Last week I was chatting with one of my friends who is based in New Jersey. He is a senior executive of a multinational bank and a key player in the high-stake game of Wall Street. (Like many members of this club, he often pretends to know all the answers and I am willing to listen to him!) The topic of discussion turned to recent financial market turmoil and how the survivors are surviving. The record quarterly profit of Goldman Sachs and huge bonus they plan to payout naturally popped up.
“The turmoil has kicked out many players. The bailout package has ameliorated extreme trauma of the remaining few. Now with reduced competition to feed the demand, the surviving bankers are up to their same old tricks. They even enjoy better margins these days” My friend explained to me. I was a bit surprised. So soon? Is the memory so short? Don’t we learn some lessons? Is it just a cynical remark of a jealous banker?
I logged onto the net to see what more renowned experts had to say on this. The following quote from Paul Krugman in the article "The Joy of Sachs” he wrote in the New York Times summarised it all. (Do take the pain to read the whole article. It is illuminating.)
“First, it tells us that Goldman is very good at what it does. Unfortunately, what it does is bad for America.
Second, it shows that Wall Street’s bad habits — above all, the system of compensation that helped cause the financial crisis — have not gone away.
Third, it shows that by rescuing the financial system without reforming it, Washington has done nothing to protect us from a new crisis, and, in fact, has made another crisis more likely.”
This brought to my mind a completely contrasting story. The story of Darbary Seth of Tata Chemicals. Soda Ash, the chemical that his company produced and marketed was under price control and one day the government removed the price control. Instead of trying to take advantage of the freedom that this decontrol offered and increase price, he actually reduced the price. To the surprised colleagues and frustrated competitors he quipped, “When there is decontrol, we should have self control”
These are two ends of the spectrum. On one end we see the corporate governance that limits itself to being technically correct and compliance to the letter of the law. On the other end we see a visionary leadership who recognizes the larger role played by every business enterprise. The world around us is a mixture of both and what lies in between. The balance keeps shifting from one extreme to another. Sometimes the crisis, that was triggered by the excesses lead to stronger shareholder activism and trigger correction mechanisms as new acts and regulations.
In the last few years the pendulum appears to have been more to the side of ‘profit at whatever costs’. More so in the areas of financial innovation or rather the how these innovations were exploited.
How do we ensure that the balance tilts more towards more responsible corporations? Is there a need to bring about some regulatory intervention? Will it help?
I agree the rules cannot be the solution. But when the financial innovations significantly expanded product options and as Krugman noted “directed vast quantities of capital into the construction of unsellable houses and empty shopping malls which increased risk rather than reducing it, and concentrated risk rather than spreading it” there appears to be a definite case for some tweaking of regulations to ensure that the checks and balances are built with no/ minimum conflicts of interest. (Refer to my posting Checks and Balances - Who checks and Who balances” for some thoughts on this)
Don’t get me wrong. I am not advocating a return to license and control raj. My limited point is that we need to strengthen our institutional framework further and the regulators should improve the quality of their team so that they can clearly discern what is right and what is fair and don’t let the political expediency rule their judgement; especially when the market participants get caught in a spiral of short-termism and incentive structures that could be disastrous to the society in the long term. On the other hand a little more of introspection in the board rooms and among managers could also help.(Take a look at "Devastation of world financial markets - A case of Policy Reversals in India?” for some different perspectives on this)
Showing posts with label Finance. Show all posts
Showing posts with label Finance. Show all posts
Monday, July 27, 2009
Monday, July 20, 2009
It makes Sense – Part 4: SEBI asks Mutual Funds to go light on entry
Investment in stocks has its share of risk. When I participate in the market, what is the sensible way to reduce my risk? Do good research and have a diversified portfolio. Both these need some amount of time and resources to commit. So investing in mutual funds is the next best option for me.
I know for the benefit of diversification, expertise in fund management and diversification of portfolio the AMC offers me I need to pay a price. So the funds are allowed to charge a certain management fee.
But then there is charge that the funds take from me that they call the entry load which is in the vicinity of about 2%. A good part of this goes as the commission to the distributor. I, as the investor, have no right to decide what I pay the distributor who helps me to make this investment. But when I invest in the stocks directly I can decide what I want to pay my broker. Today he charges me a very small fee of 35 to 50 basis points compared to almost 200 basis points that the fund distributor charges. In addition, the distributor gets to share a part of my return every year as the trail commission. (The rumor in the market is that sometimes these commissions get shared by some decision makers). I feel that the total effort that the broker spends on me when I buy shares in the market is much more than the effort that the fund distributor spends on me even though the ticket size of each of my transaction is much larger when I invest in funds.
