb some losses if calamity struck.Therefore, Wall Street bankers and the Federal Reserve evolved a brilliant financial scheme where big chunksof economic shock could be transferred to unsuspecting economies of European nations. For instance, manyforeign banks had been carefully conned to make risky investments in American mortgage-backed securities.This way, in the event of a financial fiasco, banks in Europe were forced to take some of the shock from WallStreet. Incidentally, in the recent financial crisis, the Federal Reserve was unwilling to publicize informationon the list of foreign and local banking institutions that were a part of the AIG bailout package. The FederalReserve wished to conceal the identities of AIG derivative counterparties. The element of secrecy seems topoint to the likelihood that the Federal Reserve is being covertly used by a powerful banking cartelorchestrating speculative financial investments on a global scale. These speculative investments benefit theAmerican economy. 7
  8. 8. IndiaMBA rEFERENCE Library Series. Copyright © 2011 by Shivaprasad Srikantia. All rights reserved. Croydon Books, EQUATION MERIDIAN (Publishing & Syndication).CREDIT SWAPS, DERIVATIVES, ANDTHE SUBPRIME CRISISThere is a battle between two factions in Wall Street. One faction wants capital made available only to theFortune 500. This factions want to decimate small business enterprises poised to weaken the hold of bigcorporations. Another faction that wants a new generation of high technology startups to rise up and challengethe supremacy of the Fortune 500 companies. They want to make billions of dollars of capital available to smallstart ups and entrepreneurs. Everyday of the week, ingenious financial instruments are being conceived by boththese factions to control, balance, transfer, distribute, and spread financial risk. The two factions are trying tooutsmart each other through new financial concepts and inventions. Therefore, in a savagely competitiveenvironment, it is apprehension that is driving the creation of instant wealth on paper through illusions. As thecharacter of financial markets is now becoming very complex, the real value of money is itself is being re-discovered. In this backdrop, and within the limited framework of newly invented knowledge, financialinstruments are being evolved with oversimplified assumptions. Senior executives of banks in Wall Street werewilling to take more risk than their businesses were structured to withstand. Many of these executives whodisplayed recklessness as a trait were on the advisory council of management schools.Wall Street offered upward mobility to risk takers hailing from poor working class backgrounds. Many WallStreet executives who got together and engineered the financial collapse actually came from poor working classbackgrounds. Most of the chief executives who were responsible for the recent financial meltdown in Wall Streethailed from poor labor class families. They did not come from aristocratic and wealthy families that had handledmoney over several generations. In fact, in many instances, these Wall Street executives were the first in theirfamilies to have attended college. In America, college education often served as a springboard. A degree fromHarvard or Wharton could change lives dramatically. For those hailing from poor families. money making oftenbecame the single most important objective in life. This is striking contrast to the corporate scenario in Europe.The top business schools in Europe prefer to admit students from wealthy and aristocratic families. In European society,it was only the children of wealthy capitalists, business owners, or company presidents who could hope to become chiefexecutives. In other words, the children from middle class households dd not ordinarily have access to jobs that give themcontrol of finances. 8
  9. 9. IndiaMBA rEFERENCE Library Series. Copyright © 2011 by Shivaprasad Srikantia. All rights reserved. Croydon Books, EQUATION MERIDIAN (Publishing & Syndication).At J.P Morgan, an executive named Dennis Weatherstone had spearheaded a mathematical study on riskmanagement. J.P. Morgan developed a technique of assessing market risks on a daily basis. Incidentally, J.P.Morgan’s investment banking arm was Morgan Stanley. Major banks in America came in droves and embracedthe J.P. Morgan technique of risk assessment wholeheartedly. Today, the new financial instruments are tryingto bring together financial institutions with conflicting agendas or opposing positions. For instance, oneinstitution benefits from high interest rates, while another institution benefits from low interest rates. Bothoperate out of Wall Street. Wall Street is trying to evolve new financial instrument that balances financialinterests of these two opposing institutions. Along the way, mistakes will be made. The mistakes cannot beavoided, and in many cases the intent is never to defraud. Mistakes and financial catastrophes are all a part ofthe learning process.The subprime crisis was a part of the learning process. For about 4 uninterrupted years starting from 2000, realestate prices began increasing sharply. This began attracting speculative investments in real estate. As the pricesof houses was steadily rising, obtaining a loan for investment in real estate became relatively easy. In thisscenario, the banking cartel in America had decided that credit worthiness should not be made a major issue fornew borrowers. However, by about 2005 public sentiment began to flutter. By 2006 real estate prices startingdown sharply. In 2007 over a million home owners initiated foreclosure proceedings. Meanwhile about 10percent of American home owners saw their equity eroded significantly. Many started defaulting on their loans.These chain of events following speculative investments in real estate had by now begin to create a serious creditcrunch.Bankers were generally required to cover about 8 percent of assets. However, Wall Street institutions began todiscover that mortgage products could be sold with less reserve capital. Securitized tranches required even lesscapital than ordinary mortgage products. The novel idea of credit swaps provided an elegant mechanism to takeaway credit risk from a party that was terribly risk averse, and place it in the hands of another party that had agreat appetite for risk. Fundamentally, the latter had a risk appetite