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Kerala PSC Indian Economy Book Study Materials Page 613Book's First Page
onomi on epts and erminolo ies 22.47 echoing time and again recently has its origin in the United States housing market by Late 2007— subsiDy biDDing being considered as the major financial crisis of It is competitive bidding for subsidies, where the new millenium. companies bid against one another to serve an Basically, the period 2000-07 had seen a area at the lowest price—the lure is the subsidy gradual softening of international interest rates, and other benefits. This system is a way of relatively easier liquidity conditions across the administrating subsidies without leaving any room world motivating the investor (i.e., banks, financial for some competitors or technologies gaining an institutions, etc.) to expand their presence in the edge over others. But competitive bidding has sub-prime market, too. The risks inherent in sub- anticompetitive effects, since it gives a special prime loans were sliced into different components advantage to one company. Regulators should and packed into a host of securities, referred to as asset-backed securities and collaterised debt adopt a consumer choice system, under which any obligations (CDOs). Credit rating agencies have subsidy for each high cost customer it served. If assigned risk ranks (e.g., AAA, BBB, etc.) to the customer moved to a competing carrier, the them to facilitate their marketability. Because subsidy would move, too. of the complex nature of these new products, intermediaries (such as hedge funds, pension funds, substitution effect banks, etc.) who held them in their portfolio or through special purpose vehicle (SPVs), were not The replacement of one product for another fully aware of the risks involved. When interest resulting from a change in their relative prices. rates rose leading to defaults in the housing sector, the value of the underlying loans declined sunk costs along with the price of these products. As a result The costs in commercial activities that have been institutions were saddled with illiquid and value- incurred and cannot be reversed. The cost on eroded instruments, leading to liquidity crunch. This crisis of the capital market subsequently advertisement, research and development, etc. spread to money market as well. are examples of such costs. Sunk costs are a big The policy response in the US and the Euro deterrant to new entrants in the commercial world area has been to address the issue of enhancing as after the venture has failed these costs cannot be liquidity as well as to restore the faith in the recovered—there is no two-way process here. financial system. The sub-prime crisis has also impacted the emerging economies, depending on swAp their exposure to the sub-prime and related assets. The act of exchanging one by another. It could be India remained relatively insulated from this of many economic items: crisis. The banks and financial institutions in India do not have marked exposure to the sub-prime currency sWAP and related assets in matured markets. Further, India’s gradual approach to the financial sector The simultanous buying and selling of foreign reforms process, with the building of appropriate currencies could be spot or forward/future currency safeguards to ensure stability, has played a positive swaps. This is used by MNCs to minimise the risk role in keeping India immune from such shocks. of losses arising from exchange rate changes.