Defending everyones whipping boy
MYTHILI BHUSNURMATH
IN TERMS of timing, I couldnt have picked a less opportune moment to stick my neck out on bank nationalisation; the public is still smarting at how nationalised bank employees held them to ransom with their strike earlier this month.
But come to think of it, given its connotations think bank nationalisation and Indira Gandhi and the Emergency immediately come to mind there is, probably, never a good time to defend bank nationalisation.
Earlier this year the Congress president and the FM were both ridiculed when they dared to speak in support of nationalisation. If the UPA chairpersons views were, somewhat charitably, put down to economic naivete, the FMs homage was seen as another instance of his anti-reform mindset.
Clearly 40 years after the event, bank nationalisation is still a bad word (never mind that both the US and the UK have only recently gone down the same path). So at the risk of being branded a revisionist, or, perhaps worse, clubbed with Mrs Sonia Gandhi and the FM, let me make my pitch in defence of public sector banks (PSBs).
Before you dismiss this as some sort of plug for PSBs, consider: in 1969, when banks were nationalised, the population per bank branch was 82,000 in the rural areas and 33,000 in urban areas. By 2007 that number had fallen to 17,000 in rural areas and 13,000 in the urban areas. In 1969, just 17% of the branch network was in rural areas; today that number is 32%, thanks almost entirely to PSBs.
Yes, there is a large section (41%) of the population that is still without access to modern banking. But what is indisputable is that but for PSBs, access to banking, especially in the rural areas, would have been far less (see table). As of March 2008, PSBs had 35% of their branch network in rural areas; the corresponding number for new private sector banks was just 6.3% while in metropolitan areas where business is more lucrative , private sector banks led the way with 36% of their branch network in metros as against 20% for PSBs.
Take another parameter: credit growth. It is widely accepted that the financial crisis in many western economies took a turn for the worse after credit markets froze. As banks took fright and shied away from lending, many borrowers were left high and dry, perpetuating a vicious downward spiral. Hence, part of the solution lay in persuading banks to continue lending, despite the slowdown. It is a different matter that few complied!
In India, too, industry chambers and the government have been shouting from the rooftops about the need for banks to continue lending. But once again it is PSBs that have ridden to the rescue; credit extended by PSBs, growing 20.4% in the year to March 2009 as against just 4% and 11% for foreign and private sector banks respectively. Yes, it is possible that when they expand their portfolios in a slowdown (in the larger interest of the economy at the diktat of the government), they might also see a rise in the level of NPAs. But that is the flip side of their delivering on their larger social responsibility and not necessarily a commentary on their efficiency.
Indeed, as the report of the Committee on Financial Sector Assessment points out, far from being slothful behemoths, PSBs have responded well to the challenge of competition . Not only is there an overall convergence in their financial results with the other banking groups but, surprise, surprise, their share in the overall profit of the banking sector has increased (emphasis added).
Moreover, thanks to their implicit government guarantee, PSBs are instrumental in promoting financial stability. Contrast the irrational fear that overtook depositors of ICICI Bank on rumours that the bank was in trouble with their rock-solid faith in Indian Bank back in the 1990s when despite public knowledge of its precarious financial position , there was no run on the bank.
This is not to say all is hunky-dory with PSBs. It is not! It is rather to point out that if we expect PSBs to heed a larger call promote financial inclusion, drop interest rates at governments behest (even when it does not make commercial sense to do so), lend to weaker sections, open branches in remote areas and so on and so forth, we must also be prepared to put up with the downside of their public ownership, of which strikes are just one manifestation. Poor work ethos, slow decision-making , bureaucratic interference , etc., being the others.
Does that mean we should cave in to the demands of PSB employees regardless, simply because they have more nuisance value than employees of say, a BHEL or SAIL Not at all! It merely means there is a case for public ownership of banks in a country like India in economic parlance, at our stage of development PSBs are a public good . So there is no point in berating them they are what they are because that is what we want them to be. It is far better, then, to give them greater professional and operational autonomy , even as we retain public ownership!
The recent strike by nationalised bank employees has made the public see red Everyone loves to hate public sector banks but they meet a larger social need and contribute greatly to financial stability Its far better to give them greater professional and operational autonomy, even as we retain public ownership
Sunday, August 16, 2009
New tax code A paradigm shift - by NK Singh
New tax code A paradigm shift
It will be a test of perseverance and political will to ensure the early enactment of the new tax code and, more importantly, prevent any serious dilution of its basic features, says N K Singh
IN MORE ways than one the new direct tax code is a culmination of tax reforms initiated in the early 90s. Chidambarams dream budget with which I was associated had compressed income-tax rates to three slabs of 10, 20, 30 and corporate rate at 35. This was based on two well accepted paradigms. First that modest tax rates create virtuous circle of improved compliance and widen the tax net. Second, the so-called undocumented Laffer Curve effect in which lowering of tax rates in fact improve overall revenue realisation . The present tax code and the enabling legislation appended with the code bears the imprint of Chidambarams drafting skills and clarity of intent. Pranab Mukherjee must be complemented in having overcome multiple hurdles and in putting this document in public domain.
Taxation must subserve multiple objectives . Most importantly to finance government expenditure but in the process combine equity and efficiency. In doing so it needs to harmonise the objectives of maximising resources with a wider social purpose of fostering development, encouraging capital accumulation and investment as well as minimising the distortionary impact of exemptions designed to benefit a group of individuals or segments of society. Earlier attempts to eliminate this complex contradictory spagetti bowl of distortionary exemptions were stalled by powerful lobbies, a nexus between the law makers, beneficiaries and policy designers. The success of this code is therefore predicated on the ability to withstand these debilitating pressures to restore exemptions in one form or the other.
I am given to understand that the overall impact of the proposed legislation is revenue neutral. I expect this to be revenue positive if past is any guide to the future and the broad principle that lower tax rates will lead to tax widening and improved compliance continues to be valid. One broad criticism of the code could be to question whether it is progressive enough. Given our development compulsions and high incidence of poverty progressivity in tax regime is an important objective. That is why improved revenue buoyancy will be its cardinal test and in some ways it is raison detre . Of course, everyone realises the more heavily a man is supposed to be taxed the more power he has to escape being taxed.
The tax code introduces several features, which deserve attention:
First and foremost in fostering savings and investments by discouraging consumption . This is in line with what analysts have suggested that India unlike China must move away from a consumption-led growth to an investment-led growth. Their prescription for China is just the opposite. This explains the rationale of EET (Exempt Exempt Tax), namely, initial investment and interest are exempt but withdrawal would be subject to normal taxes. This will cause hardship for PF, senior citizens and others who towards the latter part of their life wish to enjoy better life quality through enhanced consumption. Similarly, for the corporate sector the exemption regime moves away from a profit-based to investment-based incentives for specific categories of investments in sectors like power, oil and gas, SEZs. However, it is often suggested that in times of recession consumption also needs a stimulus. The higher disposable incomes in the hands of consumers and corporates would hopefully achieve this purpose.
SECOND , the code by accepting the principle of grand-fathering and seeking prospective applications avoids multiple controversies and makes for easier transition.
Third, while retaining exemptions in religious institutions but subjecting other trusts and organisations to a modest 15% tax, it combines the virtue of pragmatism, while minimising multiple misuse.
Fourth, the simplification of capital gains tax by eliminating the distinction between short-term and long-term gains and encouraging more transactions by eliminating the security transactions tax and simplifying the dividend distribution tax are positive.
Fifth, the provision of a minimum alternative tax at 2% of the value of gross assets is based on the principle of incentivising efficiency . This deserves wider consultations. It could discourage long-term lumpy investments and more importantly not protect against business cycles with prolonged recession with negative cash flows if companies do not have the reserves to meet this onerous liability. At the same time the original intend of MAT needed to be restructured to subserve its original intent.
Sixth, while the provisions of general avoidance rule and double taxation is designed to prevent misuse, it is not clear if a code can override existing international treaties and obligations embedded in double taxation agreements. Given international experience and the need to discourage round tripping, this is a good time to renegotiate our multiple double taxation agreements by aligning them with the provisions of the tax code.
Finally, litigation and tax pendency has been an area of continuing concern. Alternative tax resolution methods and dispute settlement mechanism need further innovation . The constitution of the National Tax Tribunal to hear appeals from ITAT could minimise high court pendencies. Nonetheless , the existing appellate mechanisms which the code endorses need further consideration . The present regime leaves both revenue officials and assessees dissatisfied even making the allowances that their interest can never be symmetrical. The reports of the Comptroller and Auditor General and the working of the Public Accounts Committee that induce assessing officers to make large additions and exhaust all appellate processes result in serious distortions.
This needs a mindset change embedded in greater trust and accepting the bona fide judgements of tax officials. All over the world, tax officials are never high in popularity rating. While we must seek greater transparency and minimise scope for corruption , we need to invest more in training, technology infrastructure and resources. India has one of the lowest cost of compliance even compared to emerging markets. As we move to adopt a new code, we need to assign more talent and resources to the revenue department.
The new legislation is a paradigm shift in our approach to taxation. It will be a test of perseverance and political will to ensure its early enactment and more importantly prevent any serious dilution of its basic features . The code is a composite package. This is a case where the whole is bigger than mere sum of the parts.
(The author, a former revenue secretary,
is a Rajya Sabha member)
It will be a test of perseverance and political will to ensure the early enactment of the new tax code and, more importantly, prevent any serious dilution of its basic features, says N K Singh
IN MORE ways than one the new direct tax code is a culmination of tax reforms initiated in the early 90s. Chidambarams dream budget with which I was associated had compressed income-tax rates to three slabs of 10, 20, 30 and corporate rate at 35. This was based on two well accepted paradigms. First that modest tax rates create virtuous circle of improved compliance and widen the tax net. Second, the so-called undocumented Laffer Curve effect in which lowering of tax rates in fact improve overall revenue realisation . The present tax code and the enabling legislation appended with the code bears the imprint of Chidambarams drafting skills and clarity of intent. Pranab Mukherjee must be complemented in having overcome multiple hurdles and in putting this document in public domain.
Taxation must subserve multiple objectives . Most importantly to finance government expenditure but in the process combine equity and efficiency. In doing so it needs to harmonise the objectives of maximising resources with a wider social purpose of fostering development, encouraging capital accumulation and investment as well as minimising the distortionary impact of exemptions designed to benefit a group of individuals or segments of society. Earlier attempts to eliminate this complex contradictory spagetti bowl of distortionary exemptions were stalled by powerful lobbies, a nexus between the law makers, beneficiaries and policy designers. The success of this code is therefore predicated on the ability to withstand these debilitating pressures to restore exemptions in one form or the other.
I am given to understand that the overall impact of the proposed legislation is revenue neutral. I expect this to be revenue positive if past is any guide to the future and the broad principle that lower tax rates will lead to tax widening and improved compliance continues to be valid. One broad criticism of the code could be to question whether it is progressive enough. Given our development compulsions and high incidence of poverty progressivity in tax regime is an important objective. That is why improved revenue buoyancy will be its cardinal test and in some ways it is raison detre . Of course, everyone realises the more heavily a man is supposed to be taxed the more power he has to escape being taxed.