The question that SEBI has now asked the AMC is precisely this. Why shouldn’t the brokerage for my distributor be decided by me? In addition it reduces the incentive that the distributor has to make me switch in and out of the funds more often. Further when the incentive to the distributor is paid for by the fund house he is not my advisor who looks after my interest; his loyalties will naturally lie with the fund house. Sometimes the poorly managed funds are able to get my investment because they have been able to influence the distributor with a more lucrative incentive.
Surprisingly it is not just SEBI who is asking question. The regulators in UK and Australia are also thinking along similar lines. In fact SEBI has advised that the new charge structure should be in place from August 2009.
The fund houses are not amused. It reduces the leverage they had with the distributors. Naturally they point out that the incentive structure is more skewed in the insurance industry where many of the insurance products are more of fund management solutions and less of insurance. But SEBI can regulate only the mutual funds. They cannot wait for the whole world to clean up before they clean their backyard. Can they?
It makes enormous sense for the investor; but not for the fund house.
I know for the benefit of diversification, expertise in fund management and diversification of portfolio the AMC offers me I need to pay a price. So the funds are allowed to charge a certain management fee.
But then there is charge that the funds take from me that they call the entry load which is in the vicinity of about 2%. A good part of this goes as the commission to the distributor. I, as the investor, have no right to decide what I pay the distributor who helps me to make this investment. But when I invest in the stocks directly I can decide what I want to pay my broker. Today he charges me a very small fee of 35 to 50 basis points compared to almost 200 basis points that the fund distributor charges. In addition, the distributor gets to share a part of my return every year as the trail commission. (The rumor in the market is that sometimes these commissions get shared by some decision makers). I feel that the total effort that the broker spends on me when I buy shares in the market is much more than the effort that the fund distributor spends on me even though the ticket size of each of my transaction is much larger when I invest in funds.
The question that SEBI has now asked the AMC is precisely this. Why shouldn’t the brokerage for my distributor be decided by me? In addition it reduces the incentive that the distributor has to make me switch in and out of the funds more often. Further when the incentive to the distributor is paid for by the fund house he is not my advisor who looks after my interest; his loyalties will naturally lie with the fund house. Sometimes the poorly managed funds are able to get my investment because they have been able to influence the distributor with a more lucrative incentive.
Surprisingly it is not just SEBI who is asking question. The regulators in UK and Australia are also thinking along similar lines. In fact SEBI has advised that the new charge structure should be in place from August 2009.
The fund houses are not amused. It reduces the leverage they had with the distributors. Naturally they point out that the incentive structure is more skewed in the insurance industry where many of the insurance products are more of fund management solutions and less of insurance. But SEBI can regulate only the mutual funds. They cannot wait for the whole world to clean up before they clean their backyard. Can they?
It makes enormous sense for the investor; but not for the fund house.
Saturday, March 28, 2009
Optimism amidst Gloom – Opportunities for Value Investment
The Capital market is always choppy and wavy, like the high seas. That is the nature of the beast. There is no moment of rest. Each trough spreads its share of gloom, negativity and suicides and each crust bring with it euphoria, splurges and binges. We have seen many across centuries; Tulip Mania of Amsterdam 1637, South Sea Bubble 1720, Wall Street Crash 1929 and again in 1987, Harshad Metha driven boom in India 1992, South East Asian melt down in 1997, internet boom and bust around the world of 2000 and now the mayhem in world financial market.
I was looking at an article that I had written in 2003, when the sentiments were down after the tech bust, 9/11 Iraq war, Enron, Worldcom and Arthur Anderson scams. The BSE Sensex was around 3000. Paul Krugman’s observation in Fortune in September 1998 that ‘never in the course of economic events-not even the early years of economic depression- has so large part of the world economy experienced so devastating a fall from grace” looked relevant in 1998, 2003 and even today.
My article was an expression of my optimism that what goes down will come back. Since then we have gone up and now come down again. The Sensex in the region of 9,000 – 10,000. At this stage I feel it is relevant to feel optimistic again. I wanted to pen my thoughts about it and I realized that I don’t need to write a new article again. Just a few edits of my old article. And that is what I have done. For the sake of convenience, continuity and a bit of wry humor, I have retained the original parts in (bracketed small font) that I have edited out and marked the additions in italics. This is how it goes.
With (war clouds looming large) the world of financial markets having experienced a worldwide melt down, the world of investment seems to be in a state of limbo. Adding to this woe has been a spate of poor corporate performance (in developed) around the world, few high profile bankruptcies and accounting scams which have literally pulled the rug from under the leg. All in all the general perception seems to be in hoarding money in cash or near cash equivalent or park in yellow metal.
