Triumphant return of John M Keynes

It is imperative that we not just respond adequately to the current crisis but undertake the long-run reforms that will be necessary if we are to create a more stable, more prosperous and equitable global economy, says Joseph E Stiglitz

WE ARE all Keynesians now. Even the right in the United States has joined the Keynesian camp with unbridled enthusiasm and on a scale that at one time would have been truly unimaginable. For those of us who claimed some connection to the Keynesian tradition, this is a moment of triumph, after having been left in the wilderness, almost shunned, for more than three decades. At one level, what is happening now is a triumph of reason and evidence over ideology and interests. Economic theory had long explained why unfettered markets were not selfcorrecting, why regulation was needed, why there was an important role for government to play in the economy. But many, especially people working in the financial markets, pushed a type of ‘market fundamentalism’. The misguided policies that resulted — pushed by, among others, some members of US President-elect Barack Obama’s economic team — had earlier inflicted enormous costs on developing countries. The moment of enlightenment came only when those policies also began inflicting costs on the US and other advanced industrial countries. Keynes argued not only that markets are not self-correcting, but that in a severe downturn, monetary policy was likely to be ineffective. Fiscal policy was required. But not all fiscal policies are equivalent. In America today, with an overhang of household debt and high uncertainty, tax cuts are likely to be ineffective (as they were in Japan in the 1990s). Much, if not most, of last February’s US tax cut went into savings. With the huge debt left behind by the Bush administration, the US should be especially motivated to get the largest possible stimulation from each dollar spent. The legacy of underinvestment in technology and infrastructure, especially of the green kind, and the growing divide between the rich and the poor, require congruence between short-run spending and a long-term vision. That necessitates restructuring both tax and expenditure programmes. Lowering taxes on the poor and raising unemployment benefits while simultaneously increasing taxes on the rich can stimulate the economy, reduce the deficit, and reduce inequality. Cutting expenditures on the Iraq war and increasing expenditures on education can simultaneously increase output in the short and long run and reduce the deficit. Keynes was worried about a liquidity trap — the inability of monetary authorities to induce an increase in the supply of credit in order to raise the level of economic activity. US Federal Reserve chairman Ben Bernanke has tried hard to avoid having the blame fall on the Fed for deepening this downturn in the way that it is blamed for the Great Depression, famously associated with a contraction of the money supply and the collapse of banks. And yet one should read history and theory carefully: preserving financial institutions is not an end in itself, but a means to an end. It is the flow of credit that is important, and the reason that the failure of banks during the Great Depression was important is that they were involved in determining creditworthiness; they were the repositories of information necessary for the maintenance of the flow of credit. BUT America’s financial system has changed dramatically since the 1930s. Many of America’s big banks moved out of the ‘lending’ business and into the ‘moving business’. They focused on buying assets, repackaging them, and selling them, while establishing a record of incompetence in assessing risk and screening for creditworthiness. Hundreds of billions have been spent to preserve these dysfunctional institutions. Nothing has been done even to address their perverse incentive structures, which encourage shortsighted behaviour and excessive risk taking. With private rewards so markedly different from social returns, it is no surprise that the pursuit of self-interest (greed) led to such socially destructive consequences. Not even the interests of their own shareholders have been served well. Meanwhile, too little is being done to help banks that actually do what banks are supposed to do — lend money and assess creditworthiness. The federal government has assumed trillions of dollars of liabilities and risks. In rescuing the financial system, no less than in fiscal policy, we need to worry about the ‘bang for the buck’. Otherwise, the deficit – which has doubled in eight years – will soar even more. In September, there was talk that the government would get back its money, with interest. As the bailout has ballooned, it is increasingly clear that this was merely another example of financial markets mis-appraising risk – just as they have done consistently in recent years. The terms of the Bernanke-Paulson bailouts were disadvantageous to taxpayers, and yet remarkably, despite their size, have done little to rekindle lending. The neo-liberal push for deregulation served some interests well. Financial markets did well through capital market liberalisation. Enabling America to sell its risky financial products and engage in speculation all over the world may have served its firms well, even if they imposed large costs on others. Today, the risk is that the new Keynesian doctrines will be used and abused to serve some of the same interests. Have those who pushed deregulation ten years ago learned their lesson? Or will they simply push for cosmetic reforms — the minimum required to justify the megatrillion dollar bailouts? Has there been a change of heart, or only a change in strategy? After all, in today’s context, the pursuit of Keynesian policies looks even more profitable than the pursuit of market fundamentalism! Ten years ago, at the time of the Asian financial crisis, there was much discussion of the need to reform the global financial architecture. Little was done. It is imperative that we not just respond adequately to the current crisis, but that we undertake the long-run reforms that will be necessary if we are to create a more stable, more prosperous and equitable global economy.

