Recent events have shown that the American financial system is not as robust as its advocates
claim. The system’s so-called checks and balances have failed to avert the financial crisis that
has engulfed the country’s leading commercial banks, insurance companies and investment
banks.
The failure of the American financial giants means that the growth prospects of America will be
affected. Many of our industries, especially in the service sector, depend on markets in the US
and could be affected. Outsourcing industry, which depends on the level of demand in the US
and Europe, may take a hit.
Sparked by sub-prime crisis
In recent years the American financial system has encountered serious problems. Some of these
arose as a result of the sub-prime crisis, followed by fall in house prices and exploitation by
lenders to credulous sub-prime borrowers by offering them loans at initially low interest rates
and subsequently raising the rates. What made matters worse was that the sub-prime loans were
packaged, securitised so to say, and marketed to investment banks.
The investment banks did not, however, have a direct contact with the borrowers. They did not
have a clue as to how reliable the sub-prime borrower was. When defaults started, the investment
banks realised they were getting on worthless securities.
What was worse was that the sub-prime related securities were also invested in by various
international banks, including those in Europe, such as UBS. Many of the banks, which had such
exposures, were persuaded to make such investments because of optimistic rating by various
reputed rating agencies.
The latest episode of failures was led by the collapse of the State Guaranteed Mortgage
Institutions, known as Fannie and Freddie. Apart from the fact that these institutions accounted
for the bulk of the mortgage lending in the US, they were also attracting investments in their debt
securities from various central banks of the world, especially...