normally synonymous with insurancecompanies. A party that was less risk averse would be willing to provide default protection in exchange for ahefty fee. During good times, these default protectors were entitled to windfall profits.Credit default faults would allow banking institutions to operate with less reserve capital, as a mechanism forbuying protection to take care of default risk had become available. In this scheme of things, the credit riskwould never have disappeared altogether. Credit risk would have been quietly shifted to a financial institutionthat was less closely monitored and regulated by the government. In all of this, the financial arguments createdto hoodwink regulatory authorities was that derivatives were making the banking business less risky.Furthermore, it was argued that regulatory intrusion in such matter would be undesirable and even obnoxious.The fundamental point however was that derivatives were not actually making risk disappear. Derivatives wouldsimply distribute the risk and quietly push them under the carpet. Incidentally, the idea of credit swaps was firstenvisioned and conceived by a lady named Blythe Masters. While J.P. Morgan was promoting the idea behindcredit default swaps, Goldman Sachs became the largest dealer of derivatives.Many of the financial risk models based on probability theory seem to be deeply flawed. These modelsdangerously attempt to create illusions of profit. They provide the tools and an operational framework for whitecollar crime in Wall Street. They utilize complex mathematics and probability theory to legitimize white collarcrime and fraud. At one brief time in American history, the Commodity and Futures Trading Commission(CFTC) considered regulating derivatives. However, Alan Greenspan did not want regulatory control overderivatives. Senior executives at the Treasury and at the Office of Thrift Supervision also held the view thatdefinitives should stay unregulated. Therefore, while a financial tornado was spinning out of control, SECChairman Christopher Cox remained in the sidelines as a mute spectator. Neither the Secretary of the Treasurynor the Federal Reserve stepped in at a critical time. With a great deal of certainty, Greenspan assured the world 9
  10. 10. IndiaMBA rEFERENCE Library Series. Copyright © 2011 by Shivaprasad Srikantia. All rights reserved. Croydon Books, EQUATION MERIDIAN (Publishing & Syndication).that market players alone would intelligently manage the risk. The chain of events that lead to the financial crisisprove that Alan Greenspan was dead wrong. Greenspan had ruled out the possibility of the market failing todiscipline itself. Moreover, Alan Greenspan was reluctant to oversee subprime lenders. The Federal Reserve wasallowed to be misguided by Wall Street mathematicians and the investment banking cartel. This was nothingshort of a major blunder.Wall Street mathematicians had perfected the art of concealing financial risk while embellishing it with complexprobabilistic theory. These mathematicians provided the tools to deceptively make risky collateral debtobligations seem on the surface as safe as US Treasury bonds. Through complex arguments ridden withmathematical theory, they also managed to deceive the rating agencies. Meanwhile, the vast majority of WallStreet neither had the information nor the intuitive intelligence to recognize risk. In many instances, investorswere planning their buying based on incorrect ratings. Quite often, American executives were not aware of therisk they were exposed to. Information pertaining to risk was quietly suppressed by the middle managementbefore it reached top management. Subprime mortgages were created without careful scrutiny. Notional valueswere utilized to drive the American economy. Brick by brick, mortgage lending was being built on foundationsof deception, and fraud. Market values of homes were inflated by middle managers trying to meet their salestargets. Sometimes, even loan applicants were allowed to provide false information and forged documents tosupport a home loan application. Borrowers were entrapped in loan schemes and threatened with severe penaltiesin the event of a prepayment.Large quantities of risky subprime mortgages were bundled into Collateral Debt Obligations (CDOs). While thegeneral industry norm was about 15 percent, the new players were building CDO instruments with 80 percentdubious subprime mortgages. They justified the 80 percent levels by arguing ferociously that real estate priceswould steadily keep rising. However, a simple study of real estate history over a period of 50 years would haverevealed that real estate prices go through upward and downward cycles. Wall Street Mathematicians failed tounderstand these cycles before devising business models for use by the American mortgage industry.American capitalism often places faith in the wrong people. In fact the SEC attained notoriety for its laid backattitude. Organizations such as the FDIC, SEC, Treasury, and the Federal Reserve never took the pains tounderstand the risks associated with unregulated derivatives. Perhaps, the only American institution that wasworried about derivatives was the General Accounting Office (GAO). In the subprime era, companies withillusionary profit were created by the hundreds. At an earlier time, credit rating agencies had been successfullydeceived by Enron, Worldcom, and Tyco.There was something inherently wrong in the way rating agencies conducted their operations. In some ways, therating agencies themselves are part of a big scam within American capitalism. The American government andthe regulatory authorities probably know this very well, but intentionally look the other way. It is often allegedthat rating agencies give away Triple A ratings in exchange for a fat consulting fee. When audit firms beganlooking at the balance sheets of AIG, they were probably stunned and horrified. In a shady practice, thesubsidiaries of AIG were granted Triple A rating based on the financial credentials of the parent company. 10
  11. 11. IndiaMBA rEFERENCE Library Series. Copyright © 2011 by Shivaprasad Srikantia. All rightsreserved. Croydon Books, EQUATION MERIDIAN (Publishing & Syndication). 4CROYDON BOOKS EQUATION MERIDIAN (Publishing & Syndication) 10 Hornby Building, 172/174 Second Floor, Dr. D.N. Road, Fort, Mumbai 400 001 11

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