The tax code introduces several features, which deserve attention:
First and foremost in fostering savings and investments by discouraging consumption . This is in line with what analysts have suggested that India unlike China must move away from a consumption-led growth to an investment-led growth. Their prescription for China is just the opposite. This explains the rationale of EET (Exempt Exempt Tax), namely, initial investment and interest are exempt but withdrawal would be subject to normal taxes. This will cause hardship for PF, senior citizens and others who towards the latter part of their life wish to enjoy better life quality through enhanced consumption. Similarly, for the corporate sector the exemption regime moves away from a profit-based to investment-based incentives for specific categories of investments in sectors like power, oil and gas, SEZs. However, it is often suggested that in times of recession consumption also needs a stimulus. The higher disposable incomes in the hands of consumers and corporates would hopefully achieve this purpose.
SECOND , the code by accepting the principle of grand-fathering and seeking prospective applications avoids multiple controversies and makes for easier transition.
Third, while retaining exemptions in religious institutions but subjecting other trusts and organisations to a modest 15% tax, it combines the virtue of pragmatism, while minimising multiple misuse.
Fourth, the simplification of capital gains tax by eliminating the distinction between short-term and long-term gains and encouraging more transactions by eliminating the security transactions tax and simplifying the dividend distribution tax are positive.
Fifth, the provision of a minimum alternative tax at 2% of the value of gross assets is based on the principle of incentivising efficiency . This deserves wider consultations. It could discourage long-term lumpy investments and more importantly not protect against business cycles with prolonged recession with negative cash flows if companies do not have the reserves to meet this onerous liability. At the same time the original intend of MAT needed to be restructured to subserve its original intent.
Sixth, while the provisions of general avoidance rule and double taxation is designed to prevent misuse, it is not clear if a code can override existing international treaties and obligations embedded in double taxation agreements. Given international experience and the need to discourage round tripping, this is a good time to renegotiate our multiple double taxation agreements by aligning them with the provisions of the tax code.
Finally, litigation and tax pendency has been an area of continuing concern. Alternative tax resolution methods and dispute settlement mechanism need further innovation . The constitution of the National Tax Tribunal to hear appeals from ITAT could minimise high court pendencies. Nonetheless , the existing appellate mechanisms which the code endorses need further consideration . The present regime leaves both revenue officials and assessees dissatisfied even making the allowances that their interest can never be symmetrical. The reports of the Comptroller and Auditor General and the working of the Public Accounts Committee that induce assessing officers to make large additions and exhaust all appellate processes result in serious distortions.
This needs a mindset change embedded in greater trust and accepting the bona fide judgements of tax officials. All over the world, tax officials are never high in popularity rating. While we must seek greater transparency and minimise scope for corruption , we need to invest more in training, technology infrastructure and resources. India has one of the lowest cost of compliance even compared to emerging markets. As we move to adopt a new code, we need to assign more talent and resources to the revenue department.
The new legislation is a paradigm shift in our approach to taxation. It will be a test of perseverance and political will to ensure its early enactment and more importantly prevent any serious dilution of its basic features . The code is a composite package. This is a case where the whole is bigger than mere sum of the parts.
(The author, a former revenue secretary,
is a Rajya Sabha member)
Thursday, August 13, 2009
An idea whose time has come - courtesy economic times
The new direct taxes code is a great idea, many of the provisions are well intentioned and most importantly, time has come to embrace, adapt and run with the code as early as possible, says Sudhir Kapadia
THE freshly unveiled direct taxes code (DTC) is an idea which was overdue and whose time has perhaps never been more appropriate. There seem to be three key objectives behind the introduction of the DTC: simplification of language, resulting in lesser litigation; a law which promotes inclusive growth and yet retains the incentives for businesses to make profits; and allow businesses to function in the free market economy but with proper regulations. This article attempts to analyse some of the key provisions of the DTC in the light of the above objectives.
Taking a leaf out of the Chinese tax code, the DTC pegs the corporate tax rate to 25% which is clearly a very attractive rate compared to prevailing rate elsewhere. This, of course, comes with the removal of profitlinked incentives. We now have investment-linked incentives in specific sectors (infrastructure, power, exploration and production of mineral oil, etc) to incentivise capital formation and to remove the incentive to shift profits from “taxable units” to “exempt units”. We also now have capital assets deployed in the businesses (e.g., plant and machinery) to be treated as business assets and any profits arising on sale of these assets to be treated as normal business income and not as capital gains.
In practical terms, a company will now be subject to the same uniform rate of 25% tax on gains from transfer of such business capital assets as against the current rate of 20% for long-term capital gains on transfer of all capital assets. The downside in these provisions is the fact that a loss arising on such a business transfer will not be allowed to be written off in one year but will be amortised like depreciation over a period of time. This provision seems to be inconsistent with the treatment of gains as business income in the year when the gains arise.
However, there is a significant dampener to this feel-good story in the form of the new basis of levy of minimum alternate tax (MAT). The MAT will now be levied at 2% of the value of gross assets in the case of all companies except in the case of banking companies (tax at 0.25% for banking companies). This shift in the MAT base from book profits to gross assets is sought to be justified on the grounds of encouraging “optimal utilisation of the assets and thereby increased efficiency”. This measure, however, seems to run counter to the objective of encouraging capital investment for productive growth. For e.g., in the case of an infrastructure company where the pay back on the investments is longer, on the one hand we have the investment-linked capital allowance reducing taxable profits significantly, on the other hand is the imposition of MAT calculated at the same base of capital investments.
To make matters worse, there is no provision for reducing liabilities incurred for acquisition of assets, i.e., MAT is to be calculated on value of gross assets without corresponding reduction in borrowings incurred. This could result in a kind of “punitive tax” on capital-intensive companies including public sector companies as well as chronically sick companies making consistent losses.
A very significant shift is sought to be made in the area of capital gains taxation. Since 1991, capital gains on sale of shares and securities has always been accorded preferential tax treatment to encourage investment in equity market. The DTC now proposes to remove the distinction between short-term and long-term capital gains on all classes of assets, thereby taxing any gains on transfer of capital assets at normal rates of tax.
THUSindividuals in the higher tax bracket of 30% would be more adversely affected than companies, as companies would pay taxes at a uniform tax rate of 25% on similar gains. This also means that the abolition of the Securities Transaction Tax (STT) will be more than made up by a levy of normal tax on all stock market transactions, be they short term or long term. Further, gains on transfer of immovable property which at present is at 20% if property is held for more than three years will now be taxed at the normal rate of 30% for individuals in the higher tax bracket and 25% for companies.
Some very significant changes are proposed in the international tax area. A time-tested principle of characterising a foreign company as a resident Indian company on the basis of the foreign company being wholly controlled and managed from India is sought to be substituted by a more stringent and arguably a more subjective rule, i.e., a foreign company partly controlled and managed from India will also be regarded as an Indian resident company. In its present form, it would appear that overseas subsidiaries of Indian companies would be subjected to taxation in India on their worldwide income solely on the basis of them being “partly controlled and managed from India”. This seems to be an unintended onerous outcome which needs to be corrected.
An elaborate provision spelling out the general anti-avoidance rule is proposed. While it has features of comprehensiveness, it seems ripe for several different interpretations in respect of features like “commercial substance”, “round trip financing”, “accommodating party”, etc. It is further provided that the general anti-abuse rule will override the provisions of any tax treaty. Thus, for example, the current controversy on the use of Mauritius DTAT will get further ammunition as the Revenue will now seem to invoke the general antiabuse rule in specific cases to override the provisions of the Mauritius treaty. If the intent behind the code was to eliminate litigation and simplify provisions of law, this particular provision certainly does not stand anywhere close to achieving that objective.
In continuation of the introduction of the Alternate Dispute Mechanism in Budget 2009, the DTC seems to now extend this benefit to all taxpayers and not restrict it to foreign companies which is a welcome move and will help the entire tax community. Also, there is a proposal to introduce advance pricing mechanism on transfer pricing which has been a long standing request by multinational corporations. All in all, the idea of the DTC is great, many of the provisions are well intentioned and most importantly time has come to embrace, adapt and run with the DTC as early as possible.
(The author is Partner, Tax & Regulatory
Services, Ernst & Young Pvt Ltd)
THE freshly unveiled direct taxes code (DTC) is an idea which was overdue and whose time has perhaps never been more appropriate. There seem to be three key objectives behind the introduction of the DTC: simplification of language, resulting in lesser litigation; a law which promotes inclusive growth and yet retains the incentives for businesses to make profits; and allow businesses to function in the free market economy but with proper regulations. This article attempts to analyse some of the key provisions of the DTC in the light of the above objectives.
Taking a leaf out of the Chinese tax code, the DTC pegs the corporate tax rate to 25% which is clearly a very attractive rate compared to prevailing rate elsewhere. This, of course, comes with the removal of profitlinked incentives. We now have investment-linked incentives in specific sectors (infrastructure, power, exploration and production of mineral oil, etc) to incentivise capital formation and to remove the incentive to shift profits from “taxable units” to “exempt units”. We also now have capital assets deployed in the businesses (e.g., plant and machinery) to be treated as business assets and any profits arising on sale of these assets to be treated as normal business income and not as capital gains.
In practical terms, a company will now be subject to the same uniform rate of 25% tax on gains from transfer of such business capital assets as against the current rate of 20% for long-term capital gains on transfer of all capital assets. The downside in these provisions is the fact that a loss arising on such a business transfer will not be allowed to be written off in one year but will be amortised like depreciation over a period of time. This provision seems to be inconsistent with the treatment of gains as business income in the year when the gains arise.
However, there is a significant dampener to this feel-good story in the form of the new basis of levy of minimum alternate tax (MAT). The MAT will now be levied at 2% of the value of gross assets in the case of all companies except in the case of banking companies (tax at 0.25% for banking companies). This shift in the MAT base from book profits to gross assets is sought to be justified on the grounds of encouraging “optimal utilisation of the assets and thereby increased efficiency”. This measure, however, seems to run counter to the objective of encouraging capital investment for productive growth. For e.g., in the case of an infrastructure company where the pay back on the investments is longer, on the one hand we have the investment-linked capital allowance reducing taxable profits significantly, on the other hand is the imposition of MAT calculated at the same base of capital investments.
To make matters worse, there is no provision for reducing liabilities incurred for acquisition of assets, i.e., MAT is to be calculated on value of gross assets without corresponding reduction in borrowings incurred. This could result in a kind of “punitive tax” on capital-intensive companies including public sector companies as well as chronically sick companies making consistent losses.
A very significant shift is sought to be made in the area of capital gains taxation. Since 1991, capital gains on sale of shares and securities has always been accorded preferential tax treatment to encourage investment in equity market. The DTC now proposes to remove the distinction between short-term and long-term capital gains on all classes of assets, thereby taxing any gains on transfer of capital assets at normal rates of tax.
THUSindividuals in the higher tax bracket of 30% would be more adversely affected than companies, as companies would pay taxes at a uniform tax rate of 25% on similar gains. This also means that the abolition of the Securities Transaction Tax (STT) will be more than made up by a levy of normal tax on all stock market transactions, be they short term or long term. Further, gains on transfer of immovable property which at present is at 20% if property is held for more than three years will now be taxed at the normal rate of 30% for individuals in the higher tax bracket and 25% for companies.
Some very significant changes are proposed in the international tax area. A time-tested principle of characterising a foreign company as a resident Indian company on the basis of the foreign company being wholly controlled and managed from India is sought to be substituted by a more stringent and arguably a more subjective rule, i.e., a foreign company partly controlled and managed from India will also be regarded as an Indian resident company. In its present form, it would appear that overseas subsidiaries of Indian companies would be subjected to taxation in India on their worldwide income solely on the basis of them being “partly controlled and managed from India”. This seems to be an unintended onerous outcome which needs to be corrected.
