While I had strongly criticized the previous package of purchasing bonds directly from financial institutions as this would effectively tantamount to bailing out the shareholders i.e. saving them first and then, the economy from the mistakes that the shareholders themselves were responsible for, the new package of investing through equity / preferential instruments in the banking companies is a far sensible and effective mechanism, and is being increasingly accepted world over.
It may prima-facie appear appalling to allow, to the champions of free markets to whom Nobel prizes awarded, but we must understand that this appears essential if any effort by the government is to bear meaningful success. With control on the banks and in turn on the Banks’ lending functions, the government will be in a better position to direct liquidity to the real economy - to the masses / affected sectors as against the current hoarding being done by banks. In effect this forced lending would restart the now collapsed lending activity. Also, by owning the banks the government would be in a better position to control the tax payer monies utilized for these banks than it would have been in case it bought the securities. More than over $ 10 trillion have been injected in the world debt markets and these figures show no signs of abating. Furthermore, this model has worked previously in a European country where the government recapitalized the banks. But, that model had an extra offshoot that led to its success. Banks were forced to come out with all losses in their books, subsequent to which a triage of the banks which could survive was done and only those recapitalized. A similar triage must be done in the current scenario. This triage fulfills the intention of the TARP as the weaker banks / institutions that cannot function despite a capital infusion due to their weak structure and heavy investment in complex failing securities should be allowed to close down as irrespective of there being or not being a recapitalization these banks would have failed. So, only those that stand a chance to survive this crisis should be bailed out through recapitalization.
Also, the financial institutions prior to recapitalization should be subject to a quick but thorough due-diligence of their books and their rusted portfolios be written off. Only when the government knows the extent of the rotten parts can it sufficiently take a call on recapitalization. If the elephants were to be brought in the boardroom at every quarter end then the government would have to resort to recapitalizing banks on a regular basis and thus leading to more confusions world over let alone the increased cost that the government will have to bear! So, post the due-diligence those banks that can function with additional support should be bailed out and the ones that cannot should be left to go under.
The current predicament is best understood by studying Hyman Minsky’s theory on financial market fragility and on speculative investment bubbles endogenous to financial markets. Minsky claimed that in prosperous times, when corporate cash flow rise beyond what is needed to pay off debt, a speculative euphoria develops, and soon thereafter debts exceed what borrowers can pay off from their incoming revenues, which in turn produces a financial crisis. As a result of such speculative borrowing bubbles, banks and lenders tighten credit availability, even to companies that can afford loans, and the economy subsequently contracts. Minsky identifies hedge, speculative, and Ponzi finance as distinct income-debt relations for economic units. He asserts that if hedge financing dominates, then the economy may well be an equilibrium-seeking and containing system: conversely, the greater the weight of speculative and Ponzi finance, the greater the likelihood that the economy is a "deviation-amplifying" system. Thus, he suggests that over periods of prolonged prosperity, capitalist economies tend to move from a financial structure dominated by hedge finance (stable) to a structure that increasingly emphasizes speculative and Ponzi finance (unstable).
So Mr. Bernanke & Co. does the current scenario sound familiar? Are we at the Ponzi stage now? Unfortunately, it seems so!
Of Red Socks!
This cataclysm and financial ignominy is despite the presence of supposedly austere and punishing regulations a la SOX, Basel, SEC rules coupled with the “Free Capital Market” theories propounded by armies and armies of men. These so called benchmark regulations have failed miserably to serve their intended purposes! Free markets sans effective capital and trade regulations is but a whitewash as when things are doing well they appear to be going fantabulously well but when things go bad it feels as though suddenly there are no rails amidst the descent of the rollercoaster journey! While “free markets” is almost always the destination of all economic philosophy and we all wish that there exist free markets so that the best man wins, but is this beneficial to the end user? Is this beneficial to the economies world over?
While I am not presenting a case for socialism, I am pressing for increased regulation wherever capital related aspects are invovled as money is highly fungible and whose speed of movement of which is second only to light!
SOX, Basel and other policies have not worked because of the “laissez faire” of capital involved. So, despite coming out with more regulations, the problems will not stop unless we stem the issue at its root. When ‘SOX’ was introduced we thought that it would save the investors at large and was the guardian of the Investing public as the senior management was to certify the risk framework of their company in their personal capacity. While regulatory laws might have allowed Banks / Investments Banks to borrow and leverage at levels as high as 35:1 (Lehman) but then shouldn’t the senior management had reassessed whether they had the wherewithal to address such a huge leverage while signing the SOX compliance? It is akin to building a ship, certifying it to be sea-worthy and then gracefully releasing the ship to the open seas as though it were a citadel of sorts, only to let the passengers drown in mid sea!
European Banks use the risk weightage of the Basel norms, and justify their high leverage by pointing to the high quality of their assets (including quite a lot of sovereign debt) When the major European banks were rescued by the governments, the creditworthiness of the governments themselves may be tainted. So the 0 risk weightage assigned by banks to government debt may be a potential time bomb as was evidenced last week when even government debt could get tainted in a crisis aka Iceland.
Of Libor the great!
The Libor which is set each day in London covers financial contracts valued at $360 trillion -- or $53,500 for each person worldwide. Now, you expect a rate that covers such an enormous figure to be trustworthy right? Wrong! The Libor was an overstated mechanism that was controlled by 16 major banks that used to mutually decide on the Libor rates daily for different periods and varying currencies. In April this year there Libor took the worst blow there was to and along with it so did the leading banks world over. While the Libor was set at a particular rate by the consenting banks, this rate was actually lower than the rate the rate that these banks themselves used to borrow for the respective tenures! So in effect these banks were showing an incorrect picture to the world financial markets and furthermore by showing lower rates they themselves could eventually try to borrow at rates set by themselves!!! What an orchestra! That is why major commercial banks now are lending at their own risk adjusted rates and not the Libor.