(The author, professor of economics at Columbia University, is recipient of the 2001 Nobel Prize in Economics)

(Source: Economic Times)

Who will let the dollar go down?

Asian economies have to creatively invest their resources in productive activities instead of parking them in US treasuries. That’s the only way Asia can bring the world economy out of recession, says Neeraj Kaushal.
IN THE United States, half a million jobs evaporated last month, over 1.2 million were lost in the last three months. Businesses are closing down every day. Banks are afraid to lend, credit market continues to be tight. Consumer confidence is dwindling. Most forecasts suggest that the US gross domestic product will decline by 4% to 5% on an annualised basis in fourth quarter of 2008, and the economy will continue to experience a decline in GDP in 2009. Every expert and non-expert has declared that the US economy is in the worst recession since the 1929 Great Depression. But the US dollar is unfazed; it continues to enjoy strong confidence in a world economy shaken by financial turmoil. The greenback is getting stronger every day just as the US economy is plunging deeper into recession. Since August, the dollar has appreciated 17% against the rupee, 23% against the euro, and 34% against the British pound. Couple of weeks ago, the dollar strengthened somewhat even against the Chinese currency, renminbi. News reports suggest that the recent decline in export orders is putting pressure on the Chinese government to allow the renminbi to depreciate against the dollar — by five or even 10%. Dollar’s resurgence is a puzzle when compared with how currencies of other countries collapsed in national or regional financial crises in the past two decades. The Argentine peso depreciated 75% against the US dollar during the Argentine economic and financial crisis during 1999-2002. In the 1994 Mexican peso crisis, the Mexican currency fell 55% against the dollar. During the 1997 Southeast Asian financial turmoil, Thai bhat, Indonesian rupiah, Korean won experienced huge depreciations as did the currencies of Malaysia, the Philippines and other Southeast Asian economies. Financial crises in these countries not only caused substantial depreciations of their currencies, but also flight of foreign, and sometimes even domestic, capital. So far there is no shine off the value of the dollar, nor any major flight of foreign capital from American shores. What’s with the greenback? Against all odds, how has it regained in the past four months what it lost against most currencies in the previous three years? Clearly, the dollar has benefited from the fact that it continues to be the international currency of exchange, trade and reserve. The strengthening of the dollar is also helped by the fact that Japan and the economies of the euro zone are as deeply sunk in recession as is the American economy and growth in China and India is projected to be lower than it had been in the previous few years. Most of all, fright in world financial markets has sent investors running away from risky assets towards the US dollar and US treasury bonds. In the worst financial crisis since the Great Depression, the dollar has regained almost half of what it lost in the past six years. Consequently, American businesses are becoming less competitive as compared to foreign businesses. This will dampen demand for American exports and increase its imports. American multinational corporations will also find that returns to their investments abroad decline, when expressed in dollars. American travellers, who have suffered erosion in their purchasing power abroad during the past seven years will, however, benefit from the current strengthening of the greenback. HOW will the dollar fare once the full impact of the US government’s $700-billion bailout package becomes known is not clear. Will investors start shunning US treasury bonds once they realise the full import of US fiscal deficit? Will foreign investors’ confidence in the US economy fade with the prospects of its future economic growth? If the answer to these questions is yes, then it is clear that the ‘global’ economic recession has not yet led to the much needed correction in the global financial system. While the world economy is looking towards Asia, in particular China and India, for economic growth in the coming five years, Asian economies in turn depend heavily on US consumers. The recent depreciation of the Chinese yuan, said to be triggered by the slackening of export orders, is an indicator. A weak Chinese currency is expected to keep US demand for Chinese goods buoyant, while the recession in the US would dampen it. However, if the US economy remains in a prolonged recession, it would be foolish to expect that somehow the US would continue to increase its purchase of goods from the rest of the world to keep the world economy going, and it would be foolish and even dangerous to keep financing American imports through debt. If China continues to use its reserves to prop up the dollar, it will seriously weaken its own position and reduce its policy options. Any future dollar depreciation would only result in a decline in the value of Chinese reserves. China can keep its economy growing at double digits by using its $2 trillion reserves to bring prosperity to its people, by creating more jobs and paying workers higher salaries. China can also provide its own people consumer goods at low prices, same as it has been doing for American consumers for decades. China can redeploy its reserves to increase investment in other Asian economies. The Chinese government has announced a $600-billion initiative to boost its economy over the next two years. The boost constitutes 14% of China’s GDP, and can help China maintain its potential economic growth even with slackening of US imports. According to the most recent forecast of the world economy by the International Monetary Fund, advanced economies will experience almost a one percentage point reduction in their GDP in 2009. It is clear from these forecasts that world economic growth in the next two to three years would heavily depend on Asian economies. Asian economies have to creatively invest their resources in productive activities instead of parking them in US treasuries. That’s the only way Asia can bring the world economy out of recession.

