lemmings, the sea and going green

Anything about economics and you are already in a twist. How do you start the article. No two economists agree and the same economist over different time frames would not agree with his earlier view!! Why is this? Very interesting..

Lets rewind to the 90's when the Yen made a sudden gain against the dollar and was marching relentlessly upwards. This was so because of the continuous flow of dollars to japan due to the BOP between japan and the US. The mishandling of the inflows by sucessive japanese governments in not deflating the explosive growth (like what dr yv reddy in india tried to do for which the FM saw to it that the country didnt get a well deserved extension of his tenure) saw them caught in a serious economic twist - on one side the Yen was rising very very fast and on the other threatening to blow all the asset bubbles in japan sky high. As a student of economics at that time i had predicted that the best gains that the japanese could do was to allow the Yen to rise in a measured and managed manner, use a portion of the forex reserves to recapitalise banks for the losses suffered in the asset bubble and make their homegrown MNC's shift to other countries like India or similar countries wherein the balance of their forex reserves could be used to gain political and economic benefits besides securing their investments. Additional spin off benefits is that the country they choose to shift to would have become part of their domestic consumption story as well!!

Instead of the above we now have the famous lost decade of Japan.

When a currency fluctuates 40-60% as the Yen did more than 12 years back, it does become very difficult to manage the effects of this on the local economy and mainly on asset prices. The net effect is that today after all these years the Yen is back up to a high of 87 (currently at 93 -20/7/09) and the forex reserves have accumulated to gigantic proportions which if used now would only furthur increase the relative strength of the Yen vis a vis the dollar.

It is still not late for the Japanese governement to use a sizeable portion of these funds to go through another round of deflation in their country with a target of 45-50 yen / dollar over the next decade. This should effectively end all chances of a surplus BOP with the US or any other nation for that matter and at the same time their continuous selling of these reserves to meet local social needs would also help them smoothen out the process of deflation. Radical but then these tough times need tough decisions.

Economists would argue the damage that deflation does to businesses - but we are not talking of a closed system here - Japan by virtue of the investments made abroad - lets say in INR would continue to keep its businesses alive - tax them and at the same time keep selling the dollar to manage the currency rates besides providing the liquidity within the country till such time the natural forces of economics display acceptable self perpetuating tendencies.

The above might actually help a nation like India/ China/ Brazil etc as they can affectively employ their teeming populations/ get their SEZ's functioning and create demand locally with all the extra disposable income sloshing around. The demand that the japanses make on the country accepting their investment is to show a deflation in population growth !!

Time of policy makers to put their thinking caps on!!

Personally would you vote for deflation or inflation. With the extra angle that high cost items will have lower to nil demand i think deflation is the best as we also get to save the environment - as the net result of the nay sayers arguments to deflation is that only needs will be compulsarily bought !!

so instead of being lemmings and being all at sea, i think we can also do with a dose of deflation and going green. A stronger rupee in the medium to longer term wouldnt hurt as well!!

PS: note on lemmings - they dont commit suicide by falling into the sea - they just migrate by swimming across the sea - of course as they dont know where the next land is and hence most of them die due to exhaustion.

central clearing - derivatives

following up on my post of 19th march - the basel committee recommendations on risk capital requirements are already getting diluted.

the january recommendations required a direct capital adequacy for each derivative/ cdo etc. (similar to what mr yv reddy did to deflate the real estate bubble in india). however revised guidelines issued last week has removed this more onerous requirement with the following:

a) banks will test their portfolio for predetermined stresses.

b) valuation of their portfolio will be based on their own methods. (ties in beautifully with fair value of IFRS - refer march 5th blog entry)

c) only when the banks internal assessment of one year confidence levels for the "valued" portfolio is less than 99.9% will they need to provide the CAR else no need to allocate risk capital.

this directly reopens the door for a gaussian copula and another Li to emerge and lay waste this diluted apology of an offering from the basel committee on banking supervision.

like i said earlier - the more the things change - the more they remain the same...

the next default will be by the central clearing house as all its members will be bankrupt and the various governments will now save these clearing houses - after all the banks have learnt their lesson - they are not the ones standing in line for tarp this time around.. jai ho!!

illegal v legal

the US AG is to set up a special prosecutor to look into the allegation that CIA operatives illegally tortured terrorist suspects. i am wondering then - is there a legal torture? if so can somebody provide the blow by blow procedure of that?!! no pun intended..

too big to fail

The outpouring of angst against the companies that were helped by the various bailouts over the world has a basic theme - governments are scared what a failure would do to the system.

