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—
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
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.