Let us take a look at it from a different perspective. I believe that this is the time for investors who are looking for value opportunities. A time to pick up shares at real good value. To get some good returns in medium term you don’t have to be even adventurous in terms of investing in speculative and high risk ventures. Just look for few well established and well performing conventional companies. The chance of disappointment is really low. What gives me this confidence? The same reason the prices are down today; the uncertainty around us. It has been always seen that at times of uncertainty the investor looks for a high risk premium and it translates to a lower price for stock. This means that the investor is willing to pay a relatively lower price, compared to times when the uncertainty is low, to buy a piece of the same company. Today we are surrounded by innumerable of factors of uncertainty, which leads to depressed prices.
There is certainly a very high probability that at least some sources of this uncertainty will get sorted out in the near future. This means that general level of depression will certainly pass and this has to convert to better valuations. We have seen this in all markets at all times. Look at what happened after the Gulf war in the US market. The markets have produced above-average gains following U.S. involvement in the World Wars, the Korean War, Vietnam and the Gulf War.
From the general let me venture in to specifics. Let us look at what can be one of the winning markets for the coming year. One of the winners definitely will be the Indian Market. The factors in favor are just too many.
Indian economy in general has been on a high gear. With a GDP growth of around (5%) 6.5% in 2009 compared to an average of about (2%) 3% for the world as a whole India has been one of the fastest growing economies in the recent past. Even the projections for the coming couple of years seem to be in the same direction.
Corporate Sector in India has been performing outstandingly till last year. The current year has witnessed the aftershocks of the worldwide melt down. (When the general results from the corporate sector around the world has been filled with more bad news than good, Indian corporates have been showing a different color.) Indian companies in the earlier era of protected markets had significant inefficiencies inherent in them. Now that they have been exposed to global competition, they have tightened their belts and released significant gains. (During half year ended in September 2002 the net profit of the Indian corporate increased by more than 50%. In the third quarter ended in December 2002, the results of the major 679 companies which released their results shows that the sales has increased by 70% and net profit has increased by 15%.) CMIE expects aggregate profit after tax (PAT) of listed Indian corporates to rise by 77.3 per cent in 2009-10.The detailed analysis by CMIE is given at the bottom of this article
The foreign exchange reserves have been growing at a quicker pace. For the first time after 1978 the year 2002 showed a surplus in the current account. With more than $ 290 (72) billion in foreign exchange in September 2008 Indian government has now allowed Indian citizens to buy and own foreign assets out of their rupee earnings in India.
(The external debt situation has also reduced significantly to 21% from a peak of 39% in March 1992. This has resulted in debt service ratio improving from 27% in 1992 to 17% in 2002). As per Ministry of Finance Press Release India’s total external debt stock at end September 2008 stood at US $ 222.61 billion, which is marginally lower than the level of US $ 223.81 billion at end June 2008. The ratio of foreign exchange reserves to total external debt as at end September 2008 stood at a comfortable level of 128.6 per cent.
(Realizing the reversal in the Rs /US$ exchange rate Indian companies are today taking un-hedged US$ denominated loans.)The recent depreciation of the Rs on account some capital flight has given some jitters to such companies. In fact these companies have been lobbying to get teh accounting standards modified so that they will not have to show the marked-to-market losses in their annual report.:-)
Even infrastructure sector has improved in an encouraging fashion. The telecom cost which was one of the most expensive in the world has seen price reduction of more than 50% since the complete decontrol of this segment. Today in spite of recession it is one of the fastest growing segments in India and one of the most attractive by world standards. Roads and Ports are getting significant investment.
With so much to go for India is an excellent bet for investment in medium term. Although I have been in the Industry for a long time I am normally very conservative and very guarded. But I have very little reservation in being bullish on India in the near future.
Corporate India’s PAT to grow by 77.3% in 2009-10 - CMIE clarifies
CMIE expects aggregate profit after tax (PAT) of listed Indian corporates to rise by 77.3 per cent in 2009-10. This robust profit growth projection is based on the expectation of the petroleum products sector returning into profits from the March 2009 quarter. The losses incurred by the petroleum products sector had eaten away more than a third of the aggregate profits made by the rest of the Corporate India during April-December 2008. Benefiting from the fall in the crude oil prices, we expect the petroleum products sector to make net profits of Rs.11,225 crore in 2009-10 as against the net losses of Rs.56,533 crore estimated for 2008-09.
The aforementioned profit figures are exclusive of prior period and extra-ordinary income. CMIE always uses PAT figures exclusive of P&E as it enables meaningful inter-period comparison.
