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Ten defining moments of 2008 - Views on News from Equitymaster

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Ten defining moments of 2008

Dec 30, 2008

2008 was a mixed year for most of us. We will like to forget it for the mishaps (financial and otherwise), but also like to remember it for the hard lessons it taught us. We have compiled a list of incidents that have affected the world during the year, most of which are not so good! We had earlier thought of restricting ourselves to five, but were tempted to increase the count to ten.

1) Fall of financial Berlin Wall

15th September 2008 was the day Lehman Brothers filed for bankruptcy. An era ended on Wall Street. This 158-year old institution, which had earlier survived the two world wars and the Great Depression, was finally liquidated on this day. None of the other financial firms was willing to acquire Lehman considering the magnitude of its potential losses.

Nobel winner economist Dr. Joseph Stiglitz compares this event to the fall of Berlin Wall. Lehman’s demise “was in many ways to market fundamentalism what the fall of the Berlin Wall was to Communism,” he says.

A market economy cannot work if people don’t have trust. People lost theirs following the demise of Lehman and Bear Stearns. With it ended (possibly) the era of excessive leverage on Wall Street. The count of global investment banks reduced from ‘five’ at the end of 2008 to ‘zero’ at the end of the year. While Lehman died, Bear Stearns and Merrill Lynch were absorbed by JP Morgan and Bank of America respectively. Goldman Sachs and Morgan Stanley converted to bank holding companies.

2) Global recession

The realisation that economies, especially those in the developed world are in a stage of stagnation and decline finally set in during 2008. The National Bureau of Economic Research (NBER) confirmed the ‘recession’, twelve months after it actually began in the US. This late realisation was in spite of the increasing unemployment rates, lower consumer spending and the slowdown in real estate and auto industries.

The International Monetary Fund (IMF) expects the US to grow by 1.57% in 2008 and subsequently by 0.06% in 2009. As for the other developed nations such as the UK and Japan, it expects these economies to grow by 0.99% and 0.69% respectively in 2008 and by -0.13% and 0.47% in 2009 (real GDP). The IMF’s projection for India’s growth stands at 7.93% in 2008 and 6.94% in 2009.

3) Lot of bubbles burst

There have been bull runs aplenty in the past. But never have they been as coordinated as the one that has preceded the current bear market. Coordinated because virtually every asset class, right from stocks and commodities, to real estate went up in perfect synchronisation. And investors made merry while the fun lasted. Barely did they know that the decline too would amount to a synchronised collapse, leaving them with no place to hide. Almost a year into the carnage, most stocks and commodities are now trading at their multi year lows, with the very same people who did not hesitate to invest in crude at US$ 147, shying away from the commodity at US$ 40 a barrel. While US$ 147 may prove to be an extreme in hindsight, few years from now, US$ 40 might also prove to be the same.

But this time around, investors who went long on the commodity would most likely rejoice just as those outliers who shorted the commodity at US$ 147. Similar events could play out in other asset classes as well. And we have the audacity to say that - Human mind is rational.

4) Myth of a ‘decoupled’ India broken

Financial markets and their underlying economies worldwide learnt a lot of difficult lessons in 2008. Although the Indian economy also suffered, as we know, it fared relatively better. But one cannot say the same about the Indian financial markets.

While the Indian economy is domestically driven and as a result rather insulated from the world, Indian financial markets have very strong global linkages. This is the age of electronic capital flows. And it glides across the world with great ease. If foreign money drove the Sensex to the heydays of 21,000, its flight out of India also plugged the rug under its (Sensex) feet. No one will speak of the decoupling of financial markets for a long time to come.

5) Inflation goes for a toss

Having turned more heads in 2008, than probably ever before, inflation may continue to remain in the headlines in 2009. The term commonly used by economists, bankers and investments analysts made the common man ‘economy savvy’ this year. Even housewives tracked the figures on a weekly basis as rising EMI dues and higher grocery bills made inflation a household problem. Wholesale Price Index (WPI) which is the metric on which inflation is commonly measured in India trooped dangerously close to its decade highs. The final months of 2008 although offering some notional relief on the inflation number, failed to kick the consumption demand. The onset of 2009 is expected to do most of that.

6) Bailouts flying thick and fast, liquidity crunch, real estate crash

While the subprime crisis reared its ugly head in 2007, the crisis escalated in 2008 and the demise of Lehman Brothers only aggravated the situation further. Governments all over the world went on an overdrive to announce bailout packages to ensure that the financial community and economies did not collapse under the strain of the crisis. With the era of investment banking coming to an end, liquidity suddenly dried up as banks (also hit hard in this crisis) became vary of lending to one another.