An elaborate provision spelling out the general anti-avoidance rule is proposed. While it has features of comprehensiveness, it seems ripe for several different interpretations in respect of features like “commercial substance”, “round trip financing”, “accommodating party”, etc. It is further provided that the general anti-abuse rule will override the provisions of any tax treaty. Thus, for example, the current controversy on the use of Mauritius DTAT will get further ammunition as the Revenue will now seem to invoke the general antiabuse rule in specific cases to override the provisions of the Mauritius treaty. If the intent behind the code was to eliminate litigation and simplify provisions of law, this particular provision certainly does not stand anywhere close to achieving that objective.
In continuation of the introduction of the Alternate Dispute Mechanism in Budget 2009, the DTC seems to now extend this benefit to all taxpayers and not restrict it to foreign companies which is a welcome move and will help the entire tax community. Also, there is a proposal to introduce advance pricing mechanism on transfer pricing which has been a long standing request by multinational corporations. All in all, the idea of the DTC is great, many of the provisions are well intentioned and most importantly time has come to embrace, adapt and run with the DTC as early as possible.
(The author is Partner, Tax & Regulatory
Services, Ernst & Young Pvt Ltd)
Tuesday, May 12, 2009
Worth a read
It is August. In a small town on the South Coast of France, holiday season
is in full swing, but it is raining so there is not too much business
happening. Everyone is heavily in debt.
Luckily, a rich Russian tourist arrives in the foyer of the small local
hotel. He asks for a room and puts a Euro100 note on the reception counter,
takes a key and goes to inspect the room located up the stairs on the third
floor.
The hotel owner takes the banknote in hurry and rushes to his meat supplier
to whom he owes E100.
The butcher takes the money and races to his supplier to pay his debt.
The wholesaler rushes to the farmer to pay E100 for pigs he purchased some
time ago.
The farmer triumphantly gives the E100 note to a local prostitute who gave
him her services on credit.
The prostitute goes quickly to the hotel, as she owed the hotel for her
hourly room use to entertain clients.
At that moment, the rich Russian is coming down to reception and informs the
hotel owner that the proposed room is unsatisfactory and takes his E100 back
and departs.
There was no profit or income. But everyone no longer has any debt and the
small town people look optimistically towards their future.
COULD THIS BE THE SOLUTION TO THE Global Financial Crisis? Or, is
there a catch here?
is in full swing, but it is raining so there is not too much business
happening. Everyone is heavily in debt.
Luckily, a rich Russian tourist arrives in the foyer of the small local
hotel. He asks for a room and puts a Euro100 note on the reception counter,
takes a key and goes to inspect the room located up the stairs on the third
floor.
The hotel owner takes the banknote in hurry and rushes to his meat supplier
to whom he owes E100.
The butcher takes the money and races to his supplier to pay his debt.
The wholesaler rushes to the farmer to pay E100 for pigs he purchased some
time ago.
The farmer triumphantly gives the E100 note to a local prostitute who gave
him her services on credit.
The prostitute goes quickly to the hotel, as she owed the hotel for her
hourly room use to entertain clients.
At that moment, the rich Russian is coming down to reception and informs the
hotel owner that the proposed room is unsatisfactory and takes his E100 back
and departs.
There was no profit or income. But everyone no longer has any debt and the
small town people look optimistically towards their future.
COULD THIS BE THE SOLUTION TO THE Global Financial Crisis? Or, is
there a catch here?
Saturday, April 4, 2009
Explanation .
Heidi is the proprietor of a bar somewhere in Europe. In order to increase
sales, she decides to allow her loyal customers - most of whom are
unemployed alcoholics - to drink now but pay later. She keeps track of the
drinks consumed on a ledger (thereby granting the customers loans).
Word gets around and as a result increasing numbers of customers flood into
Heidi's bar.
Taking advantage of her customers' freedom from immediate payment
constraints, Heidi increases her prices for wine and beer, the most-consumed
beverages. Her sales volume increases massively.
A young and dynamic customer service consultant at the local bank recognizes
these customer debts as valuable future assets and increases Heidi's
borrowing limit.
He sees no reason for undue concern since he has the debts of the alcoholics
as collateral.
At the bank's corporate headquarters, expert bankers transform these
customer assets into DRINKBONDS, ALKBONDS and PUKEBONDS. These securities
are then traded on markets worldwide. No one really understands what these
abbreviations mean and how the securities are guaranteed. Nevertheless, as
their prices continuously climb, the securities become top-selling items.
One day, although the prices are still climbing, a risk manager
(subsequently of course fired due his negativity) of the bank decides that
slowly the time has come to demand payment of the debts incurred by the
drinkers at Heidi's bar.
However they cannot pay back the debts.
Heidi cannot fulfill her loan obligations and claims bankruptcy.
DRINKBOND and ALKBOND drop in price by 95 %. PUKEBOND performs better,
stabilizing in price after dropping by 80 %.
The suppliers of Heidi's bar, having granted her generous payment due dates
and having invested in the securities are faced with a new situation. Her
wine supplier claims bankruptcy, her beer supplier is taken over by a
competitor.
The bank is saved by the Government following dramatic round-the-clock
consultations by leaders from the governing political parties.
The funds required for this purpose are obtained by a tax levied on the
non-drinkers.
sales, she decides to allow her loyal customers - most of whom are
unemployed alcoholics - to drink now but pay later. She keeps track of the
drinks consumed on a ledger (thereby granting the customers loans).
Word gets around and as a result increasing numbers of customers flood into
Heidi's bar.
Taking advantage of her customers' freedom from immediate payment
constraints, Heidi increases her prices for wine and beer, the most-consumed
beverages. Her sales volume increases massively.
A young and dynamic customer service consultant at the local bank recognizes
these customer debts as valuable future assets and increases Heidi's
borrowing limit.
He sees no reason for undue concern since he has the debts of the alcoholics
as collateral.
At the bank's corporate headquarters, expert bankers transform these
customer assets into DRINKBONDS, ALKBONDS and PUKEBONDS. These securities
are then traded on markets worldwide. No one really understands what these
abbreviations mean and how the securities are guaranteed. Nevertheless, as
their prices continuously climb, the securities become top-selling items.
One day, although the prices are still climbing, a risk manager
(subsequently of course fired due his negativity) of the bank decides that
slowly the time has come to demand payment of the debts incurred by the
drinkers at Heidi's bar.
However they cannot pay back the debts.
Heidi cannot fulfill her loan obligations and claims bankruptcy.
DRINKBOND and ALKBOND drop in price by 95 %. PUKEBOND performs better,
stabilizing in price after dropping by 80 %.
The suppliers of Heidi's bar, having granted her generous payment due dates
and having invested in the securities are faced with a new situation. Her
wine supplier claims bankruptcy, her beer supplier is taken over by a
competitor.
The bank is saved by the Government following dramatic round-the-clock
consultations by leaders from the governing political parties.
The funds required for this purpose are obtained by a tax levied on the
non-drinkers.
Monday, March 23, 2009
U.S. unveils 'bad asset' plan
By partnering with private investors, government hopes it can finally flush out toxic assets from banks' balance sheets.
ROAD TO RESCUE
* Stocks spike on bank plan
* Flying the dirt-cheap skies
* Bank stocks surge on 'bad-asset' plan
* Existing home sales spike 5%
* U.S. unveils 'bad asset' plan
Treasury Secretary Tim Geithner said the public-private partnership program was the best alternative for cleaning toxic assets from banks' balance sheets.
Road to Rescue
Economy rescue: Adding up the dollars
The government is engaged in an unprecedented - and expensive - effort to rescue the economy. Here are all the elements of the bailouts.more
chart_bad_assets.gif
WASHINGTON (CNNMoney.com) -- The Treasury Department unveiled its long-awaited plan to remove many of the troubled assets from banks' books Monday, representing one of the biggest efforts by the U.S. government so far aimed at tackling the ongoing financial crisis.
Under the new so-called "Public-Private Investment Program," taxpayer funds will be used to seed partnerships with private investors that will buy up toxic assets backed by mortgages and other loans.
The goal is to buy up at least $500 billion of existing assets and loans, such as subprime mortgages that are now in danger of default.
Treasury said the program could potentially expand to $1 trillion over time, but that the hope is that it would not only help cleanse the balance sheets of many of the nation's largest banks, which continue to suffer billions of dollars in losses, but help get credit flowing again.
The government will run auctions between the banks selling the assets and the investors buying them, hoping to effectively create a market for these assets.
To kickstart things, the administration said it will commit $75 billion to $100 billion and would consider how the program is progressing before committing more money.
Even as he acknowledged that the government was taking on risk with this new program, Treasury Secretary Tim Geithner defended it as the best alternative, saying that doing nothing would result in a deeper credit crunch and a "longer, deeper recession."
The plan, which was widely hinted at over the weekend, appeared to be warmly received by Wall Street. The Dow Jones industrial average gained almost 4% in late morning trading Monday, helped by a surge in the financials. Shares of Citigroup (C, Fortune 500) and Bank of America (BAC, Fortune 500) each climbed about 15% on the New York Stock Exchange.
Investors have been waiting expectantly for details since Geithner first announced the framework of a plan last month to address two of the biggest problems in the banking sector: the toxic assets keeping banks from lending and the shortage of capital at major institutions.
But the latest program may very well add to the cost of federal bailouts to date. So far, the government has spent $2.5 trillion of the more than $12 trillion authorized for programs aimed at propping up the nation's financial services industry and the broader U.S. economy.
Will the plan work?
One of the biggest difficulties in getting the program off the ground was how to price the soured assets. If the government paid too little, banks would take the hit. But if the government overpaid, then already-soaked taxpayers would feel the pinch.
One nagging concern, however, is whether the government's involvement will actually spur banks and private investor groups, such as hedge funds, pension plans and insurance companies to participate.
Administration officials indicated Sunday they had gotten support from private investors and banks who have been briefed about the program. But some analysts questioned whether the government's help would be enough to push investors and banks toward figuring out a price.
At the same time, there are fears that investors may be reluctant to participate in light of the fact that Congress has retroactively altered the terms of many of the government rescue programs so far.
Bill Gross, co-chief investment officer of Pimco, one of the world's largest bond investment managers, said those concerns were not enough to deter his firm's interest in the program.
He told CNN that Pimco planned to participate and would also apply to the Treasury for one of the available asset manager positions to help run the program. Asset manager BlackRock (BLK, Fortune 500) said it also planned to apply.
ROAD TO RESCUE
* Stocks spike on bank plan
* Flying the dirt-cheap skies
* Bank stocks surge on 'bad-asset' plan
* Existing home sales spike 5%
* U.S. unveils 'bad asset' plan
Treasury Secretary Tim Geithner said the public-private partnership program was the best alternative for cleaning toxic assets from banks' balance sheets.
Road to Rescue
Economy rescue: Adding up the dollars
The government is engaged in an unprecedented - and expensive - effort to rescue the economy. Here are all the elements of the bailouts.more
chart_bad_assets.gif
WASHINGTON (CNNMoney.com) -- The Treasury Department unveiled its long-awaited plan to remove many of the troubled assets from banks' books Monday, representing one of the biggest efforts by the U.S. government so far aimed at tackling the ongoing financial crisis.
Under the new so-called "Public-Private Investment Program," taxpayer funds will be used to seed partnerships with private investors that will buy up toxic assets backed by mortgages and other loans.
