2009: Welcome to February

As the first month of this year 2009 comes to an end, the economic environment is no better (or no worse!). Stock markets are not bullish yet. Reading a number of blogs on Friday evening, here is a summary of my understanding on the market:

What happened ?
Banks, Brokers, Investment Banks in the USA developed a shadow banking system. What is this ? A system that is not regulated by the banking authorities. Why ? Because in an unregulated environment , the bankers could take on large amounts of leverage and invest. If the investments made money, bankers stood to make large profits. (The bankers borrowed 97 Dollars for 3 dollars of owned funds. In a bank, this was not permitted. So they set up ‘shadow’ entities, away from the regulated environment.)
Why no one complained ?
Because thanks to rising asset prices, everyone was happy.
What is this to do with India ?
Why do you think India enjoyed its biggest bull market in history ? Because of investments made by these shadows. These are the FII’s.
So, what went wrong?
At some point, asset prices went sky high. The first problem started with ‘sub prime’. Housing loans given to people did not get repaid. The shadows owned these loans. Their capital got wiped out. Then, their failures started causing price destruction in most classes. Whatever they had touched earlier had turned into gold. Now, that gold was turning into ashes.

The Future:
The shadows are gone. Governments (including the USA) are regulating the banking sector with strict rules. The enormous amounts of money (due to leverage) that was available in the past will not come in the market in the next few years.
Stock markets will fluctuate, but the next bubble is probably far away.