The global financial crisis might largely be the outcome of the incompetence and greed of the private sector. Many experts in the US however blame the government for its mindless affirmative action at the root of the mortgage crisis. If it is true India is also fast slipping into a similar situation.
As in the US, in India too some of the actions of the government have all the potential to create a financial disaster. The Manmohan Singh government has crossed all permissible limits in budget deficit by its various poll-oriented populist schemes like loan waiver and subsidy. The real attack on the health of the financial system has come in the form of affirmative action with the pledge of giving minorities the ?first right? in national resources. The sincerity of this statement is widely doubted. But the manner in which the government implemented it raised many eyebrows.
Let'ssee how it undermines the banking. So far a number of securitisation instruments have been introduced in the Indian market but the banks were largely protected because 70 per cent of assets are still held by the public sector banks.
There is an interesting and uncanny parallel in the present US crisis and the UPA government'senthusiasm to promote banking business for the minorities. It is not only that the UPA has unleashed what Keynes called ?the animal spirits of the entrepreneurs? by allowing a free run on market for speculators, but it might have by introducing its vote-bank dictated populism into the financial system shaken the foundations of the economy.
Take the American example. The financial institutions are going down like ninepins. The credit crunch is because of the fact that banks are nervous of lending to each other and the public. This is created by a combination of factors. First of all it is the suspicion about the creditworthiness of the borrower that makes the bank cautious. In bank-to-bank transactions if the suspicion about the extent of exposure of the other, or the realisation that the whole financial system stood on an unstable house of cards of credit banks refuse to lend. This could be the cumulative result of bad lending or mad speculation. In the US both played their role.
Columnist Jeff Jacoby in his column in The Boston Globe (September 28, 2008) has given an incisive insight into the crumbling of the US economy because of accumulation of political system induced bad debt. But the financial institutions here were private unlike in India. He says, ?Mortgage lenders didn'twake up one fine day deciding to junk long held standards of creditworthiness in order to make ill-advised loans to unqualified borrowers. It would be closer to the truth to say they woke up to find the government twisting their arms and demanding that they do so?or else?That was when government officials egged on by left wing activists began accusing mortgage lenders of racism and ?redlining? because urban blacks were being denied mortgages at a higher rate than suburban whites. The pressure to make more loans to minorities became relentless? Lenders responded by loosening their underwriting standards and making increasingly shoddy loans.?
The situation is similar in India. There is a political clamour that minorities are not being given sufficient loans and that there are not enough bank branches in Muslim localities. The banks counter that the weak credit history of the segment and not any bias is the reason. The government'sresponse was equally ridiculous.
In the Budget for 2008-09, the Finance Minister announced a huge loan waiver of Rs 72,000 crore striking the bottom out of the banking system. This was not community specific. It was meant to entice the voter. This was not all. In the budget he also announced the creation of separate minority fund worth thousands of crores under various schemes and the creation of 90 Muslim districts where banks were asked to open new branches for extending easy and compulsory loans to the community. The schemes the UPA has initiated include bank loans for minority students at cheaper rates, compulsory bank loan for setting up industry by minority communities and housing loans at less than market rates. Banks were asked to compulsorily open branches in minority concentration areas even if they did not make economic sense. The minister said 256 branches of public sector banks were opened in 2007-08, until December 2007, in districts with substantial minority population. 288 more were to be opened by March 2008 and many more are in the offing in 2008-09. This is at a time when 35,000 bank branches have been closed down all over the country as part of banks financial prudence. Similarly, 60,000 staff reduction was introduced both in rural and semi-urban areas.
All the banks have been asked to give 15 per cent of the loan disbursement to the minorities and also 15 per cent of the entire 11th Plan Fund has been earmarked for the minorities.
The parallel with what happened in the American bank crisis is intriguing. In 1977, US Congress passed the Community Reinvestment Act empowering regulators to punish banks that failed to ?meet? the credit needs of low income, minority and distressed neighbourhoods. In 1995, under President Bill Clinton the law was made more stringent. The two government chartered mortgage finance firms now gone bust, Fannie Mae and Freddie Mac encouraged sub-prime lending by authorising ever more flexible criteria by which high risk borrowers could be qualified for home loans. They bought up hundreds of billions of dollars worth of questionable mortgages in the process. Some state and local governments added pressure to give more loans. And the banks complied.
?All this was justified as a means of increasing home ownership among minorities and the poor. Affirmative action policies trumped sound business practices?, says the author.
The financial profligacy in the name of affirmative action introduced by Manmohan Singh has great similarity with what has happened in the US. The only difference is in the case of the US, the action had the legal sanction. In India, the Constitution does not accept communal budgeting or affirmative action by discriminating people on religious lines. For vote-bank considerations the UPA government has thrown financial system to winds.
The US situation is as comical as in India. The above mentioned report says, influential US Democrat Congressman from Massachusetts Barney Frank, a vocal advocate of ?shoddy loans? used to insist that the administration was more concerned about financial safety than about housing. Now that the bubble has burst and the ?systemic risk? is apparent to all Frank blithely declares, ?The private sector got us into this mess.?
In the US a manual issued by the Federal Reserve Bank of Boston advised mortgage lenders to disregard financial common sense. ?Lack of credit history should not be seen as negative factor? the Feds guidelines instructed. Applicants lacking sufficient savings to cover a down payment and closing scores were allowed to rely instead on gifts, grants or loan from relatives, non-profit organisations or municipal agencies. Lenders were even directed to accept welfare payments and unemployment benefits as valid income sources. And the financial institutions were threatened compliance with legal action.
In India from time-to-time, the central and state governments issue diktats to financial institutions to give away unsecured loans. The trouble is unimaginable. Think of the situation. A top source in the bank says that so far they have been keeping off customers whose credit worthiness was in doubt. Traditionally, India has a conservative system. The banks don'tnormally violate basic principles of banking. Their experience in the localities where the government is forcing them to open branches has been that banking was a failure. Should the financial system fail this will also have a role.
In a social milieu where even a police search for terror accused creates communal tension, how is it possible for the bank man to realise his bad debt? Any legal action to force loan repayment will be immediately described as harassment of the minority. And there would be any number of political parties to demand another round of loan waiver. And they will derail the system.
(The views expressed in this column are personal. The writer can be contacted at [email protected])