We must remember that the effectiveness of any policy or regulation is to be judged not by the successes it delivers but more so by the failures that they have prevented, full stop!
Despite what people say about the future of the economy and markets, when in crisis people vote with their money and if we see the markets world over be it BRICs or the developed markets (I wonder if we should still use the term developed?)
Consider the UK, where the combined assets of the big five banks is four times GDP. A recapitalisation equal to 1% of their assets would cost the government an increase in debt equal to 4% of GDP and a 5% recapitalisation would cost 20%of GDP. You can’t expect economies with major issues in their borrowings being over 3-4 times of GDP to just “switch” back on track!
There is both blood and bodies on the floor now. A 2.8% fall in US Industrial Production in September as against 1% in August, the largest since December 1974. Singapore’s economy sank 6.3 % in the quarter ended September 30th after a 5.7% contraction in the previous quarter. Malaysian government report released on October 11th showed industrial output grew in August at the slowest pace in 16 months. Brazil’s slowing down, India’s IIP at 1%.
Pain is rampant through systems from the poles to the eqautor but the world has to bear for all the success that the world has gloated in. Every transaction has a winner and a loser for status quo to exist, but last year when the markets world over went up there appeared only winners – commodities, equity markets, debt name it! But where were the losers? Alas, we have been finding them these days after their long hibernation. The fact is that people now want ‘Return of their Money rather than Return on Money”.
Yes, our own country is no exception. Even the bank credit week on week is declining and so is the manufacturing inflation which unlike the food inflation is not that erratic. Once a reduction in manufacturing inflation sets in as it has today, it continues to fall! That’s at a macro level but even at a micro level leading Indian companies are conveniently flouting laid accounting norms that even are even mandatory by law! The impacts of this àThe biggest company in the refining sector’s first quarter net would have been lower by close to a fourth. Kar Lo duniya muthi mai’s net profit would have been lower by two thirds; and India’s finest international Airline’s net profit in comparable terms would have reduced from a Rs.100 to a – Rs.600!
But the fact remains that we are resilient economy and so these anomalies do not warrant much attention from the Indian regulatory authorities! Yes, this seems to be the answer as there is hardly anything being done on this blatant fact that almost everyone in the accounting community is aware of! The SAT and the SEBI seem to have divergent views on almost every matter that confronts them. Is it a show of strength of who’s stronger between the two? Beats me!
Of Money and its policies!
Now it is all too clear that Monetary policy effectiveness is best judged in hindsight. While we all raised eyebrows on the hawkish stance taken by the RBI (including myself too!), it is only now that we are learning to appreciate the RBI’s moves. The Fed’s record is something we all know now.
And there are those that rose to the occasion and embraced capital convertibility. But they were in for a total shocker! The Latin American and the South East Asian crisis are the best examples that demonstrate the malice of complete capital account convertibility without any control and the wide spread domino effect it causes on countries. In times of crisis money will flow the fingers of the economy the harder you hold it! So, instead of these adventures though this may sound boring but isn’t prevention better than cure? All say Aye!!!
Of too much dark gold and glitter!
One classic example that I love to loathe about is of the failure of self regulation resulting in falling prices is that of the crude gang lords and their hubris. Be it the Gulf, Russia, Latin American Countries – all of them acquired a sense of jubilation following crude reaching $148 with a short in the arm from I Bankers predicting $ 175 and $ 200 targets (Oil was leveraged 13 times i.e only one barrel delivered for every 13 barrels traded). Where these countries went wrong is that they allowed crude prices to go to a level where the whole world started asking “should we trust these guys’ who simply want to gloat in other’s money and for oil prices to hit circuits?” While the crude boys made merry in their newly designed 7 star hotels and palaces the world economy bore the cost of their lavishness and hence this hurt everyone’s margins including you and me. Now this decline in operating profits and the credit squeeze has exacerbated the once rosy scenario of the crude boys because once the world slows down so will demand for the dark matter! More so, with slowdown sentiments even production cuts have not caused crude to rise as it used to only a couple of months back. The game theory has been lost by the Crude boys as they have now all to much breached that limit in price terms that people world over are seriously beginning to look at alternative energy, while de leveraging from crude may certainly take some time to come the fact is that crude may now play lesser weight age than it once did. Strategically, if the price was kept at such a stage where the world could grow and not really look back at the price of crude then we would have seen a far better picture over the long term than we will see now and so the oil producers would have shared their wealth with the world. But Hubris is the name of the game; the colour of money is green and its greed never ending! I recently saw on TV that a certain country spent $ 7 million (35 crores) only in designing the layout for a property exhibition, further on display were buildings and figures that posed challenges to even geometry itself! I just wonder considering the current crisis world over there might not be too many a people to invest in trapezium and constellation shaped buildings. So, while they have enjoyed short term benefits of over a $ 1 trillion dollar reserves, over the longer terms I am not too sure of their predicament. So, an ineffective self regulatory policy by the OPEC is now turning into a vicious circle for them and it is only a matter of time that Oil reaches $50 1/3rd of its all time highs.
So Mesdames et Messieurs we all can and will surely hope that the world economy is back and kicking and we wake another day to switch on the tube and hope to see a smiling Ben Bernake and the governors of the Central Banks world over having a vacation in the Bahamas. We can hope or can we? I end by quoting from the Matrix…
COUNCILLOR HAMANN: Commander, just one more question. Has there been word from the Nebuchadnezzar?
LOCK: None, and at this point there's no reason to expect that there ever will be.
COUNCILLOR HAMANN: Perhaps. But we can hope.
LOCK: I'm afraid hope is an indulgence I don't have time for.