We have excluded Rs.60,967 crore received by the petroleum products companies during April- December 2008 from the government in the form of oil bonds. The oil bonds are not with respect to the sales made during the quarter in which they were received. It is a reimbursement of the loss suffered by the petroleum products companies.
We expect the petroleum products sector to show a major turnaround at the PAT (net of P&E) level in 2009-10. This will have a major bearing on the overall profit performance of Corporate India as the petroleum products sector contributes 25-30 per cent to the aggregate net sales.
Excluding the petroleum products sector, the rest of the Indian corporates (listed on Indian bourses) are expected to report a 22.7 per cent rise in aggregate PAT in 2009-10. The healthy order-book positions of the construction companies and the machinery companies are expected to help them report robust sales growth. Sharp rise in sales, softening of interest rates and fall in commodity prices, particularly metals are expected to help the construction and machinery sectors to report 40- 50 rise in PAT in 2009-10. A gamut of other sectors such as commercial vehicles, wires & cables, tyres & tubes, plastic products and polymers are also expected to benefit from the fall in input (commodity) prices and low interest rates.
Non-financial services such as hotels, health services and LNG storage & distribution are also expected to report over 20 per cent growth in PAT in 2009-10. The hotels sector witnessed a fall in income and PAT in the December 2008 quarter because of the fall in occupancy rate following the terror attack and slowdown in the global market.
We expect the sector to show an improvement in income and PAT growth in 2009-10 backed by improvement in occupancy and hike in room rates. Similarly, the health service sector is also expected to report a healthy growth in profits backed by capacity
additions and higher average revenue per customer. Doubling of capacity by Petronet LNG and the additional transmission volumes of gas from the KG basin of Reliance are expected to help the LNG storage & distribution sector report a healthy income growth in 2009-10. This coupled with the lower raw material prices is expected to help the sector to report a 47.4 per cent rise in PAT in 2009-10.
We expect the profit performance of the banking segment in 2009-10 also to be healthy. The sector is expected to report a 28.3 per cent rise in PAT owing to continuation of healthy over 20 per cent growth in credit, lower operating expenses and lower provisioning levels compared to 2008-09.
Finally, it is not unusual for Corporate India to report very high or very low profit growth. In 2002-03 and 2003-04, PAT had grown by 70.2 and 76.0 per cent, respectively. In 1994-95, PAT had more than doubled (104.2 per cent) in a single year.
I was looking at an article that I had written in 2003, when the sentiments were down after the tech bust, 9/11 Iraq war, Enron, Worldcom and Arthur Anderson scams. The BSE Sensex was around 3000. Paul Krugman’s observation in Fortune in September 1998 that ‘never in the course of economic events-not even the early years of economic depression- has so large part of the world economy experienced so devastating a fall from grace” looked relevant in 1998, 2003 and even today.
My article was an expression of my optimism that what goes down will come back. Since then we have gone up and now come down again. The Sensex in the region of 9,000 – 10,000. At this stage I feel it is relevant to feel optimistic again. I wanted to pen my thoughts about it and I realized that I don’t need to write a new article again. Just a few edits of my old article. And that is what I have done. For the sake of convenience, continuity and a bit of wry humor, I have retained the original parts in (bracketed small font) that I have edited out and marked the additions in italics. This is how it goes.
With (war clouds looming large) the world of financial markets having experienced a worldwide melt down, the world of investment seems to be in a state of limbo. Adding to this woe has been a spate of poor corporate performance (in developed) around the world, few high profile bankruptcies and accounting scams which have literally pulled the rug from under the leg. All in all the general perception seems to be in hoarding money in cash or near cash equivalent or park in yellow metal.
Let us take a look at it from a different perspective. I believe that this is the time for investors who are looking for value opportunities. A time to pick up shares at real good value. To get some good returns in medium term you don’t have to be even adventurous in terms of investing in speculative and high risk ventures. Just look for few well established and well performing conventional companies. The chance of disappointment is really low. What gives me this confidence? The same reason the prices are down today; the uncertainty around us. It has been always seen that at times of uncertainty the investor looks for a high risk premium and it translates to a lower price for stock. This means that the investor is willing to pay a relatively lower price, compared to times when the uncertainty is low, to buy a piece of the same company. Today we are surrounded by innumerable of factors of uncertainty, which leads to depressed prices.
There is certainly a very high probability that at least some sources of this uncertainty will get sorted out in the near future. This means that general level of depression will certainly pass and this has to convert to better valuations. We have seen this in all markets at all times. Look at what happened after the Gulf war in the US market. The markets have produced above-average gains following U.S. involvement in the World Wars, the Korean War, Vietnam and the Gulf War.
