On Urchins And Subprime Blues.

Certain things I find hard to chew, so why not start with a lucid "Once upon a time..."

...Imagine you were a scholarly school chap who has just sympathized on few naughty urchins in the class. You plan to help them in the next test by tutoring, on a collateral that they would never noise and rock in the class again - which carries the fine of even expulsion. Its a big deal (Risk) helping these dumb asses, cos it takes more T&E to assist them than other people, but the payoffs (Returns) are bright, for you'll win appreciation of others and will have peaceful time in class forevermore.

So there you go on a pedagoguing bout, spending extra hours for them and they meekly follow you so as to just pass the tight exam. They finally do...thanks to you. And they are all elated and sing and rock all around and now separate ways, duping you (Risk Failure).

Courtesy: RJ Matson, CagleCartoons.

And to add to your fury, they turn out good performers and do a stellar show and now classes and masses start admiring them like stars. At least the urchins pay the price and are expelled but who cares they are already stars! And now nobody wants order, nobody listens to you, instead its rock n roll time after s (Crash). You wander about preaching discipline, order and peace, and again pour incentives for everyone but there are no takers (excess supply). You falter, but wait for next exam, next opportunity to bounce back to the walls.

That was somewhat (oversimplified, if you take that) version of what has happened in the subprime markets in the US. Bullets follow:

• Subprime: When you lend to somebody who doesn't have good credit history.
• Something that's not ideal, burrowers not qualified for market interest rates - Loan rate much higher than normal ones.
• Lending to Subprime borrowers - More the risk, more the return. Collateral security - Confiscating of property (House).
• The situation: Most borrowers have defaulted. So many people selling their property (Real Estate Bubble) - supply outplaying demand.
• Assets Backed Security: Things are entangled normally. Mortgage lender normally give loans to some set of people (say 20). If lender wants money immediately, he can sell if off to some vying people looking for long term investments (say MF, traders). This means a cascading effect - investors all around the world have lost grounds.

But ironically, good news is:

• India is not hurt badly because exports to US is smaller part of GDP compared to other countries.
• Compared to other markets, Risk appetite is less here, so investors all around have good reason to feel more secure in Indian market. Recent sensex surges are maybe result of that.
  
• Lending norms pretty stringent here so Subprime crisis may never happens in market like India.

Even if the story doesn't help much, hope that you have some takeaway from here.