Easy money: Recipe for financial crisis

Money in its modern form is needed for various purposes. It is especially needed for economic transactions that drive economic development. However, easy money made available to certain sectors of an economy or to certain groups has caused problems from time to time and put nations in serious financial and economic crises.
Easy money has two characteristics. One is supply and the other is price. Abundant supply at lower prices is the main form of easy money. The sub-prime lending crisis in the housing markets in the US was accompanied by easy supply but with higher interest rates that were not sustainable for most of the borrowers. Credits for mortgage loans flooded the market. Borrowers were enticed to take loans knowing their inability to repay those at such high rates of interest. Finally, defaults occurred and banks were loaded with what is called toxic assets in their balance sheets. The large and famous investment bank Lehman Bros collapsed.
The US government adopted a rescue package to buy those toxic assets at over $700 billion and injected liquidity to the banking system in 2007 and 2008. Interest rates came down drastically, and the process is still going on in 2012 through what is known as quantitative easing, in other words printing notes to buy back government bonds from the market. Most mortgage loans are being rescheduled at lower payment, making loans affordable to the borrowers. Interest rates on bank deposits have been close to 1% pa in the US since 2010. The US economy is still struggling to grow as high unemployment following the financial crisis is continuing to affect consumers' buying pattern.
Easy money also flowed to some EU countries and allowed governments to incur budget deficits and maintain higher levels of consumption. These nations (Greece, Spain, Portugal and Italy) are affected by recession and rising unemployment. Some of them are being bailed out by ECB and other stronger nations such as Germany. In these countries easy money flowed from the international markets through banks. In both cases banks were held responsible for lending aggressively. Gordon Brown, while he was the PM of Britain said: "Banks should be servants of the people, not their masters" after Barclays Bank was rescued from collapse. Many reform proposals to change the culture in banking are being talked about since then. The recent scandal about fixing of LIBOR by big banks indicates that not much change has taken place in bank management.
In Bangladesh, the stock market boom in 2010 was a case where easy money flooded the rather small stock markets as many banks set up merchant banking subsidiaries. They pushed stock prices higher and higher through injecting cash supplied at lower interest rates by their principals to small investors. They also invested heavily on their own portfolios. Small individual investors got caught up in the spiraling rise in prices and were stuck with bank loans and unsold stocks when the bubble burst and the market crashed. Like in the US, the market needed huge bailout funds to rescue small investors and many half-baked schemes were launched, but with little improvement in market confidence.
The crash ended in drying up liquidity in the banking system and banks could not meet genuine demand for investment in the real sectors, including real estate that was also booming alongside the boom in the stock markets. The growth rate in GDP slowed down in 2012, except in the RMG sector that is still growing but at slower pace. In the previous year growth in export earnings exceeded 40% but it came down to under 10% this year.
When the Sonali Bank Hall-Mark scam came out in the press it created a sensation among the people through good press coverage. A blame game began over who did what. BB suggested dissolution of the Board of Directors for their failure to stop lending of over Tk.2,600 crore to a single borrower from a single branch. The MD of Hall-Mark said that he would repay every paisa as he invested the fund in projects worth 20 times the loan. As a professor of finance this statement struck me as surprising made me wonder as to what assets he had acquired in BD to give fantastic return of 2000%. When the bank demanded return of 50% of the amount within 15 days he said he could not repay such a large amount in such a short time. That was expected as no businessmen could repay loans in that manner unless he borrowed from banks at lower rate of interest and put the money with NBFIs. However, one wonders where he actually invested the huge amount borrowed from Sonali Bank.
Earlier there was report of the company group buying land illegally in Hemayetpur area and violating Rajuk's rule. If that is where he put most of the money then the question arises as to how Sonali loaned money to a single group to speculate on land prices. Now several officers, existing and retired, are being sued and a parliamentary committee has been set up to dig into the matter. The MOF initially questioned the legality of BB to suggest dissolution of Sonali Board and put the blame squarely on BB for its failure to stop the scam at a particular branch of Sonali.
It is now being reported that such scams took place in other state owned banks also. That is what is expected to happen when a government put its chosen people at top position of banks including the BB. Such easy money to selected groups has created shortage of funds for other investors and its ultimate impact will be slowdown in economic growth during this and the next year.
Such is the history of easy money all over the world. In the case of BD its impact will be severe because we already have high unemployment, and slower growth will make it still higher. In a country where governments come and go while economic conditions do not improve people will go hungry and without basic services such as education and health.
The political parties deliberately created uncertainty about holding the next parliamentary election and diverted the attention of the people from the economic crunch emanating from financial crisis of easy money flowing to certain sections in the society through scams in stock markets and the recent shoddy bank loans from state owned banks. Although the previous CTG turned these banks into PLCs nothing was done by this government to change their policies and operations to conform to company laws.
In this hodgepodge situation, clever people took advantage and made billions out of tax payers' money as the losses will have to be met from budgetary provisions this year and the next. That will curtail funds for investment in the public sector. The promise of higher growth rate in GDP, 7-8% a year will remain a mirage. Let us not create conditions for easy money in the future.

The writer is a former Professor of Finance at IBA, Dhaka University and VC Northern University Bangladesh.