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"!!