The goal is to buy up at least $500 billion of existing assets and loans, such as subprime mortgages that are now in danger of default.
Treasury said the program could potentially expand to $1 trillion over time, but that the hope is that it would not only help cleanse the balance sheets of many of the nation's largest banks, which continue to suffer billions of dollars in losses, but help get credit flowing again.
The government will run auctions between the banks selling the assets and the investors buying them, hoping to effectively create a market for these assets.
To kickstart things, the administration said it will commit $75 billion to $100 billion and would consider how the program is progressing before committing more money.
Even as he acknowledged that the government was taking on risk with this new program, Treasury Secretary Tim Geithner defended it as the best alternative, saying that doing nothing would result in a deeper credit crunch and a "longer, deeper recession."
The plan, which was widely hinted at over the weekend, appeared to be warmly received by Wall Street. The Dow Jones industrial average gained almost 4% in late morning trading Monday, helped by a surge in the financials. Shares of Citigroup (C, Fortune 500) and Bank of America (BAC, Fortune 500) each climbed about 15% on the New York Stock Exchange.
Investors have been waiting expectantly for details since Geithner first announced the framework of a plan last month to address two of the biggest problems in the banking sector: the toxic assets keeping banks from lending and the shortage of capital at major institutions.
But the latest program may very well add to the cost of federal bailouts to date. So far, the government has spent $2.5 trillion of the more than $12 trillion authorized for programs aimed at propping up the nation's financial services industry and the broader U.S. economy.
Will the plan work?
One of the biggest difficulties in getting the program off the ground was how to price the soured assets. If the government paid too little, banks would take the hit. But if the government overpaid, then already-soaked taxpayers would feel the pinch.
One nagging concern, however, is whether the government's involvement will actually spur banks and private investor groups, such as hedge funds, pension plans and insurance companies to participate.
Administration officials indicated Sunday they had gotten support from private investors and banks who have been briefed about the program. But some analysts questioned whether the government's help would be enough to push investors and banks toward figuring out a price.
At the same time, there are fears that investors may be reluctant to participate in light of the fact that Congress has retroactively altered the terms of many of the government rescue programs so far.
Bill Gross, co-chief investment officer of Pimco, one of the world's largest bond investment managers, said those concerns were not enough to deter his firm's interest in the program.
He told CNN that Pimco planned to participate and would also apply to the Treasury for one of the available asset manager positions to help run the program. Asset manager BlackRock (BLK, Fortune 500) said it also planned to apply.
Wednesday, March 18, 2009
How to fail to recover - Economic Times - 18/03/09
The stimulus will strengthen America’s economy, but it is probably not enough to restore robust growth. This is bad news for the rest of the world too, for a strong global recovery requires a strong US economy, says Joseph E Stiglitz.
SOME PEOPLE thought that Barack Obama’s election would turn everything around for America. Because it has not, even after the passage of a huge stimulus bill, the presentation of a new programme to deal with the underlying housing problem, and several plans to stabilise the financial system, some are even beginning to blame Obama and his team.
Obama, however, inherited an economy in free fall, and could not possibly have turned things around in the short time since his inauguration. President Bush seemed like a deer caught in the headlights — paralysed, unable to do almost anything — for months before he left office. It is a relief that the US finally has a President who can act, and what he has been doing will make a big difference.
Unfortunately, what he is doing is not enough. The stimulus package appears big — more than 2% of GDP per year — but one-third of it goes to tax cuts. And, with Americans facing a debt overhang, rapidly increasing unemployment (and the worst unemployment compensation system among major industrial countries), and falling asset prices, they are likely to save much of the tax cut.
Almost half of the stimulus simply offsets the contractionary effect of cutbacks at the state level. America’s 50 states must maintain balanced budgets. The total shortfalls were estimated at $150 billion a few months ago; now the number must be much larger — indeed, California alone faces a shortfall of $40 billion.
Household savings are finally beginning to rise, which is good for the long-run health of household finances, but disastrous for economic growth. Meanwhile, investment and exports are plummeting as well. America’s automatic stabilisers — the progressivity of our tax systems, the strength of our welfare system — have been greatly weakened, but they will provide some stimulus, as the expected fiscal deficit soars to 10% of GDP.
In short, the stimulus will strengthen America’s economy, but it is probably not enough to restore robust growth. This is bad news for the rest of the world, too, for a strong global recovery requires a strong American economy.
The real failings in the Obama recovery programme, however, lie not in the stimulus package but in its efforts to revive financial markets. America’s failures provide important lessons to countries around the world, which are or will be facing increasing problems with their banks:
• Delaying bank restructuring is costly, in terms of both the eventual bailout costs and the damage to the overall economy in the interim.
• Governments do not like to admit the full costs of the problem, so they give the banking system just enough to survive, but not enough to return it to health.
• Confidence is important, but it must rest on sound fundamentals. Policies must not be based on the fiction that good loans were made, and that the business acumen of financial market leaders and regulators will be validated once confidence is restored.
• Bankers can be expected to act in their self-interest on the basis of incentives. Perverse incentives fuelled excessive risktaking, and banks that are near collapse but are too big to fail will engage in even more of it. Knowing that the government will pick up the pieces if necessary, they will postpone resolving mortgages and pay out billions in bonuses and dividends.
• Socialising losses while privatising gains is more worrisome than the consequences of nationalising banks. American taxpayers are getting an increasingly bad deal. In the first round of cash infusions, they got about $0.67 in assets for every dollar they gave (though the assets were almost surely overvalued, and quickly fell in value). But in the recent cash infusions, it is estimated that Americans are getting $0.25, or less, for every dollar.
Bad terms mean a large national debt in the future. One reason we may be getting bad terms is that if we got fair value for our money, we would by now be the dominant shareholder in at least one of the major banks.
• Don’t confuse saving bankers and shareholders with saving banks. America could have saved its banks, but let the shareholders go, for far less than it has spent.
• Trickle-down economics almost never works. Throwing money at banks hasn’t helped homeowners: foreclosures continue to increase. Letting AIG fail might have hurt some systemically important institutions, but dealing with that would have been better than to gamble upwards of $150 billion and hope that some of it might stick where it is important.
• Lack of transparency got the US financial system into this trouble. Lack of transparency will not get it out. The Obama administration is promising to pick up losses to persuade hedge funds and other private investors to buy out banks’ bad assets. But this will not establish “market prices,” as the administration claims. With the government bearing losses, these are distorted prices. Bank losses have already occurred, and their gains must now come at taxpayers’ expense. Bringing in hedge funds as third parties will simply increase the cost.
• Better to be forward looking than backward looking, focusing on reducing the risk of new loans and ensuring that funds create new lending capacity, than backward looking. Bygone are bygones. As a point of reference, $700 billion provided to a new bank, leveraged 10 to 1, could have financed $7 trillion of new loans.
The era of believing that something can be created out of nothing should be over. Short-sighted responses by politicians — who hope to get by with a deal that is small enough to please taxpayers and large enough to please the banks — will only prolong the problem. An impasse is looming. More money will be needed, but Americans are in no mood to provide it — certainly not on the terms that have been seen so far. The well of money may be running dry, and so, too, may be America’s legendary optimism and hope.
(The author, professor of economics at
Columbia University, is recipient of
the 2001 Nobel Prize in Economics)
(C): Project Syndicate, 2009
SOME PEOPLE thought that Barack Obama’s election would turn everything around for America. Because it has not, even after the passage of a huge stimulus bill, the presentation of a new programme to deal with the underlying housing problem, and several plans to stabilise the financial system, some are even beginning to blame Obama and his team.
Obama, however, inherited an economy in free fall, and could not possibly have turned things around in the short time since his inauguration. President Bush seemed like a deer caught in the headlights — paralysed, unable to do almost anything — for months before he left office. It is a relief that the US finally has a President who can act, and what he has been doing will make a big difference.
Unfortunately, what he is doing is not enough. The stimulus package appears big — more than 2% of GDP per year — but one-third of it goes to tax cuts. And, with Americans facing a debt overhang, rapidly increasing unemployment (and the worst unemployment compensation system among major industrial countries), and falling asset prices, they are likely to save much of the tax cut.
Almost half of the stimulus simply offsets the contractionary effect of cutbacks at the state level. America’s 50 states must maintain balanced budgets. The total shortfalls were estimated at $150 billion a few months ago; now the number must be much larger — indeed, California alone faces a shortfall of $40 billion.
Household savings are finally beginning to rise, which is good for the long-run health of household finances, but disastrous for economic growth. Meanwhile, investment and exports are plummeting as well. America’s automatic stabilisers — the progressivity of our tax systems, the strength of our welfare system — have been greatly weakened, but they will provide some stimulus, as the expected fiscal deficit soars to 10% of GDP.
In short, the stimulus will strengthen America’s economy, but it is probably not enough to restore robust growth. This is bad news for the rest of the world, too, for a strong global recovery requires a strong American economy.
The real failings in the Obama recovery programme, however, lie not in the stimulus package but in its efforts to revive financial markets. America’s failures provide important lessons to countries around the world, which are or will be facing increasing problems with their banks:
• Delaying bank restructuring is costly, in terms of both the eventual bailout costs and the damage to the overall economy in the interim.
• Governments do not like to admit the full costs of the problem, so they give the banking system just enough to survive, but not enough to return it to health.
• Confidence is important, but it must rest on sound fundamentals. Policies must not be based on the fiction that good loans were made, and that the business acumen of financial market leaders and regulators will be validated once confidence is restored.
• Bankers can be expected to act in their self-interest on the basis of incentives. Perverse incentives fuelled excessive risktaking, and banks that are near collapse but are too big to fail will engage in even more of it. Knowing that the government will pick up the pieces if necessary, they will postpone resolving mortgages and pay out billions in bonuses and dividends.
• Socialising losses while privatising gains is more worrisome than the consequences of nationalising banks. American taxpayers are getting an increasingly bad deal. In the first round of cash infusions, they got about $0.67 in assets for every dollar they gave (though the assets were almost surely overvalued, and quickly fell in value). But in the recent cash infusions, it is estimated that Americans are getting $0.25, or less, for every dollar.
Bad terms mean a large national debt in the future. One reason we may be getting bad terms is that if we got fair value for our money, we would by now be the dominant shareholder in at least one of the major banks.
• Don’t confuse saving bankers and shareholders with saving banks. America could have saved its banks, but let the shareholders go, for far less than it has spent.
• Trickle-down economics almost never works. Throwing money at banks hasn’t helped homeowners: foreclosures continue to increase. Letting AIG fail might have hurt some systemically important institutions, but dealing with that would have been better than to gamble upwards of $150 billion and hope that some of it might stick where it is important.
• Lack of transparency got the US financial system into this trouble. Lack of transparency will not get it out. The Obama administration is promising to pick up losses to persuade hedge funds and other private investors to buy out banks’ bad assets. But this will not establish “market prices,” as the administration claims. With the government bearing losses, these are distorted prices. Bank losses have already occurred, and their gains must now come at taxpayers’ expense. Bringing in hedge funds as third parties will simply increase the cost.
• Better to be forward looking than backward looking, focusing on reducing the risk of new loans and ensuring that funds create new lending capacity, than backward looking. Bygone are bygones. As a point of reference, $700 billion provided to a new bank, leveraged 10 to 1, could have financed $7 trillion of new loans.
The era of believing that something can be created out of nothing should be over. Short-sighted responses by politicians — who hope to get by with a deal that is small enough to please taxpayers and large enough to please the banks — will only prolong the problem. An impasse is looming. More money will be needed, but Americans are in no mood to provide it — certainly not on the terms that have been seen so far. The well of money may be running dry, and so, too, may be America’s legendary optimism and hope.