From the general let me venture in to specifics. Let us look at what can be one of the winning markets for the coming year. One of the winners definitely will be the Indian Market. The factors in favor are just too many.
Indian economy in general has been on a high gear. With a GDP growth of around (5%) 6.5% in 2009 compared to an average of about (2%) 3% for the world as a whole India has been one of the fastest growing economies in the recent past. Even the projections for the coming couple of years seem to be in the same direction.
Corporate Sector in India has been performing outstandingly till last year. The current year has witnessed the aftershocks of the worldwide melt down. (When the general results from the corporate sector around the world has been filled with more bad news than good, Indian corporates have been showing a different color.) Indian companies in the earlier era of protected markets had significant inefficiencies inherent in them. Now that they have been exposed to global competition, they have tightened their belts and released significant gains. (During half year ended in September 2002 the net profit of the Indian corporate increased by more than 50%. In the third quarter ended in December 2002, the results of the major 679 companies which released their results shows that the sales has increased by 70% and net profit has increased by 15%.) CMIE expects aggregate profit after tax (PAT) of listed Indian corporates to rise by 77.3 per cent in 2009-10.The detailed analysis by CMIE is given at the bottom of this article
The foreign exchange reserves have been growing at a quicker pace. For the first time after 1978 the year 2002 showed a surplus in the current account. With more than $ 290 (72) billion in foreign exchange in September 2008 Indian government has now allowed Indian citizens to buy and own foreign assets out of their rupee earnings in India.
(The external debt situation has also reduced significantly to 21% from a peak of 39% in March 1992. This has resulted in debt service ratio improving from 27% in 1992 to 17% in 2002). As per Ministry of Finance Press Release India’s total external debt stock at end September 2008 stood at US $ 222.61 billion, which is marginally lower than the level of US $ 223.81 billion at end June 2008. The ratio of foreign exchange reserves to total external debt as at end September 2008 stood at a comfortable level of 128.6 per cent.
(Realizing the reversal in the Rs /US$ exchange rate Indian companies are today taking un-hedged US$ denominated loans.)The recent depreciation of the Rs on account some capital flight has given some jitters to such companies. In fact these companies have been lobbying to get teh accounting standards modified so that they will not have to show the marked-to-market losses in their annual report.:-)
Even infrastructure sector has improved in an encouraging fashion. The telecom cost which was one of the most expensive in the world has seen price reduction of more than 50% since the complete decontrol of this segment. Today in spite of recession it is one of the fastest growing segments in India and one of the most attractive by world standards. Roads and Ports are getting significant investment.
With so much to go for India is an excellent bet for investment in medium term. Although I have been in the Industry for a long time I am normally very conservative and very guarded. But I have very little reservation in being bullish on India in the near future.
Corporate India’s PAT to grow by 77.3% in 2009-10 - CMIE clarifies
CMIE expects aggregate profit after tax (PAT) of listed Indian corporates to rise by 77.3 per cent in 2009-10. This robust profit growth projection is based on the expectation of the petroleum products sector returning into profits from the March 2009 quarter. The losses incurred by the petroleum products sector had eaten away more than a third of the aggregate profits made by the rest of the Corporate India during April-December 2008. Benefiting from the fall in the crude oil prices, we expect the petroleum products sector to make net profits of Rs.11,225 crore in 2009-10 as against the net losses of Rs.56,533 crore estimated for 2008-09.
The aforementioned profit figures are exclusive of prior period and extra-ordinary income. CMIE always uses PAT figures exclusive of P&E as it enables meaningful inter-period comparison.
We have excluded Rs.60,967 crore received by the petroleum products companies during April- December 2008 from the government in the form of oil bonds. The oil bonds are not with respect to the sales made during the quarter in which they were received. It is a reimbursement of the loss suffered by the petroleum products companies.
We expect the petroleum products sector to show a major turnaround at the PAT (net of P&E) level in 2009-10. This will have a major bearing on the overall profit performance of Corporate India as the petroleum products sector contributes 25-30 per cent to the aggregate net sales.
Excluding the petroleum products sector, the rest of the Indian corporates (listed on Indian bourses) are expected to report a 22.7 per cent rise in aggregate PAT in 2009-10. The healthy order-book positions of the construction companies and the machinery companies are expected to help them report robust sales growth. Sharp rise in sales, softening of interest rates and fall in commodity prices, particularly metals are expected to help the construction and machinery sectors to report 40- 50 rise in PAT in 2009-10. A gamut of other sectors such as commercial vehicles, wires & cables, tyres & tubes, plastic products and polymers are also expected to benefit from the fall in input (commodity) prices and low interest rates.