To ease the liquidity crunch, money was being poured into banks to spur lending. But the same has not taken off as anticipated as suspicions still linger as to what nasty surprises are in store. Real estate, which sowed the seeds of the subprime crisis in the US, not surprisingly, bore the brunt of investors’ fury as real estate prices crashed, bringing down realty stocks with them as well.

7) From irrationality to sheer panic: Sensex’ saga

At the start of the year, speculation was the name of the game. It is very unlikely that you may not have heard remarks such as “Sensex to touch 25,000” or “Sensex will rise to 40,000”. The reason behind the same was ‘shining’ India. The concept of rationality had gone for a toss. Now the index stands at almost 9,500 points, down by more than 53% since then.

The financial crisis translated to a significant amount of panic seeping into sentiments. This led to steady sell-off at the bourses throughout the year by both domestic and overseas investors. The global crisis put the Indian stocks under the heat as overseas investors (FIIs) pulled out nearly US$ 13 bn during the year. This is the highest amount of net outflow in 15 years. Also, this is the first time in 11 years that there has been a net outflow of FII money from India. FIIs invested nearly US$ 17 bn in the markets during 2008.

8) Rupee appreciates, depreciates, then appreciates, and then depreciates again

The rupee’s movement in the past two years was highly volatile keeping those relying heavily on exports and imports on their toes. The sharp appreciation of the rupee against the US dollar in 2007 had adversely restricted the revenue of companies in sectors like software, textiles and pharmaceuticals as these largely depend upon exports for business. However, given that India imports nearly 70% of the oil that it consumes, oil companies benefited to some extent from the rise in the rupee although crude prices remained firm.

The situation reversed completely in 2008. The intensity of the financial crisis led many to question the safety of emerging nations including India, thereby driving down the value of the rupee. While this was expected to be a major boon for the software and pharma sectors, it ended up being only a consolation prize. With the global economy slowing down, software sector had more serious issues to deal with. For pharma, the rupee depreciation only aggravated forex losses as many companies had foreign debt on their books which were marked-to-market. For oil companies, it was a double whammy till the middle of the year at least, as oil prices escalated to a record high and the rupee deteriorated sharply.

9) Investors dealt with dirty lies

If Mr. Market’s wild mood wasn’t enough for investors, there was a spate of scams that marked the investment scenario in 2008. The Western world had to contend with the US$ 50 bn Ponzi scheme run by Bernie Madoff.

Sample the following list of victims with their nationality and amounts involved as per Bloomberg: HSBC (UK, US $ 1 bn), Nomura (Japan, US$ 302 m), BNP Paribas (France, Euro 350 m), Banco Bilbao Vizcaya Argentaria (Spain, Euro 300 m), Banco Santander (Spain, Euro 2.33 bn), Royal Bank of Scotland (UK, US$ 601 m), Natixis (Paris, Euro 450 m), Man Group (UK, US$ 360 m) and UniCredit (Italy, Euro 75 m). What is even more startling is that apparently Mr. Madoff had advised the US Securities and Exchange Commission on how to regulate markets!

Coming to India, while investors did not have to contend with losses of such magnitude, there was awe and fear with which promoters treated minority shareholders. While minority shareholders were dealt a poor hand by Reliance Infrastructure and Sterlite, it was Satyam Computers that took the cake. The last few days of the year saw a spate of asatya (lie) fall out of the baggage of Satyam, India’s fourth largest software services company and the most prominent in corporate governance malpractices. After a failed “funds transfer to promoters” scheme, the promoters have tried hands at damage control without much success.

10) FCCBs… not convertible anymore

When markets were in their boom phase, FCCBs (foreign currency convertible bonds), the new docile financial instrument, were the easiest way for cash strapped companies to raise capital. It offered companies the advantage of almost nil interest rates and equity dilution that was a comfortable 3-4 years away. In fact, companies never thought of FCCBs as debt, always thinking of it as an equity infusion, which was not to require any cash outlay. They were under the impression that capital markets will continue to function smoothly and hence, would make conversion smooth.

Things have however turned out to be a lot worse than these companies could have ever imagined. All of a sudden, the holders of FCCBs who are strapped for cash themselves do not want any conversion to equity. Instead, they are looking at calling back their debt instead. For companies that are already substantially leveraged, this would mean a huge cash outflow. And there aren’t enough avenues to replace the current one. If they go for equity financing, it would mean huge dilution for promoters at current depressed prices and if they go for debt financing, it may well prove very costly at current interest rates.


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