(The author, professor of economics at
Columbia University, is recipient of
the 2001 Nobel Prize in Economics)
(C): Project Syndicate, 2009
Wednesday, February 25, 2009
Recreating a rotten system
By Swami Iyer - TOI - 25/ 02
The Obama housing plan seeks to return to the pre-crisis situation that was based on the assumption that home prices would always go up and never down. This is myopia or cowardice, or both.
INDIA cannot grow fast again till the US economy recovers. And US recovery depends on reviving the housing sector, whence the downswing began. Alas, the Obama Plan for housing is a crutch, not a cure. Putting all the blame on insufficient regulation and overpaid, greedy lenders cannot rectify the structural flaws of US housing. Equally to blame is the political illusion that by tweaking markets and arm-twisting lenders, you can make all Americans home owners.
The Obama Plan has three main components. One, cash incentives (totalling $75 billion) for lenders and home owners to renegotiate mortgages. Two, allowing those whose mortgages exceed home value to refinance, up to 105% of the home value. Three, fresh capital of $200 billion for government agencies (Fannie Mae and Freddie Mac) to expand mortgage lending.
The Obama Plan aims to raise distressed home values by $6,000, cut foreclosures, and prevent entire localities from becoming ownerless and derelict. Whether lenders will be able to renegotiate millions of mortgages remains unclear. Many mortgages have been sliced and bundled into CDO bonds, and any administrator who writes down a mortgage risks being sued by disgruntled bondholders.
Refinancing mortgages up to 105% of home value will be disastrous if home prices fall further. The crisis owes much to the slack lending standards of Fannie Mae and Freddie Mac, yet the Obama Plan provides these agencies additional capital to extend substandard lending. This risky approach will work only if home prices rise soon. Otherwise, it will cause another housing crisis within two years.
The Obama Plan addresses current distress, but ignores two fundamental flaws in the whole housing system. One is the limited liability of home owners. In most countries, a mortgage is secured by the value of the home plus a personal guarantee of the home owner. So, if he defaults on mortgage payments, the lender can go after his salary or other assets. This is called a full recourse loan, and encourages home owners to do their best to repay loans.
But the US has non-recourse mortgages, secured only by the house. The lender cannot go after other assets of the borrower. If the market price of a house sinks below the mortgage outstanding, the owner can simply walk out and mail the house keys to the lender, with no further liability. This “jingle mail” loophole encourages wilful default. European countries have full recourse mortgages — the lenders can go after all assets — and so have far lower default and foreclosure rates.
The Obama Plan is silent on closing the jingle-mail loophole. Politicians currently paint all lenders as crooks and borrowers as victims, and don’t want the supposed crooks to go after the other assets of the supposed victims. Such populism ignores the perverse incentives of jingle mail, which erode the foundations of the housing market.
The second, more fundamental flaw is the political determination to tweak housing markets to somehow attain the ideal of universal home ownership. In a market system, monthly mortgage payments are necessarily higher than monthly rents. People with uncertain incomes should rent cheaply, not borrow expensively to buy houses. Renting is an essential part of a housing market, not a deficiency.
POLITICAL measures to subsidise ownership and discourage renting have contributed to terrible lending and borrowing practices that caused the current crisis. Instead of reforming these, the Obama Plan provides billions to subsidise those same terrible practices. These practices survived for 60 years because of a quirk: US home prices never fell after World War II. Yet in a market system prices must fall as well as rise. When finally US home prices fell in 2007, the system collapsed. The US must, like other countries, have a housing system that can cope with declines as well as increases in home prices.
US politicians aim for universal home ownership in four ways. One, unlimited tax exemption for interest on home loans. Two, the creation of Fannie Mae and Freddie Mac, agencies with quasi-government guarantees to underwrite more mortgages than markets alone would find prudent. Three, federal mortgage insurance. Four, several laws — including the controversial Community Reinvestment Act — obliging banks to lend to all areas, and not discriminate against poor or crime-ridden neighbourhoods.
Though well intentioned, these measures are the wrong instruments. If you seek universal home ownership, the best way is massive public housing followed by privatisation (sale to the renters). Governments should build low-cost houses and rent these cheaply to people with low or uncertain incomes. Renters who pay rent for a specified period — say 12-15 years — will become owners. Margaret Thatcher in Britain converted millions of government tenants into home owners.
This is not socialism. Even in pre-communist Hong Kong, which came closer than any other country to laissez faire, almost half of all housing was public housing. It was a non-market measure for a non-market aim.
If Obama is serious, he must grasp some nettles. He cannot have both responsible lending practices and universal home ownership. If he wants responsible lending, he must explicitly abandon the goal of universal home ownership, and aim for affordable rents. This approach implies limiting or abolishing tax breaks on mortgage interest for home owners, and instead providing subsidies for lowincome renting. It implies full recourse mortgages. And it implies that prospective home buyers must put down 20% of the price of homes, so that the housing system can withstand a 20% fall in home prices. This will, of course, mean less home ownership and more renting.
If on the other hand Obama wants to aim for universal home ownership, he should opt for massive public housing followed by privatisation. Renters of government housing should eventually become owners.
Alas, the Obama Plan refuses to face up to this hard choice. Instead, it seeks to return to the pre-crisis situation, which was based on the assumption that home prices would always go up and never down. This is myopia or cowardice, or both.
The Obama housing plan seeks to return to the pre-crisis situation that was based on the assumption that home prices would always go up and never down. This is myopia or cowardice, or both.
INDIA cannot grow fast again till the US economy recovers. And US recovery depends on reviving the housing sector, whence the downswing began. Alas, the Obama Plan for housing is a crutch, not a cure. Putting all the blame on insufficient regulation and overpaid, greedy lenders cannot rectify the structural flaws of US housing. Equally to blame is the political illusion that by tweaking markets and arm-twisting lenders, you can make all Americans home owners.
The Obama Plan has three main components. One, cash incentives (totalling $75 billion) for lenders and home owners to renegotiate mortgages. Two, allowing those whose mortgages exceed home value to refinance, up to 105% of the home value. Three, fresh capital of $200 billion for government agencies (Fannie Mae and Freddie Mac) to expand mortgage lending.
The Obama Plan aims to raise distressed home values by $6,000, cut foreclosures, and prevent entire localities from becoming ownerless and derelict. Whether lenders will be able to renegotiate millions of mortgages remains unclear. Many mortgages have been sliced and bundled into CDO bonds, and any administrator who writes down a mortgage risks being sued by disgruntled bondholders.
Refinancing mortgages up to 105% of home value will be disastrous if home prices fall further. The crisis owes much to the slack lending standards of Fannie Mae and Freddie Mac, yet the Obama Plan provides these agencies additional capital to extend substandard lending. This risky approach will work only if home prices rise soon. Otherwise, it will cause another housing crisis within two years.
The Obama Plan addresses current distress, but ignores two fundamental flaws in the whole housing system. One is the limited liability of home owners. In most countries, a mortgage is secured by the value of the home plus a personal guarantee of the home owner. So, if he defaults on mortgage payments, the lender can go after his salary or other assets. This is called a full recourse loan, and encourages home owners to do their best to repay loans.
But the US has non-recourse mortgages, secured only by the house. The lender cannot go after other assets of the borrower. If the market price of a house sinks below the mortgage outstanding, the owner can simply walk out and mail the house keys to the lender, with no further liability. This “jingle mail” loophole encourages wilful default. European countries have full recourse mortgages — the lenders can go after all assets — and so have far lower default and foreclosure rates.
The Obama Plan is silent on closing the jingle-mail loophole. Politicians currently paint all lenders as crooks and borrowers as victims, and don’t want the supposed crooks to go after the other assets of the supposed victims. Such populism ignores the perverse incentives of jingle mail, which erode the foundations of the housing market.
The second, more fundamental flaw is the political determination to tweak housing markets to somehow attain the ideal of universal home ownership. In a market system, monthly mortgage payments are necessarily higher than monthly rents. People with uncertain incomes should rent cheaply, not borrow expensively to buy houses. Renting is an essential part of a housing market, not a deficiency.
POLITICAL measures to subsidise ownership and discourage renting have contributed to terrible lending and borrowing practices that caused the current crisis. Instead of reforming these, the Obama Plan provides billions to subsidise those same terrible practices. These practices survived for 60 years because of a quirk: US home prices never fell after World War II. Yet in a market system prices must fall as well as rise. When finally US home prices fell in 2007, the system collapsed. The US must, like other countries, have a housing system that can cope with declines as well as increases in home prices.
US politicians aim for universal home ownership in four ways. One, unlimited tax exemption for interest on home loans. Two, the creation of Fannie Mae and Freddie Mac, agencies with quasi-government guarantees to underwrite more mortgages than markets alone would find prudent. Three, federal mortgage insurance. Four, several laws — including the controversial Community Reinvestment Act — obliging banks to lend to all areas, and not discriminate against poor or crime-ridden neighbourhoods.
Though well intentioned, these measures are the wrong instruments. If you seek universal home ownership, the best way is massive public housing followed by privatisation (sale to the renters). Governments should build low-cost houses and rent these cheaply to people with low or uncertain incomes. Renters who pay rent for a specified period — say 12-15 years — will become owners. Margaret Thatcher in Britain converted millions of government tenants into home owners.
This is not socialism. Even in pre-communist Hong Kong, which came closer than any other country to laissez faire, almost half of all housing was public housing. It was a non-market measure for a non-market aim.
If Obama is serious, he must grasp some nettles. He cannot have both responsible lending practices and universal home ownership. If he wants responsible lending, he must explicitly abandon the goal of universal home ownership, and aim for affordable rents. This approach implies limiting or abolishing tax breaks on mortgage interest for home owners, and instead providing subsidies for lowincome renting. It implies full recourse mortgages. And it implies that prospective home buyers must put down 20% of the price of homes, so that the housing system can withstand a 20% fall in home prices. This will, of course, mean less home ownership and more renting.
If on the other hand Obama wants to aim for universal home ownership, he should opt for massive public housing followed by privatisation. Renters of government housing should eventually become owners.
Alas, the Obama Plan refuses to face up to this hard choice. Instead, it seeks to return to the pre-crisis situation, which was based on the assumption that home prices would always go up and never down. This is myopia or cowardice, or both.
Tuesday, February 17, 2009
Capitalism is reinventing itself
By Swami Iyer - TOI
As the recession deepens, people across the ideological spectrum declare that capitalism has failed. Almost every economic news report carries words like ‘crisis’ and ‘disaster’. Yet, recessions are not aberrations of capitalism but an intrinsic part of it.
Markets create boom and bust cycles, arising from human tendencies to swing from euphoria to fear and back. A bust is an occasion for cleaning out deadwood and failed experiments, and re-inventing capitalism.
In my youth, the Communist Party politburo would meet after every recession and declare “capitalism is now in its final death throes.” In fact, capitalism re-invented itself and grew constantly stronger, while the recession-free communist system collapsed.
Two decades ago, economist Jerry Muller chronicled never-ending predictions of the demise of capitalism, by its friends as well as foes. In the 1850s, Karl Marx claimed capitalism was dying. Rosa Luxemburg wrote in
The Accumulation of Private Capital
(1913), “Though imperialism is the historical method prolonging the career of capitalism, it is also a sure means of bringing it to a swift conclusion.” Lenin harboured similar illusions: his 1916 book was titled Imperialism: the Last Stage of Capitalism.