Non-financial services such as hotels, health services and LNG storage & distribution are also expected to report over 20 per cent growth in PAT in 2009-10. The hotels sector witnessed a fall in income and PAT in the December 2008 quarter because of the fall in occupancy rate following the terror attack and slowdown in the global market.
We expect the sector to show an improvement in income and PAT growth in 2009-10 backed by improvement in occupancy and hike in room rates. Similarly, the health service sector is also expected to report a healthy growth in profits backed by capacity
additions and higher average revenue per customer. Doubling of capacity by Petronet LNG and the additional transmission volumes of gas from the KG basin of Reliance are expected to help the LNG storage & distribution sector report a healthy income growth in 2009-10. This coupled with the lower raw material prices is expected to help the sector to report a 47.4 per cent rise in PAT in 2009-10.
We expect the profit performance of the banking segment in 2009-10 also to be healthy. The sector is expected to report a 28.3 per cent rise in PAT owing to continuation of healthy over 20 per cent growth in credit, lower operating expenses and lower provisioning levels compared to 2008-09.
Finally, it is not unusual for Corporate India to report very high or very low profit growth. In 2002-03 and 2003-04, PAT had grown by 70.2 and 76.0 per cent, respectively. In 1994-95, PAT had more than doubled (104.2 per cent) in a single year.
Friday, January 9, 2009
Devastation of world financial markets - A case of Policy Reversals in India?
The economies around the world in the last few months are trying to adjust to the neutron bomb like devastation that downed many titans of the financial market and decimated large part of the forces, both officers and the foot soldiers, all around the world. We in India have also been caught the wake of this destruction and has been exposed to a fair share of misery ourselves. This experience has since raised questions from many as to whether this is a signal that the market economy too is a failure; like the failures of communism and planned economies in the last couple of decades. For a country like ours that is struggling out of the paralyzing hold of the planned economy, the lower impact this meltdown had on our economy naturally triggered these doubts. Fanning these worries are many who enjoyed the protective cocoons, of licenses and controls we had for practically each and every economic activity ranging from manufacturing to imports and exports, which ensured profit for few at the cost of many.
I am not an expert to assess the reasons and impact of the quake that shocked the financial world. But I couldn’t help pen few thoughts that come to my mind on the issues that are being discussed among my crowd of friends.
It is in the nature of market to see cycles of growth and creative destruction. During the cycles of growth we will see extensive rallies of innovations. Many of these innovations are meant to die. Like experimental mutations of evolutionary process. The environment around test these mutations and the ones that can survive these tests precede forward in the path of evolution. As Garry Hammel has explained in ‘Future of Management’, this is one lesson we need to learn from the evolutionary process if we want to build sustaining institutions.
Some time these innovations build a momentum that takes it to ridiculous heights. If we recall, similar enthusiasm and short term orientation resulted in blowup of about 65 billion dollars in the dotcom revolution. Internet then was a new idea opening up opportunities that were not dreamed. The matrices to measure the performance were just evolving. In the meantime there was much causality. Did the internet industry die? No. The right kind of models survived. In past most of these such bubbles were localized to industry and market. Whenever new technology or new product ideas have been identified, we have seen an immediate profusion of organizations that spring up to exploit this. Most of them die and few survive to become successful players in the market. Men with showels who ventured to prospect diamonds when new continents were discovered to the number companies which were set up to manufacture electrical machinery to computers are cases in point. How many have survived till today? Very Few.
What can control this runaway acceleration is healthy governance and stronger regulatory institutions to ensure that the innovations are good for the market as whole and not just for few people. Any game would need clear set of rules and an umpire who understands the game, its rules, its compulsions and who is fair. Else, greed or muscle power or fraud will rule the game.
In the last few years we saw out of balance developments in the market in comparison to the development in regulatory mechanisms. When complex financial engineering products were being structured and marketed the credit rating institutions who are supposed to signal the true risk associated with these products failed in their duty. The pull of the unhealthy incentive structure for these agencies (where their income was derived from companies whose products are being rated by these rating agencies) distanced them away from their fiduciary responsibility leading to ratings that failed to reflect the true risk which in turn lead to mis-allocation of funds.
When such ingenious financial engineering helped US sub-prime loans to reach un-sustainable levels the bubble broke. The mere scale and spread of infected assets across the market players suddenly came to light. That took away the trust that these institutions had among them; the trust that kept the money flow between these entities.