Let us look at the indian example:

whenever there was some excess or lax oversight leading to a failure there has been some sort of government intervention. let us look at a few of them - UTI us64 scheme, global trust bank and ICICI bank.

the uti scandal was an inflextion point for crisis management as far as the government goes - the lessons learned there and later on in the global trust bank case has stood the govt in good stead later on during the icici fiasco.

lessons learnt in uti:

1. it was an oversight failure

2. thought not explicit it was implied that the said scheme was a govt backed scheme - hence your money wouldnt sink - nobody in its more than 3 decades of existance made a strong case that it wasnt the case!!

the government considering its moral obligation and also aided to a large extent by the affected population closed down the scheme - transferred the assets to a new administered scheme - with an option to the investors to get out immediately at a loss of 40%, or stay invested and hope to recover their money as the scheme does well in future.

compare the above to what the so called capitalist nations are doing with their "failed financial institutions" - keeping them alive and printing new funds so that they can continue as if nothing has changed!!

the gtb case - the bank had overextended housing and securities backed loans to their customers and after the dot com crash followed by the real estate crash - their collaterals fell in value below the value of the loans extended thus wiping out their net worth!! the govt took its own sweet time in deciding how to deal with the issue at hand before finally merging it with another bank. the interim created a state of panic as a lot of counterparties to gtb had their credit limits frozen and many businessess couldnt operate.

the icici case - more recently there were rumours that icici bank was bankrupt. this led to the first combined official denial (anybody familiar with govt functioning knows that an official denial is an offical acceptance of the denied fact!!) by the top brass of the bank, the RBI and also the FM. though technically they werent bankrupt - they had a severe liquidity issue arising out of the lehman collapse and other related counterparties which threatened their very survival. the RBI worked swiftly in the background to thrash out a compromise so that the bank may be saved.

the mechanics of the deal :

1. rbi had to finance the bank to meet its immediate obligations (political directive)

2. kamat had to go as he had outlived his "usability" (he was a major tool used by the government to "direct" financing to companies who were favourable to the ruling class alongwith idbi, ifci, lic etc etc) (ms kochar's condition to be the new head)

3. lay down parameters for the help given. (rbi's clause)

the parameter laid down by the rbi was to close down the incentive struture as it existed till then - pay employees for the loans disbursed and not for the loans collected!!

- settle all derivative deals under dispute with bank customers

- no new accretion to the loan portfolio till the funds advanced by the RBI are returned in full etc etc

as it turned out just these measures with the apparant blank cheque of the rbi worked wonders and within a span of 3 months icici was out of its mess. (of course all the cheap money policy of the rbi also helped buy time)

the handling of the icici issue was done most commendably without any panic spilling onto the streets.

the method to be adopted in the US was the one used in uti (as it was bankrupt) unlike for icici which wasnt bankrupt but temporary mismatch in cash flows almost brought down the bank to its knees.

for the US government to treat aig, gs, ml etc like icici and not like uti speaks of the lowest form of crony capitalism and sends a signal that "gamble all that you want - just make sure that "you are too big to fail"!!

SBIn - the Ye(N) drops

Amongst the many last acts that the outgoing congress government did before the last elections was the announcement of the merger of SBIn and SBI. Under the grand scheme of things this innocuous thing actually was to wash away the various acts of omission and commision that was indulged in at the behest of the politicians by the erstwhile management of the SBIn. After all who will question what was a standard procedure to cut costs when a subsidiary is merged with its parent?

Now let us look at some of the actions that prompted this move.

1. this bank was the unofficial treasurer of the UPA government aka private banker.

2. main job during election to see that cash levels for party functionaries never run dry - this is where a bank comes in handy - a bank can always move large amounts of cash without questions and that too under protection!!

3. during the past 5 years the bank helped the UPA in moving vast amounts of money in and out of the country and across the length and breadth of the country through the extensive use of LC's, factoring, credit backed lending, derivatives, other non fund based limits etc. One just has to look at the long list of companies headquartered out of Indore that have suddenly made it BIG !! (the only previous parallel was when SBSaurashtra was merged with SBI - then too a lot of local companies made it BIG{ This is the TRUE trickle down effect!!} - but then thats a different story)

This is a dangerous trend as this the first time that a banking apparatus has been widely used for election purpose. Now under the guise of a slowdown in the economy it would be interesting to see how many of these companies that made it BIG ask for restructuring of loans/ credit limit expansions etc. Also what percentage of the provisions for bad debts by SBI in the next year BS result out of the loan portfolio carried over from SBIn.

AI and JUGAAD

The most recent example of JUGAAD is what transpired in AI179 on May5th. They actually did a Local ie they carried more passengers than there were seats by seating a passenger in the extra co-pilots seat and 2 others in the jump seats meant for the staff next to the doors. This of course is afoul of security and DGCA regulations - but then lets just look at this clinically.

The other option was for offering to compensate some passenger for voluntary deboarding. Instead the logic used by the pilot was to accomodate these passengers in seats other wise valid (just not earmarked for passengers!!). This is the JUGAAD which in my opinion saw the matter resolved without any tension to any passenger. Of course if this were to become routine then it raises security issues as of course you cant have anybody in the cockpit other than the pilots!! A one off JUGAAD like this will of course lead to some rejig in the preflight checklist and maybe some serious censure of the officials concerned with the happenings on in AI179 but then frankly I dont think the technical integrity of the flight was ever in doubt as most of the news channels would like you to believe!!

Those extra seats are there and if people were sitting in those seats i dont see any technical threat - yes the issues of violating rules and security measures still remain - but then whats a little bit of Jugaad if you cant streatch the limits of the rules!!