The Great Depression of the 1930s provoked further predictions of capitalism’s demise. Ferdinand Fried, of the German radical right, made waves with his 1930 book The End of Capitalism. In the US, Howard Scott’s technocracy movement predicted the replacement of market prices by central planning. British sociologist Karl Mannheim asserted in Man and Society in An Age of Reconstruction
(1940) that democracy could survive only by delinking from capitalism.
World War II came and went, but obituaries of capitalism continued. Historian AJP Taylor declared on BBC in 1945 that “Nobody believes in the American way of life, that is, private enterprise. Or rather, those who believe in it are a defeated party, and a party which seems to have no more future than the Jacobites in England after 1688.”
Economist Joseph Schumpeter, a great protagonist of entrepreneurship, nevertheless suggested in Capitalism, Socialism and Democracy that capitalism could die through self-inflicted wounds. Nikita Krushchev was certain history was on his side: “We will crush you”.
All capitalist nations became welfare states after World War II, devoting unprecedented sums to the sick, aged and poor. This was interpreted by some as meaning that capitalism was fading away. The stagnation of capitalist economies in the 1970s fuelled new hopes in the European Left, and Francois Mitterand came to power in France on a platform of breaking with capitalism. He nationalised major French industries, raised taxes, shortened working hours and lengthened holidays. He would not, he said, take the Thatcher-Reagan path to disaster. But soon France was in even deeper recession than the US or Britain. A disillusioned Mitterand later re-privatised nationalised companies.
Why have so many intelligent, learned people been constantly wrong about capitalism? First, the word capitalism has been used by some people to mean a system with no role for governments at all, whereas modern capitalism is very much a government-business joint venture. Second, critics have constantly underestimated capitalism’s ability to re-engineer itself and evolve into new forms that get rid of some of the old defects.
The current bust certainly calls for some re-engineering of markets. Yet, economists and politicians have been quicker to condemn existing flaws than propose comprehensive reforms that will nip financial crises in the bud. Ever since the Asian financial crisis, we have heard much talk about a new financial architecture, yet in practice that has not gone much beyond suggesting higher IMF quotas for developing countries, which is desirable but of marginal importance.
We hear talk of doubling or tripling the lending power of the IMF. That will enable the IMF to rescue some developing countries or East Europeans, but not to end the housing and credit busts in the US and EU.
Everybody agrees that financial markets need more regulation. We will doubtless see more controls on financial derivatives and stricter lending norms. Yet, recessions and financial crises occured in earlier decades when lending controls were much stricter, and financial derivatives did not exist.
After having demanded for decades a greater say in the global financial system, developing countries now have a chance to actually press for reforms. They now have unprecedented clout: Asian forex reserves greatly exceed those of the IMF. The world is looking seriously for new ideas, and wants to hear from Asia. Yet, developing countries — including India — have little to suggest except larger quotas for themselves in the IMF, and bigger IMF lending. So sad. If you have nothing to say, why demand a greater say? Montek Singh Ahluwalia, here’s your big chance.
As the recession deepens, people across the ideological spectrum declare that capitalism has failed. Almost every economic news report carries words like ‘crisis’ and ‘disaster’. Yet, recessions are not aberrations of capitalism but an intrinsic part of it.
Markets create boom and bust cycles, arising from human tendencies to swing from euphoria to fear and back. A bust is an occasion for cleaning out deadwood and failed experiments, and re-inventing capitalism.
In my youth, the Communist Party politburo would meet after every recession and declare “capitalism is now in its final death throes.” In fact, capitalism re-invented itself and grew constantly stronger, while the recession-free communist system collapsed.
Two decades ago, economist Jerry Muller chronicled never-ending predictions of the demise of capitalism, by its friends as well as foes. In the 1850s, Karl Marx claimed capitalism was dying. Rosa Luxemburg wrote in
The Accumulation of Private Capital
(1913), “Though imperialism is the historical method prolonging the career of capitalism, it is also a sure means of bringing it to a swift conclusion.” Lenin harboured similar illusions: his 1916 book was titled Imperialism: the Last Stage of Capitalism.
The Great Depression of the 1930s provoked further predictions of capitalism’s demise. Ferdinand Fried, of the German radical right, made waves with his 1930 book The End of Capitalism. In the US, Howard Scott’s technocracy movement predicted the replacement of market prices by central planning. British sociologist Karl Mannheim asserted in Man and Society in An Age of Reconstruction
(1940) that democracy could survive only by delinking from capitalism.
World War II came and went, but obituaries of capitalism continued. Historian AJP Taylor declared on BBC in 1945 that “Nobody believes in the American way of life, that is, private enterprise. Or rather, those who believe in it are a defeated party, and a party which seems to have no more future than the Jacobites in England after 1688.”
Economist Joseph Schumpeter, a great protagonist of entrepreneurship, nevertheless suggested in Capitalism, Socialism and Democracy that capitalism could die through self-inflicted wounds. Nikita Krushchev was certain history was on his side: “We will crush you”.
All capitalist nations became welfare states after World War II, devoting unprecedented sums to the sick, aged and poor. This was interpreted by some as meaning that capitalism was fading away. The stagnation of capitalist economies in the 1970s fuelled new hopes in the European Left, and Francois Mitterand came to power in France on a platform of breaking with capitalism. He nationalised major French industries, raised taxes, shortened working hours and lengthened holidays. He would not, he said, take the Thatcher-Reagan path to disaster. But soon France was in even deeper recession than the US or Britain. A disillusioned Mitterand later re-privatised nationalised companies.
Why have so many intelligent, learned people been constantly wrong about capitalism? First, the word capitalism has been used by some people to mean a system with no role for governments at all, whereas modern capitalism is very much a government-business joint venture. Second, critics have constantly underestimated capitalism’s ability to re-engineer itself and evolve into new forms that get rid of some of the old defects.
The current bust certainly calls for some re-engineering of markets. Yet, economists and politicians have been quicker to condemn existing flaws than propose comprehensive reforms that will nip financial crises in the bud. Ever since the Asian financial crisis, we have heard much talk about a new financial architecture, yet in practice that has not gone much beyond suggesting higher IMF quotas for developing countries, which is desirable but of marginal importance.
We hear talk of doubling or tripling the lending power of the IMF. That will enable the IMF to rescue some developing countries or East Europeans, but not to end the housing and credit busts in the US and EU.
Everybody agrees that financial markets need more regulation. We will doubtless see more controls on financial derivatives and stricter lending norms. Yet, recessions and financial crises occured in earlier decades when lending controls were much stricter, and financial derivatives did not exist.
After having demanded for decades a greater say in the global financial system, developing countries now have a chance to actually press for reforms. They now have unprecedented clout: Asian forex reserves greatly exceed those of the IMF. The world is looking seriously for new ideas, and wants to hear from Asia. Yet, developing countries — including India — have little to suggest except larger quotas for themselves in the IMF, and bigger IMF lending. So sad. If you have nothing to say, why demand a greater say? Montek Singh Ahluwalia, here’s your big chance.
Monday, February 9, 2009
Higher Forex can worsen this recession says Swami
By Swami Iyer - again
High foreign exchange reserves have, in the current global recession, saved Asian countries (including India) from the travails they suffered in the Asian financial crisis of 1997-2000. So, they must aim for rising forex reserves in future too, right? Wrong.
In truth, high Asian forex reserves are an important reason for the current recession. High reserves promise safety in a storm. But, beyond a point this safety becomes illusory, because rising forex reserves worsen the global imbalances that have precipitated the recession.
The global recession has many roots. One is the erosion of traditional US household prudence. US households used to save 6% of their disposable income. But in recent years they went on a borrowing and spending spree, and household savings dropped to virtually zero. Corporations and financiers also ran up record debts, partly to buy assets such as houses, stocks and commodities. This created huge bubbles in all three markets.
When the bubbles finally burst, US households, corporations and financiers found themselves in dire straits. Many financial giants were rescued by the government. Meanwhile households, sobered by the turn of events, started saving 4% of disposable income, up from zero. More saving meant less spending, and made the recession deep and sharp.
Most Asians are smugly blaming US imprudence and loose financial regulation for the crisis, while portraying themselves as innocent victims. Yet, they must share the guilt too. US profligacy did not arise in a vacuum. It arose in part because Asian insistence on high forex reserves meant that they poured dollars into the US to buy US securities. This flood of dollars from Asia drove down US interest rates, making it very attractive to borrow. That spurred the borrowing spree, and the accompanying bubbles.
Historically, rich countries had surplus savings, manifested in a trade surplus. Poor countries lacked savings, manifested in trade deficits, with the deficit being plugged by an inflow of dollars from rich to poor countries. For the world as a whole, current account surpluses and deficits of countries must necessarily balance. Historically, the surpluses of rich countries were offset by the deficits of poor ones.
But after the Asian financial crisis, something strange happened. Asian countries, above all China, began generating huge savings surpluses, manifested in huge current account surpluses. Many used undervalued exchange rates to artificially create trade surpluses, which were then invested in US treasuries (that is what foreign exchange reserves are).
However, poor Asians could not run huge surpluses unless others were willing to run huge deficits. Remarkably, the rich US began to do so. This arose partly from the sophistication of its financial system, which found many ways — too many, in fact — of converting the flood of money from Asia into a borrowing and spending spree. This sharp rise in US spending boosted the global economy, and created the record global GDP growth in 2003-08. US demand sucked in huge quantities of manufactures and services from Asia, above all from China. Asian manufacturing sucked in huge quantities of commodities from Africa and Latin America, raising incomes there too.
Alas, this boom was based on huge global imbalances that had to be corrected at some point. No country, not even the rich US, could keep running gargantuan trade deficits forever, to offset the surpluses of Asia. US asset bubbles burst, the boom ended, and US spending and imports plummeted.
Ending the consequent recession means reducing global imbalances to manageable proportions. Americans will have to save more, spend less and export more. Asian countries, especially China, will have to consume more, save less, and export less. This re-balancing will restore global balance, and enable global growth to rise sustainably again.
However, such re-balancing means that Asian countries must stop piling up ever-rising forex reserves (and trade surpluses). Such reserves represent excessive saving, excessive exports and insufficient imports. Excess forex reserves have provided apparent safety to Asian countries in a recessionary crisis, yet are also a cause of that very crisis.
What will happen if Asians insist on trying to keep savings and forex reserves high? Well, if Asians keep savings high and Americans and Europeans do so too, then world demand will collapse and the recession will become a Depression. Asians must recognise that high forex reserves serve as a safety cushion only up to a point, and beyond that exacerbate global imbalances that threaten disaster. Saving too much can be as harmful as saving too little. Unless Asian countries recognize this and go slow on future reserve accumulation, the recession may become worse than anyone dares imagine today.
High foreign exchange reserves have, in the current global recession, saved Asian countries (including India) from the travails they suffered in the Asian financial crisis of 1997-2000. So, they must aim for rising forex reserves in future too, right? Wrong.
In truth, high Asian forex reserves are an important reason for the current recession. High reserves promise safety in a storm. But, beyond a point this safety becomes illusory, because rising forex reserves worsen the global imbalances that have precipitated the recession.
The global recession has many roots. One is the erosion of traditional US household prudence. US households used to save 6% of their disposable income. But in recent years they went on a borrowing and spending spree, and household savings dropped to virtually zero. Corporations and financiers also ran up record debts, partly to buy assets such as houses, stocks and commodities. This created huge bubbles in all three markets.