When the inter-institutional trust evaporated the absence of such well structured markets were exacerbated. This squeezed flow of money in the international money markets. The pumps that pressured the flow were no more primed sufficiently. It was this flow that provided the lubrication for the economy to work. And the sudden drying of the money market seized many of the moving parts of the real economy.
Financial markets can be compared to the circulatory system in a body (the other industry segments may be compared to different organs of the body). In an integrated world the infection in the circulatory system spread very fast and wide and it had its impact even in India although there has been no build up of toxic assets in India. The drying up of the western money markets added pressure on the international investors who had invested in India and the Indian corporate who had exposure to international money market which contributed to selling pressure in Indian stock market and a credit squeeze in Indian Money market.
Governments realized the magnitude of this disaster and the need for immediate action. They quarantined the infected, separated toxic assets and pumped in liquidity. Like the doctor taking series of actions to contain the infection and suggesting a life style of extreme moderation till recovery to normal health. It also suggested the need of disciplined life.
But this no way suggests the ossified existence of a vegetating economy with a permanent freeze on any innovation and experimentation. I don’t think the governments of US and Europe that came in with a bailout package, plan to permanently run these as nationalized institutions frozen permanently into a mummified existence. They wanted to contain the mess, doctor them to health and put them back to the competitive pressures of the evolution process. If we look a bit cynically, this is in a way similar to Buffet pumping funds to Goldman Sachs and buying controlling stake really cheap. I am sure both these parties are going to be better off from these transactions once the tide has turned and will not be saddled with unproductive and unresponsive companies to run. I am not suggesting that the intention of the interventions was profits; it was primarily stabilizing the rocking boat. But the process and the expected outcome is going to be similar.
The failure that we witnessed in the market and the governmental interventions even in the developed countries seem to spur pressure on the policy makers in our country to revert back to more government control of business. Let us for a second look back at what the prevailing situation was in our country before started our journey towards liberalized market economy.
The Indian manufacturing was protected from both internal and external competition. Import restrictions and high import tariffs protected them from external competition. The government licensing system, coupled with the MRTP removed any incentive for innovation or even providing quality product, customer service or improvement of product features. The history of our automotive industry is a classical case in point. India commenced production of motor cars in 1957 ; Toyota commenced production of cars in 1937 and Honda motor company of Japan commenced production of cars in 1963. For the next four decades we produced the same car, sold it at ridiculously high prices and the buyer had to wait for months after placing an order after paying an advance. In the meantime the Toyota and Honda established as world leaders in automotive industry. This is not something that was unique to automotive industry. Each and every Industry in our country from blades to cement to pharmaceuticals has the same story.
Banking and financial services industry was no better. Customers of the banks, instead of being serviced were made to feel like mendicants asking for alms. Stock market was a closed club of brokers with the interest of the investor always coming last.
What did it mean to Indian Economy? India was never regarded as place where anything was happening. The slow growth rate of around 3% was considered the characteristic Hindu rate of growth. The consumer had no options for any new products. The job opportunities were limited. Few connected industrialists made all the money by cornering licenses, sharing the booty with the political bosses who were also able to exploit this state of affairs by attracting the patronage of masses who were living in a world of shortages.
Since we gradually moved towards a liberalized economy we have now established ourselves as a place where things do happen. There is a feeling of widespread optimism that we are on a path of real development and not in a spiral of poverty.
Let the nostalgia or the convoluted interpretations of the happenings around blind us to the history. But let us use this as an opportunity to learn from these mistakes and strengthen our institutions so that the momentum we built is not extinguished.
I am not an expert to assess the reasons and impact of the quake that shocked the financial world. But I couldn’t help pen few thoughts that come to my mind on the issues that are being discussed among my crowd of friends.
It is in the nature of market to see cycles of growth and creative destruction. During the cycles of growth we will see extensive rallies of innovations. Many of these innovations are meant to die. Like experimental mutations of evolutionary process. The environment around test these mutations and the ones that can survive these tests precede forward in the path of evolution. As Garry Hammel has explained in ‘Future of Management’, this is one lesson we need to learn from the evolutionary process if we want to build sustaining institutions.
Some time these innovations build a momentum that takes it to ridiculous heights. If we recall, similar enthusiasm and short term orientation resulted in blowup of about 65 billion dollars in the dotcom revolution. Internet then was a new idea opening up opportunities that were not dreamed. The matrices to measure the performance were just evolving. In the meantime there was much causality. Did the internet industry die? No. The right kind of models survived. In past most of these such bubbles were localized to industry and market. Whenever new technology or new product ideas have been identified, we have seen an immediate profusion of organizations that spring up to exploit this. Most of them die and few survive to become successful players in the market. Men with showels who ventured to prospect diamonds when new continents were discovered to the number companies which were set up to manufacture electrical machinery to computers are cases in point. How many have survived till today? Very Few.
