The crisis is now full blown. I have not seen panic at this scale personally. I have read about it, but not seen it personally. It almost feels as if companies are being targeted one at a time. Lehman went into bankruptcy and AIG just survived through government help, though equity holders have been wiped out (almost). Now it seems the market has moved on to Morgan Stanley, Goldman Sachs and Washington mutual. It almost feels as if the market is killing one company at a time. Scary!

How does it impact us in India?
I think, the impact would initially be limited to companies with Global businesses. So IT companies with revenues in this space could get hit in the short term. However I think it should work out for these companies in the medium to long term as they find new clients, geographies and start growing again. The business model for IT companies is not under threat. However in the short run, IT companies are and could keep getting hit. However I would be worried about small IT companies with high exposure to the Financial and associated sector.

The next in line to get hit could be banks like ICICI bank and others, which have foreign operations and derivatives on their balance sheets. I am currently analyzing ICICI bank and I can tell you that complexity for most banks have gone up. As I wrote earlier, I exited banks quite some time back when I realized that I could not evaluate the risks correctly. That said, I think none of the Indian banks are under serious solvency threat. The profits could get hit, but most of the Indian banks do not have massive exposure of derivatives. I am analyzing ICICI and other banks from a depositor’s point of view and not from an equity investment point of view. So I am looking at these banks from a safety point of view.

Other than the above two sectors, I cannot think of any broad sectors, which could get hit hard by this crisis.

Second order and higher order effects
What is missed out in most analysis, is the second and higher order effects of an event. Indian companies may not get hit directly, but a recession in developed countries and lack of liquidity and risk aversion is bound to affect us in the medium term.

For the last, 3-4 years almost every asset class in India has gone up. There were all kinds of reasons given for this rise, but rarely was liquidity mentioned as one of the key reasons. Now with the liquidity drying up, I don’t think we will be seeing such double-digit growths in Real estate and other markets.

What am I doing?
I don’t get worried about drops in stock prices. Such drops are a part of the game. When I invest in equity, my main worry is permanent loss of capital and not temporary losses due to volatility.
Personally, I had put my buying on hold for the last couple of months. For some reason, I felt that the markets could go south in the medium term. As a result I stopped buying some time back. However I did not back this hunch by going short, as I may very well may have been wrong. I did buy some puts, but did not build a decent position as I was not sure. I think I should start trusting my gut more.

I am still standing pat and not planning major activity for some time. I personally don’t expect these issues to get worked out in a few weeks and feel that I could be getting better bargains in the near future.

I have a question and would appreciate if some could answer, as I have not been able to figure it out – If the bank/ DP fails, what happens to my shares. Is it similar to a savings account where you can lose your savings or are the shares held by NSDL or someone else and hence I am safe?

First it was Bear stearns, but the US treasury (similar to our Finance ministry) and the Fed (similar to our RBI) engineered a bailout. Bear stearns, an investment bank was bought out by J P morgan, a commerical bank, in March. This bailout was done to calm the markets and reduce systemic risk.

Well, next in line were Freddie Mac and Fannie Mae which were nationalized (federal takeover) for the same reason last week. Now this week it is the turn of Lehman brothers which seems to be on the verge or ready to file for bankruptcy protection. Merrill lynch, another Investment bank and brokerage, is in merger talks with Bank of america. After Lehman brothers, Merrill lynch seems to be the weakest firm and so it could come under attack.

More companies at risk
AIG, one of the largest insurers has fallen by 30% and is at risk now. So is washington mutual, another large bank. So we have a situation where the credit crisis (acutally bad investments on part of the banks and institutions) is now engulfing the financial system. Finally the S*** is hitting the fan !

We could very well see a domino effect and the US government may decide not to bail out any more companies. We could be in for some nasty times.

What does it mean for us ?
So how does it effect us ? Well if you are into medium to long term investing, not much. Actually the panic could create opportunities for us in india. I really don’t see Indian companies getting impacted (other than IT or export oriented companies due to a possible recession in the US and other economies). The impact for IT companies in the long run should not be too much. However there could a short term impact in companies with a high percentage of revenue in the BFSI segment.

All this mess, makes you wonder what kind of risk our banks and financial services firms are taking. I am repeatedly reminded of this statement by warren buffett

‘When you combine ignorance with leverage you get some pretty interesting results’