When the bubbles finally burst, US households, corporations and financiers found themselves in dire straits. Many financial giants were rescued by the government. Meanwhile households, sobered by the turn of events, started saving 4% of disposable income, up from zero. More saving meant less spending, and made the recession deep and sharp.
Most Asians are smugly blaming US imprudence and loose financial regulation for the crisis, while portraying themselves as innocent victims. Yet, they must share the guilt too. US profligacy did not arise in a vacuum. It arose in part because Asian insistence on high forex reserves meant that they poured dollars into the US to buy US securities. This flood of dollars from Asia drove down US interest rates, making it very attractive to borrow. That spurred the borrowing spree, and the accompanying bubbles.
Historically, rich countries had surplus savings, manifested in a trade surplus. Poor countries lacked savings, manifested in trade deficits, with the deficit being plugged by an inflow of dollars from rich to poor countries. For the world as a whole, current account surpluses and deficits of countries must necessarily balance. Historically, the surpluses of rich countries were offset by the deficits of poor ones.
But after the Asian financial crisis, something strange happened. Asian countries, above all China, began generating huge savings surpluses, manifested in huge current account surpluses. Many used undervalued exchange rates to artificially create trade surpluses, which were then invested in US treasuries (that is what foreign exchange reserves are).
However, poor Asians could not run huge surpluses unless others were willing to run huge deficits. Remarkably, the rich US began to do so. This arose partly from the sophistication of its financial system, which found many ways — too many, in fact — of converting the flood of money from Asia into a borrowing and spending spree. This sharp rise in US spending boosted the global economy, and created the record global GDP growth in 2003-08. US demand sucked in huge quantities of manufactures and services from Asia, above all from China. Asian manufacturing sucked in huge quantities of commodities from Africa and Latin America, raising incomes there too.
Alas, this boom was based on huge global imbalances that had to be corrected at some point. No country, not even the rich US, could keep running gargantuan trade deficits forever, to offset the surpluses of Asia. US asset bubbles burst, the boom ended, and US spending and imports plummeted.
Ending the consequent recession means reducing global imbalances to manageable proportions. Americans will have to save more, spend less and export more. Asian countries, especially China, will have to consume more, save less, and export less. This re-balancing will restore global balance, and enable global growth to rise sustainably again.
However, such re-balancing means that Asian countries must stop piling up ever-rising forex reserves (and trade surpluses). Such reserves represent excessive saving, excessive exports and insufficient imports. Excess forex reserves have provided apparent safety to Asian countries in a recessionary crisis, yet are also a cause of that very crisis.
What will happen if Asians insist on trying to keep savings and forex reserves high? Well, if Asians keep savings high and Americans and Europeans do so too, then world demand will collapse and the recession will become a Depression. Asians must recognise that high forex reserves serve as a safety cushion only up to a point, and beyond that exacerbate global imbalances that threaten disaster. Saving too much can be as harmful as saving too little. Unless Asian countries recognize this and go slow on future reserve accumulation, the recession may become worse than anyone dares imagine today.
Saturday, February 7, 2009
Indy Set to beat China in growth rates
All it the brighter side of the current downturn. India may pip export-dependent China in the last quarter of FY09 and emerge as the
As China’s GDP growth rate dropped to 6.8% during the October-December quarter and is expected to go down further, the Indian government has become hyper-active to achieve at least a 6.5% growth in Q4 to register a win over China.
If India achieves a better growth rate than China even for one quarter, the message will go across to the world and help India in wooing foreign capital, waiting to chase growth stories. Already, government officials in India have been highlighting reports of a few investment analysts who doubted China’s official GDP numbers and claimed that it could just be in the positive territory in the last quarter.
Friday, February 6, 2009
Bubble !!
Guys what you see here is the bubble ! all the financial newspapers are talkin abt . I masef found it unbelievable when i first saw it ! but it is real ! So i can add nothing more as the pic speaks for itself
Saturday, January 17, 2009
Gloom all over - This ones from Neemrana - Swaminomics
Government spokesmen claim that, after dipping in 2008-09, the economy will accelerate again next year. But some of the world’s top economists opined at last week’s Neemrana seminar, organised by National Council of Applied Economic Research (NCAER) and National Bureau of Economic Research (NBER), US, that the global economy might get worse rather than better in 2009, affecting India too.
Analysts thought initially that the global recession would end by mid-2009. After all, trillions of dollars were being pumped into economies through fiscal and monetary measures of unprecedented magnitude. This, analysts felt, would surely revive spending in flagging economies.
Alas, that’s not happened. Retail sales in the US were disastrous in November and December. One US economist at Neemrana opined that the big US economic stimulus had raised spending by $400 billion. But this was insufficient to fill a demand gap of $600 billion caused by the recession. This gap eroded sales, causing job cuts that will cut income and spending even further. Corporations don’t want to invest, and it will take time for government infrastructure investment to fill the gap in private investment.
To encourage spending, the US government sent out cheques worth $80 billion to consumers. But consumers spent only $12 billion of this, saving the rest. After years of overspending, consumers are chastened and recanting, so the stimulus is not working. President-elect Obama has promised a second stimulus of $825 billion. It’s unclear whether this will work any better than the Bush stimulus.
After initially sniggering at the US capitalist model, Europe finds itself in deep trouble too. Recessions create fiscal deficits, and stimulus packages even more so. But some European countries already have such high public debts that they bar the risk of defaulting on repayments as their economies sink, a fate once reserved for Third World countries. Iceland is the worst hit, but may be small enough to be rescued by the IMF. But the IMF lacks the resources to rescue all tottering East European countries.
The really bad news is that mainline Eurozone countries like Greece are now in danger of sovereign default. A sequential run on the credit default swaps of European governments seems to have begun. Market rates suggest a 10-15% chance of Greek default. Greece’s national debt is a high 90% of its GDP, of which 20% has to be refinanced in a few months. It’s unclear how Greece can be rescued if it defaults. If Greece goes under, Italy, a G-7 country, will be next in line — its public finances are almost as bad. Britain can devalue to survive a financial crisis, but this option is not available to troubled Eurozone members tied to the euro, including Ireland, Portugal and Spain. Ailing banks in Eastern Europe are mostly owned by West Europe, so a banking collapse in the former could lead to massive contagion in the latter.
Indeed, the very conceptual foundation of the Eurozone, as one where a common currency ensured credit to all on good terms, is now in doubt. Wages and pensions are too high in some countries relative to others. The problem was masked in good times. Now that the tide is going out, it’s becoming clear who was swimming naked.
Another top economist said at Neemrana that three aspects of the global crisis had been underestimated. One was the vicious downward spiral where financial distress caused production distress, which caused yet more financial distress. Second, the vulnerability of banks had been grossly underestimated. Third, nobody anticipated the speed with which galloping commodity prices in the first half of 20008 would be followed by collapsing prices in the second half.
As a result, he said, the world faces a shock of unprecedented proportions. Growth in advanced economies will fall in 2009, for the first time since World War II. Asia may seem in better shape than others , but this is largely because of the lag in transmission of the crisis from the West. Soon, Asia will be hit badly too. And India will suffer along with the rest of Asia.
Another top global economist declared that the crisis was structural, reflecting a serious global misallocation of money in recent years, which had created many bubbles that had now burst. Pumping in more money could not resolve the problem, since it amounted to an attempt to reflate the old bubbles. Instead painful structural change was needed, he said, and this could take years.
The mood of these top global economists at Neemrana was far gloomier than i had expected. While hoping they are wrong, we must be prepared for their being right.
Analysts thought initially that the global recession would end by mid-2009. After all, trillions of dollars were being pumped into economies through fiscal and monetary measures of unprecedented magnitude. This, analysts felt, would surely revive spending in flagging economies.
Alas, that’s not happened. Retail sales in the US were disastrous in November and December. One US economist at Neemrana opined that the big US economic stimulus had raised spending by $400 billion. But this was insufficient to fill a demand gap of $600 billion caused by the recession. This gap eroded sales, causing job cuts that will cut income and spending even further. Corporations don’t want to invest, and it will take time for government infrastructure investment to fill the gap in private investment.
To encourage spending, the US government sent out cheques worth $80 billion to consumers. But consumers spent only $12 billion of this, saving the rest. After years of overspending, consumers are chastened and recanting, so the stimulus is not working. President-elect Obama has promised a second stimulus of $825 billion. It’s unclear whether this will work any better than the Bush stimulus.
After initially sniggering at the US capitalist model, Europe finds itself in deep trouble too. Recessions create fiscal deficits, and stimulus packages even more so. But some European countries already have such high public debts that they bar the risk of defaulting on repayments as their economies sink, a fate once reserved for Third World countries. Iceland is the worst hit, but may be small enough to be rescued by the IMF. But the IMF lacks the resources to rescue all tottering East European countries.
The really bad news is that mainline Eurozone countries like Greece are now in danger of sovereign default. A sequential run on the credit default swaps of European governments seems to have begun. Market rates suggest a 10-15% chance of Greek default. Greece’s national debt is a high 90% of its GDP, of which 20% has to be refinanced in a few months. It’s unclear how Greece can be rescued if it defaults. If Greece goes under, Italy, a G-7 country, will be next in line — its public finances are almost as bad. Britain can devalue to survive a financial crisis, but this option is not available to troubled Eurozone members tied to the euro, including Ireland, Portugal and Spain. Ailing banks in Eastern Europe are mostly owned by West Europe, so a banking collapse in the former could lead to massive contagion in the latter.
Indeed, the very conceptual foundation of the Eurozone, as one where a common currency ensured credit to all on good terms, is now in doubt. Wages and pensions are too high in some countries relative to others. The problem was masked in good times. Now that the tide is going out, it’s becoming clear who was swimming naked.
Another top economist said at Neemrana that three aspects of the global crisis had been underestimated. One was the vicious downward spiral where financial distress caused production distress, which caused yet more financial distress. Second, the vulnerability of banks had been grossly underestimated. Third, nobody anticipated the speed with which galloping commodity prices in the first half of 20008 would be followed by collapsing prices in the second half.
As a result, he said, the world faces a shock of unprecedented proportions. Growth in advanced economies will fall in 2009, for the first time since World War II. Asia may seem in better shape than others , but this is largely because of the lag in transmission of the crisis from the West. Soon, Asia will be hit badly too. And India will suffer along with the rest of Asia.
Another top global economist declared that the crisis was structural, reflecting a serious global misallocation of money in recent years, which had created many bubbles that had now burst. Pumping in more money could not resolve the problem, since it amounted to an attempt to reflate the old bubbles. Instead painful structural change was needed, he said, and this could take years.
The mood of these top global economists at Neemrana was far gloomier than i had expected. While hoping they are wrong, we must be prepared for their being right.
Monday, January 12, 2009
How to spot a SCAM
FOR some it’s clearly winter, for those spoiling for a fight with neighbouring countries it’s a time for bellicosity and for many it’s a period of abstinence and renouncement. But, for Corporate India, this is, undeniably, a season for corporate governance. The nice-sounding, and sanctimonious, phrase moves from conference halls to board rooms this month as Satyam occupies business mindspace, boggles the popular imagination and becomes the new “shock-and-awe” item of the season.
The term ‘corporate governance’ tends to make an appearance and leave a strong impression mostly during times of market crashes and slow economic activity. During go-go times, no one cares. Even the Satyam skeletons would have stayed firmly locked up, rattling some consciences occasionally.
