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Subprime alphabet soup

A BT primer on words that entered and exited the business lexicon.

     Print Edition: January 11, 2009

A is for adjustable rate mortgages or ARMs: A favourite with subprime borrowers, as they can avail of lower initial interest rates. But naturally, these loans get more expensive with every year, unless, of course, interest rates go down.

B is for bailout plans: When ARMs backfire, and financial institutions stare at a full-blown subprime crisis, what do they clamour for? Bailouts, of course, which are infusions of capital from government to prevent a firm going under. AIG got it, Lehman didn’t. Citigroup got it, the troika at Detroit (GM, Ford and Chrysler) had just got it, at the time of writing.

C is for CDOs: The alphabet soup is now just beginning to get noxious. CDOs, or collaterised debt obligations (phew!), are highly-risky loans (also see MBS) that were repackaged and sold by lenders to other banks, to keep their own balance sheets clean. The CDOs were overrated by rating agencies. Investment banks would in turn rake in fees and bonuses by making CDOs of CDOs, and some poor sucker (Bear Stearns or Lehman perhaps) was on hand to buy them. Then housing prices crashed.

D is for deleveraging: A very ungainly word made to look even more clumsy by short-sighted bankers (see also undercapitalised), overambitious businesses (which expanded relying largely on debt) and greedy investors (who bought shares with borrowed money). Reducing debt, i.e., leverage (or, grrr, deleveraging) is the only way out. And it comes at a price—of reduced economic growth and corporate profits.

E is for Equity: Individuals and institutions lost more equity in 2008 than they did in any year—what with BSE market cap down by Rs 42,85,569 crore since January 9, when the BSE Sensex touched its all-time high.

F is for flipping a loan: A sharp practice of tricking homeowners into refinancing their loans several times over, in a short period. Also known as predatory lending—typically to semi-literate, poor, elderly and minority borrowers—this is at the heart of the subprime mess.

G is for GSEs: Think Fannie Mae and Freddie Mac, the two government-sponsored enterprises are amongst the group of financial services corporations created by the US Congress to ensure flow of credit into various economic sectors. Fannie and Freddie had run up losses of close to $15 billion in the wake of the subprime crisis.

H is for Henry Paulson: H could also be for the hot seat in which Henry Merrit “Hank” Paulson Junior finds himself in. The US Treasury Secretary is spearheading the Bush administration’s efforts to resolve the subprime crisis by pumping hundreds of billions to purchase bad debt from institutions that are on the verge of going under.

I is for I-banks: Actually, this word shouldn’t be on this list simply because the investment banks no longer exist. It was in 2008 that the aura of I-banks and I-bankers faded, and their fat compensation packages became the object of loathing, disgust and ridicule.

J is for Japan: The world’s second-largest economy which, along with the European Union, was the first to feel the global recession after the US economy went down on its knees. Some of Japan’s biggest companies have announced job layoffs and production cuts. The stock market had dropped to near 26-year lows.

K is for Keynesians: British economist John Maynard Keynes is suddenly being remembered— and revered—by companies and countries. He proposed what every company is yearning for today—a large-scale government spending to create income and demand.

L is for liquidity: The most tangible effect of the US subprime crisis is the credit and liquidity crunch that’s being felt globally. In India, the situation is a bit different (banks here have a minimal subprime exposure). But with foreign investors in sell mode, the Reserve Bank has been forced to sell dollars to reduce the pressure on the rupee thereby reducing rupee availability in the financial sector.

M is for mortgage-backed securities (MBS): It all began with these assetbacked securities, whose cash flows are backed by the principal and interest payments of a set of mortgage loans. When house prices began to fall two years ago in the US, mortgage delinquencies began to soar; as a result, securities backed by subprime mortgages, which were held by most banks, lost most of their value.

N is for NINJA loans: No income, no job, no asset—that’s NINJA for you—and you can still get a loan! Sounds straight from Ripley’s Believe it or Not, but it’s true.

O is for originate-to-distribute: Another mouthful of big words, OTD (as opposed to originate-to-hold) allows banks to ‘originate’ more loans without expanding their capital. Banks can issue new loans to customers by selling them to investors (like pension funds and hedge funds). Once these loans are passed on, banks have room to ‘originate’ some more loans, and pocket some more fees.

P is for Ponzi Nation: Named after the original swindler (Charles Ponzi) who devised it, a Ponzi scheme involves paying huge returns to investors out of money brought in by subsequent investors. The party obviously ends later than sooner. The latest Ponzi disciple is Bernard Madoff who pulled off an alleged $50-billion hedge fund fraud.

R for recession: It’s all over, right from the US to Japan to Europe. Back home, however, the R-word is much abused. Even if economic growth moderates, it’s still the kind of growth most developed economies would give an arm and a leg to have.

S is for stimulus packages: Every economy needs one, even India. But the sheer scale of such packages in the developed economies will take your breath away. In the US, for instance, President-elect Barack Obama has pledged new spending of $400-500 billion; European nations have announced stimulus measures worth $260 billion.

T is for toxic assets: MBS, ABS, CDS, CDOs… all that was considered exotic a year ago has turned lethally toxic. These troubled assets are still sitting on banks’ balance sheets. Citi, for instance, is reported to be sitting on risky assets worth $306 billion.

U is for undercapitalised: Expanding the capital base is expensive, but expanding one’s lending business without adequate capital can be disastrous (see originate-to-distribute).

W is for Wachovia: Last fortnight, Wachovia Bank reportedly offered a $25,000 reward for a three-man gang that had robbed three metro Atlanta banks at gunpoint. Pity nobody offered a reward to find out what led Wachovia to almost go under and eventually merge into Wells Fargo to ensure survival.

XYZ is for the next flameout: With the washout on Wall Street virtually complete, the action now shifts to Main Street. Expect more carcasses in 2009.

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