Raghuram Rajan — My inspiration
My family and I were discussing colleges, and my father said he wanted me to study at UChicago’s Booth School of Business. One of the reasons was Mr. Raghuram Rajan, an economics professor at Booth. That conversation made me curious about why my father admired a professor I had only heard about. When I researched about him, I found that among many others, he is remembered for 2 accomplishments: his 2005 Jackson Hole speech where he predicted the 2008 financial crisis and his role in rescuing the Indian economy as RBI governor from 2013 to 2016. The RBI, or Reserve Bank of India, is India’s central bank, similar to the Federal Reserve in the US, that controls the monetary policy.
Raghuram Rajan was born in Bhopal, India, in 1963, and had a modest childhood. He spent his early years living all across the world because his dad worked for R&AW, the Indian foreign intelligence agency. He went to school in Indonesia, Sri Lanka, Belgium, and India. When the time came for college, Rajan went to IIT (Indian Institute of Technology) Delhi for his bachelor’s degree in electrical engineering and then studied at IIM (Indian Institute of Management) Ahmedabad for his MBA. He also completed his doctorate in economics at MIT, where he wrote “Essays on Banking.” After receiving his PhD from MIT in 1991, Rajan joined the faculty at UChicago’s Booth School of Business. In 2003, he became director of research and the youngest ever chief economist at the IMF.
Around 2003, Rajan made his famous Jackson Hole speech. Alan Greenspan had been Chairman of the Federal Reserve (Fed) for 18 years, and at the time, his term was seen as one of the most successful in history, having navigated America through the largest single-day stock market collapse, Black Monday, in 1987, and the Dot-Com bubble in the early 2000s. Every year, the Federal Reserve Bank of Kansas City takes industry leaders, central bankers, economists, and finance ministers from around the world to Jackson Lake Lodge in Wyoming. In 2005, as Greenspan was retiring the next year, the symposium was dedicated to him, and Rajan was invited to give a speech praising Greenspan. While he was researching for his speech, he realized that Greenspan’s deregulation of the finance industry led to banks giving risky loans, which could lead to a problem. After he gave his speech, Rajan was called a crackpot by the press and a luddite by Larry Summers, a famous economist.
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Greenspan’s deregulation and a system in which bankers were given bonuses based on short-term revenue encouraged bankers to make risky loans that looked good in the short term and earned them bonuses, but by the time debtors defaulted, it no longer affected bankers’ bonuses. The banks didn’t want the risk on their books either, so they bundled thousands of risky loans together and sold them, telling investors that if one debtor defaults, the rest will cover it. This is similar to investing in the S&P 500 because it spreads the risk, but like the S&P, with the stock market, the housing market moves together. Debtors took loans so that in the first few years, the interest rates would be low but then interest rates would go higher. To avoid the jump, these debtors would refinance their mortgages before it. The problem was that refinancing relies on housing prices going up, so when housing prices dropped in 2006–2007, all of these debtors defaulted. Because of how interconnected the financial sector is, the effects led to a total collapse of the finance industry. In 2007, several banks collapsed as a result of these defaults, but the crisis stayed in the financial sector. The collapse of Lehman Brothers, one of the largest investment banks in the US at the time, led to a domino effect, with American International Group, a company that basically provided insurance for loans, collapsing a few hours later, though it was bailed out afterward. These collapses brought down the entire financial industry and eventually the broader economy. Rajan’s prediction that the world had laughed at came true.
The financial crisis was dealt with through stimulus, federally funded jobs (similar to the New Deal of FDR), cutting interest rates, and more than 4 and a half trillion dollars were put into the market by the Federal Reserve by buying bonds, which is called quantitative easing. The thing about quantitative easing is that the more of a currency there is, the more its value decreases. So by putting so many dollars into the market, the Fed devalued the dollar, which increased the value of other currencies. This led investors to buy these currencies, one of which was the Indian Rupee. In 2013, the crisis was over, and America was rebuilding, so the Fed no longer needed to inject money, so they said they would taper off the easing. This led investors to pull out of other currencies, including the Rupee, which led to foreign currency reserves dropping significantly in these countries. India was part of the “Fragile Five”, five countries that looked shaky after the tapering. India’s foreign exchange reserves were low, their inflation was rising, & also rising current account deficits (they imported more than they exported), and their growth was slowing, a perfect storm in the making.
During this time, the Indian government appointed Rajan as RBI’s governor. On his first day, he made a policy decision to allow Indian banks to receive foreign money from Non-Resident Indians and offered high interest rates, then swap them for Indian currency at low rates. This gave the RBI the foreign reserves it needed to fight the rupee’s decline. Next, he set a formal inflation target for the RBI at 4%-6%, which gave investors confidence, and he successfully brought inflation down to 5.8% in 2015 from 9.4%. He also made changes in RBI rules so that interest rate decisions would be made by a 6-person committee, instead of just the governor, to protect the institution’s independence from the government which can appoint a governor of its choice and control the monetary policy. Rajan also introduced banking reforms, ensuring that a bad loan would be classified as a non-performing asset sooner, and forced all banks to come clean about hiding bad loans by giving new loans to pay back the old ones. All these changes, combined with his experience and reputation, collectively helped pull India out of the 2013 crisis and prevent a future one.
Rajan’s RBI governor’s term ended in 2016, and he did not serve another term, because Rajan and the government of India disagreed about interest rates. Rajan instead went back to Chicago to teach at Booth, where he remains till today. He’s known for his willingness to speak out against ideas he believes are wrong, even when the people defending them are more powerful than he is — the same instinct that, in 2005, made him the only person in the room willing to say a global crisis was coming.