What can control this runaway acceleration is healthy governance and stronger regulatory institutions to ensure that the innovations are good for the market as whole and not just for few people. Any game would need clear set of rules and an umpire who understands the game, its rules, its compulsions and who is fair. Else, greed or muscle power or fraud will rule the game.
In the last few years we saw out of balance developments in the market in comparison to the development in regulatory mechanisms. When complex financial engineering products were being structured and marketed the credit rating institutions who are supposed to signal the true risk associated with these products failed in their duty. The pull of the unhealthy incentive structure for these agencies (where their income was derived from companies whose products are being rated by these rating agencies) distanced them away from their fiduciary responsibility leading to ratings that failed to reflect the true risk which in turn lead to mis-allocation of funds.
When such ingenious financial engineering helped US sub-prime loans to reach un-sustainable levels the bubble broke. The mere scale and spread of infected assets across the market players suddenly came to light. That took away the trust that these institutions had among them; the trust that kept the money flow between these entities.
When the inter-institutional trust evaporated the absence of such well structured markets were exacerbated. This squeezed flow of money in the international money markets. The pumps that pressured the flow were no more primed sufficiently. It was this flow that provided the lubrication for the economy to work. And the sudden drying of the money market seized many of the moving parts of the real economy.
Financial markets can be compared to the circulatory system in a body (the other industry segments may be compared to different organs of the body). In an integrated world the infection in the circulatory system spread very fast and wide and it had its impact even in India although there has been no build up of toxic assets in India. The drying up of the western money markets added pressure on the international investors who had invested in India and the Indian corporate who had exposure to international money market which contributed to selling pressure in Indian stock market and a credit squeeze in Indian Money market.
Governments realized the magnitude of this disaster and the need for immediate action. They quarantined the infected, separated toxic assets and pumped in liquidity. Like the doctor taking series of actions to contain the infection and suggesting a life style of extreme moderation till recovery to normal health. It also suggested the need of disciplined life.
But this no way suggests the ossified existence of a vegetating economy with a permanent freeze on any innovation and experimentation. I don’t think the governments of US and Europe that came in with a bailout package, plan to permanently run these as nationalized institutions frozen permanently into a mummified existence. They wanted to contain the mess, doctor them to health and put them back to the competitive pressures of the evolution process. If we look a bit cynically, this is in a way similar to Buffet pumping funds to Goldman Sachs and buying controlling stake really cheap. I am sure both these parties are going to be better off from these transactions once the tide has turned and will not be saddled with unproductive and unresponsive companies to run. I am not suggesting that the intention of the interventions was profits; it was primarily stabilizing the rocking boat. But the process and the expected outcome is going to be similar.
The failure that we witnessed in the market and the governmental interventions even in the developed countries seem to spur pressure on the policy makers in our country to revert back to more government control of business. Let us for a second look back at what the prevailing situation was in our country before started our journey towards liberalized market economy.
The Indian manufacturing was protected from both internal and external competition. Import restrictions and high import tariffs protected them from external competition. The government licensing system, coupled with the MRTP removed any incentive for innovation or even providing quality product, customer service or improvement of product features. The history of our automotive industry is a classical case in point. India commenced production of motor cars in 1957 ; Toyota commenced production of cars in 1937 and Honda motor company of Japan commenced production of cars in 1963. For the next four decades we produced the same car, sold it at ridiculously high prices and the buyer had to wait for months after placing an order after paying an advance. In the meantime the Toyota and Honda established as world leaders in automotive industry. This is not something that was unique to automotive industry. Each and every Industry in our country from blades to cement to pharmaceuticals has the same story.
Banking and financial services industry was no better. Customers of the banks, instead of being serviced were made to feel like mendicants asking for alms. Stock market was a closed club of brokers with the interest of the investor always coming last.
What did it mean to Indian Economy? India was never regarded as place where anything was happening. The slow growth rate of around 3% was considered the characteristic Hindu rate of growth. The consumer had no options for any new products. The job opportunities were limited. Few connected industrialists made all the money by cornering licenses, sharing the booty with the political bosses who were also able to exploit this state of affairs by attracting the patronage of masses who were living in a world of shortages.
Since we gradually moved towards a liberalized economy we have now established ourselves as a place where things do happen. There is a feeling of widespread optimism that we are on a path of real development and not in a spiral of poverty.
Let the nostalgia or the convoluted interpretations of the happenings around blind us to the history. But let us use this as an opportunity to learn from these mistakes and strengthen our institutions so that the momentum we built is not extinguished.
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