Friday, July 30, 2010

Fault Lines- Raghuram G Rajan

Yesterday, I attended a Global Leadership Series Lecture by Professor Raghuram G Rajan, where he discussed in detail some of the factors outside the financial sector that led to the financial crisis. 
While most of the news stories and public discussions over last two years have focussed on the 'greed of banking community', his observations on how the hidden fractures still threaten the world economy were quite insightful. He also shares these insights in his latest book 'Fault Lines'.

Well, the immediate suspects for this crisis seem to be – bankers, rating agencies, the Fed, Fannie, and Freddie, etc.; but if we dig deeper and analyze, What went wrong? It becomes abundantly clear that it was a crisis where not only the private sector was to blame, but also the government. It was a crisis caused by the faulty interface between the two.

Fault lines such as~Growing 'inequality' and Thin( or entirely absent) Social Security net create tremendous pressure on the political community to find the easy route. i.e., make cheaper credit available if they can't create that many jobs(as witnessed in the push for universal home ownership in the United States extensive lending by Fannie Mae, Freddie Mac, and others,  low-interest rates, targeted and relaxed lending to the sub-prime borrower, etc.).

It is also apparent that the real reasons for the crisis are still not addressed; the fiscal stimulus is only a temporary 'band-aid' solution. The world today needs to make hard choices to ensure greater stability and lasting prosperity.

The fundamental idea of this book (and his talk) is to focus on slow-moving tectonic plates in the global economy: Consumption by borrowing in countries with fiscal deficits, Excess savings in exporting countries that are fiscally in surplus, and growing sophistication of the financial sector. 

None of these movements might seem dangerous in itself, but when these plates come together and collide, the global economy can get badly shaken. To most players focused narrowly on their positions, leave alone the movements of the plate they stand on, the earthquake - like this crisis - may seem an unfortunate happenstance.

In the analytical framework of Fault Lines, it is apparent, that the current crisis was not a pure accident and that more severe crises could arise in future unless the root causes are addressed sufficiently soon.

Please also check Paul Krugman and Robin Wells review of Rajan's book, and Rajan's response to it.

1 comment:

Vishwanath Seshadri said...

Interesting thought.. Will check out this book.

We may give various interpretations and analysis for the causes of the sub-prime crisis. However, the key underlying reason for this as well as all other crisis is the absense of and dilution of moral values across the world. As people become more self centered and obsessed with accumulating more at the cost of others, they tend to create all kinds of crisis, shortages and conflicts.