But, this time, long faces are discussing the issue seriously on television channels, equity analysts are saying they knew all along that India Inc was seriously in deficit and many company promoters are looking over their shoulders every so often.
Does this end here? Hopefully. But, if one is to hear all the doomsday artists and professional corporate watchers, this could just be the beginning of a long procession of companies waiting to be outed. So, here’s a favourite parlour game: how to spot and detect the next wrong ones. Look out for these traits:
1) This one is a sure give-away. Be suspicious of companies suddenly launching on unrelated diversifications with great gusto. For instance, a chemicals processing company starting a floriculture project is a sure sign that it is planning some land-related scam or is using up shareholder’s money for a hare-brained project to be launched by the promoter’s son.
2) Beware of companies which have huge related-party transactions. This is one old (and successful) model of siphoning off cash from the company. It is also a not-sosubtle way of ‘inflating’ sales. About 50% of one large, and listed, real estate company’s sales are to a group company (which stays resolutely private), but the money to be received from the same company somehow does not jive with the sales number. In this way, the listed company uses public money to build projects, sells them to the private company, shows pumped-up sales, but the buyer (the private company) is over time shown as incapable of paying up, the receivable is written off from the listed company and when the sales eventually happens, the shareholders of the private company gain the most. Cost is borne by the public, but profits stay with only the promoters.
3) Keep your antennae up for companies which suddenly change their accounting policies. Many companies suddenly change either their depreciation policy or even their revenue recognition policy. A change in the depreciation policy allows many companies to either reduce their actual losses or helps balloon profits. Many corporates also suddenly change how they acknowledge revenue accretion. In many cases, this helps show a sudden increase in sales, resulting in better valuation on the stock markets.
4) Another red flag: Companies that suddenly show a dramatic jump in sales, when nothing extraordinary has happened in the economic environment to justify the spurt in growth. One media company which went public a few years ago, showed a spectacular jump in its total revenue a couple of months before filing its prospectus. Recently, another technology company showed a 900% jump in sales over just six quarters ended September 2008! People should be beating a path to this company’s door for some clues on how to locate undiscovered multitudes of buyers.
5) Many companies, during good times, entered into some exotic foreign exchange derivative contracts, hoping to punt on the movement of currencies they had no clue about, such as the Swiss franc. In good times, all’s acceptable. But, come crunch time and all these derivative contracts have now shrunk in value. But, the companies that bought these fancy products are yet to recognise the forex losses on their profit and loss accounts. It’s a bit like a time bomb ticking away in the accounts. Some companies have disclosed their exposure, but are refusing to provide for it, hoping it will go away one day like a bad dream.
6) Ditto is the case with many companies which had loaded up on forex debt, like a famished urchin landing up at a free, five-star buffet. Today, they are shying away from showing the losses on these debts, especially since the rupee-dollar has moved adversely from the time they had contracted the debt. Expect to hear more about a fancy term called Accounting Standard 30 in the coming days.
So, what’s the lesson from this time? Sorry to sound cynical, but as long as the system stays what it is, there might be just a few more revelations, and then it’s back to business as usual. C’mon, we’re all forgetting the basics. Can you ask people to keep a tight rein on greed in a market that’s asking everybody to buy that fancy yacht, or that bejewelled watch, in the space of a heart-beat? Perhaps, it’s better for all of us if we were to accept this silver-tongued beast as an irrefutable part of our lives.
The term ‘corporate governance’ tends to make an appearance and leave a strong impression mostly during times of market crashes and slow economic activity. During go-go times, no one cares. Even the Satyam skeletons would have stayed firmly locked up, rattling some consciences occasionally.
But, this time, long faces are discussing the issue seriously on television channels, equity analysts are saying they knew all along that India Inc was seriously in deficit and many company promoters are looking over their shoulders every so often.
Does this end here? Hopefully. But, if one is to hear all the doomsday artists and professional corporate watchers, this could just be the beginning of a long procession of companies waiting to be outed. So, here’s a favourite parlour game: how to spot and detect the next wrong ones. Look out for these traits:
1) This one is a sure give-away. Be suspicious of companies suddenly launching on unrelated diversifications with great gusto. For instance, a chemicals processing company starting a floriculture project is a sure sign that it is planning some land-related scam or is using up shareholder’s money for a hare-brained project to be launched by the promoter’s son.
2) Beware of companies which have huge related-party transactions. This is one old (and successful) model of siphoning off cash from the company. It is also a not-sosubtle way of ‘inflating’ sales. About 50% of one large, and listed, real estate company’s sales are to a group company (which stays resolutely private), but the money to be received from the same company somehow does not jive with the sales number. In this way, the listed company uses public money to build projects, sells them to the private company, shows pumped-up sales, but the buyer (the private company) is over time shown as incapable of paying up, the receivable is written off from the listed company and when the sales eventually happens, the shareholders of the private company gain the most. Cost is borne by the public, but profits stay with only the promoters.
3) Keep your antennae up for companies which suddenly change their accounting policies. Many companies suddenly change either their depreciation policy or even their revenue recognition policy. A change in the depreciation policy allows many companies to either reduce their actual losses or helps balloon profits. Many corporates also suddenly change how they acknowledge revenue accretion. In many cases, this helps show a sudden increase in sales, resulting in better valuation on the stock markets.
4) Another red flag: Companies that suddenly show a dramatic jump in sales, when nothing extraordinary has happened in the economic environment to justify the spurt in growth. One media company which went public a few years ago, showed a spectacular jump in its total revenue a couple of months before filing its prospectus. Recently, another technology company showed a 900% jump in sales over just six quarters ended September 2008! People should be beating a path to this company’s door for some clues on how to locate undiscovered multitudes of buyers.
5) Many companies, during good times, entered into some exotic foreign exchange derivative contracts, hoping to punt on the movement of currencies they had no clue about, such as the Swiss franc. In good times, all’s acceptable. But, come crunch time and all these derivative contracts have now shrunk in value. But, the companies that bought these fancy products are yet to recognise the forex losses on their profit and loss accounts. It’s a bit like a time bomb ticking away in the accounts. Some companies have disclosed their exposure, but are refusing to provide for it, hoping it will go away one day like a bad dream.
6) Ditto is the case with many companies which had loaded up on forex debt, like a famished urchin landing up at a free, five-star buffet. Today, they are shying away from showing the losses on these debts, especially since the rupee-dollar has moved adversely from the time they had contracted the debt. Expect to hear more about a fancy term called Accounting Standard 30 in the coming days.
So, what’s the lesson from this time? Sorry to sound cynical, but as long as the system stays what it is, there might be just a few more revelations, and then it’s back to business as usual. C’mon, we’re all forgetting the basics. Can you ask people to keep a tight rein on greed in a market that’s asking everybody to buy that fancy yacht, or that bejewelled watch, in the space of a heart-beat? Perhaps, it’s better for all of us if we were to accept this silver-tongued beast as an irrefutable part of our lives.
SCAMS
Company Involved (Year of Scam Expose'): CRB Capital Markets Limited (1996)
Amount Involved: Rs 1200 crore
Type of Fraud: Chairman Chain Roop Bhansali, was accused of siphoning off Rs 12 billion in the CRB scam. CRB was accused of using its SBI accounts to siphon off bank funds, claiming it was encashing interest warrants and refund warrants.
Impact: The Unit Trust of India and the Gujarat government also incurred losses.
Company Involved (Year of Scam Expose'): ITC – Chitalia's Fera Violation(1996)
Amount Involved: FERA violations were estimated at around $80 million.
Type of Fraud: In June 1996, ED started FERA investigation into the export transactions between ITC and the Chitalia group of companies (EST Fibres) during 1990- 1995.
Impact: The Chitalias and several directors of the company including ITC Chairman KL Chugh were detained but later released on bail. ITC in turn slapped a suit on Chitalias for $15 million, Chitalias in turn sued ITC for $55 million, which they claimed ITC owed them.
Company Involved (Year of Scam Expose'): Home Trade (2002)
Amount Involved: Rs 6000 cr
Type of Fraud: Eight co-operative banks, like Valsad People's Co-operative Bank and Navsari Co-operative Bank from South Gujarat, collectively lost over Rs 80 crore due to bad investments by the Home Trade. It was also linked to Rs 82 lakh forgery in a central government undertaking EPF scheme.
Impact: Home Trade chairman Sanjay Agarwal and Director Ketan Seth were arrested
Company Involved (Year of Scam Expose'): DSQ Software (2003)
Amount Involved: Rs.595 crore
Type of Fraud: Dinesh Dalmia's Company DSQ Software was accused of dubious acquisitions and biased allotments made in the year 2000 & 2001.
Impact: Dalmia was arrested in 2006 and is currently serving jail sentence.
Company Involved (Year of Scam Expose'): Nagarjuna Finance (2003)
Amount Involved: Rs 98.37 crore
Type of Fraud: Executives of Nagarjuna Finance, an promoted by KS Raju, was accused of failure to return about Rs 100 crore to depositors in 1997-98.
Impact: NFL could repay only Rs 54.8 crore as at December 2003.
Company Involved (Year of Scam Expose'): Satyam (2009)
Amount Involved : Rs. 7000 cr.
Type Of Fraud : Inflated Balance Sheets.
Impact : Founder Arrested.
Amount Involved: Rs 1200 crore
Type of Fraud: Chairman Chain Roop Bhansali, was accused of siphoning off Rs 12 billion in the CRB scam. CRB was accused of using its SBI accounts to siphon off bank funds, claiming it was encashing interest warrants and refund warrants.
Impact: The Unit Trust of India and the Gujarat government also incurred losses.
Company Involved (Year of Scam Expose'): ITC – Chitalia's Fera Violation(1996)
Amount Involved: FERA violations were estimated at around $80 million.
Type of Fraud: In June 1996, ED started FERA investigation into the export transactions between ITC and the Chitalia group of companies (EST Fibres) during 1990- 1995.
Impact: The Chitalias and several directors of the company including ITC Chairman KL Chugh were detained but later released on bail. ITC in turn slapped a suit on Chitalias for $15 million, Chitalias in turn sued ITC for $55 million, which they claimed ITC owed them.
Company Involved (Year of Scam Expose'): Home Trade (2002)
Amount Involved: Rs 6000 cr
Type of Fraud: Eight co-operative banks, like Valsad People's Co-operative Bank and Navsari Co-operative Bank from South Gujarat, collectively lost over Rs 80 crore due to bad investments by the Home Trade. It was also linked to Rs 82 lakh forgery in a central government undertaking EPF scheme.
Impact: Home Trade chairman Sanjay Agarwal and Director Ketan Seth were arrested
Company Involved (Year of Scam Expose'): DSQ Software (2003)
Amount Involved: Rs.595 crore
Type of Fraud: Dinesh Dalmia's Company DSQ Software was accused of dubious acquisitions and biased allotments made in the year 2000 & 2001.
Impact: Dalmia was arrested in 2006 and is currently serving jail sentence.
Company Involved (Year of Scam Expose'): Nagarjuna Finance (2003)
Amount Involved: Rs 98.37 crore
Type of Fraud: Executives of Nagarjuna Finance, an promoted by KS Raju, was accused of failure to return about Rs 100 crore to depositors in 1997-98.
Impact: NFL could repay only Rs 54.8 crore as at December 2003.
Company Involved (Year of Scam Expose'): Satyam (2009)
Amount Involved : Rs. 7000 cr.
Type Of Fraud : Inflated Balance Sheets.
Impact : Founder Arrested.
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