Of Lehman Brothers and Blade companies

The Malayalees are chuckling.................................One of the most well read amongst the people of India, the malayalee is upto date with happenings across the world.................he is chuckling quietly when he heard the news that the Global investment/industrial banks Lehman Brothers and Meryll Lynch has collapsed taking with them numerous investors down.

Now, why is he chuckling? There is a history to it.

In 1980s, private investment companies mushroomed in Kerala. They were unregulated. At that time, the nationalized banks whose services were poor, and the post offices or treasury bonds, were the only other option for the small investors. Stock markets were in its infancy and there were hardly any other financial instruments.

These private investment companies, who exploited a loop hole in the Banking law for non banking financial institutions, were started by dubious individuals who offered nearly 36% interests on deposits per year. The samll investors, who were getting a measly 8 - 10% from nationalized banks, flocked to invest their money in these investment cmpanies.

How could these companies survive by paying such high interest rates? They used to lend it short term at higher rates to needy customers, businessmen etc. Those days, it was notoriously difficult to get a loan from the nationalized banks. Well, it was almost impossible. The only source of financing for the small, medium traders were these Private Financiing Companies. They loaned at a ridiculous interest rate of 5% per month (equal to 60% per year) without doing due diligence, without adequate collateral cover and without assessing the risks involved. Not for once did anyone in the system thought about how sustainable it is for these traders to have a cost of capital of 60% and run a viable business model. Added to this, these private investment companies (aptly called 'Blade Companies' - because the interest rates were considered to be equal to cutting your throat) ventured into high risk, high return (purportedly) investments like movie making which were doomed to fail at some stage. That is precisely what happened. One by one these blade companies vanished without repaying the investors their deposit money. Millions of malayalees lost their hard earned savings and some even committed suicide. Though the situation is much better now, these Blade companies still mushroom now and then, and history is repeated.

The parallel to what is happening in US Financial sector is amazing. Only that the magnitude is bigger. These private equity firms, banks and other financial institutions offered high returns to the investors and invested in hedge funds, speculative real estate without taking the necessary due diligence process. Added to this the holier than thou attitude of the top management and their arrogance. They broke all the fundamentals of the investment banking. Is there any wonder then that they are falling like a pack of cards? What happened in a smaller scale in Kerala in 1980's is being replicated couple of decades down the line in USA.

The underlying cause in both the cases is same - GREED - of both the investors and the investment company.

Can you blame the Malayalee for chuckling?