(The author teaches at Columbia University)

(Source: Economic Times)

Looking at the jungle for some succour

By R A J R I S H I S I N G H A L
THE markets have always been fascinated by animals. Time and again, innovative market players have delved into the animal kingdom for inspiration on new products. Whenever, capital market players, especially those in the bond market, have come up with new products, and were faced with the prospect of naming the newer beast, they found inspiration from animal names. The time may have come again to look to the jungle for some respite. The fascination with quadrupeds began with investment banks venturing into the government securities market. These banks would buy US government treasury bonds, put them into an escrow account and re-create instruments derived from these bonds. The interest payout on the original bond would be used to create new bonds. Typically, these instruments would be issued at a deep discount to their face value and investors would receive the face value at maturity, the difference being the implied interest rate.

These bonds were issued mostly between 1982 and 1986. Merrill Lynch — recently taken over by Bank of America — floated TIGRs, or Treasury Investors Growth Receipts. Similarly, Lehman Brothers, which went bankrupt and had to be shut down floated LIONs, or Lehman Investment Opportunity Notes. Not to be outdone, Salomon Brothers invented CATS, or Certificates of Accrual on Treasury Receipts. Predictably, the market referred to these bonds collectively as “felines”. In the past, Indian MFs also took a stab at launching new fund offers with similar names. For example, DSP Merrill Lynch had floated a new scheme called the TIGER fund, which was an acronym for The Infrastructure Growth and Economic Reforms Fund. ING Bank’s local mutual fund arm floated LION Fund, which expanded into the slightly contrived and convoluted Large-cap, Intermediate-cap Opportunities New Offerings Fund. Recently, insurance companies, stung by the colossal damage claims arising out of storms, hurricanes, typhoons, earthquakes and other similar natural calamities, came up with CAT bonds, which are different from the ones floated by Salomon Brothers. These are a short form for “catastrophe bonds”. Insurance companies float these specialised bonds to transfer their risk to the broader capital market. Typical investors include hedge funds and dedicated catastrophe-oriented funds. Given the upheaval in the world markets — called by various people a calamity, catastrophe or a cataclysm — this might be the right time to launch some more “animal” bonds to revive investor interest. Here are some of the mythical beasts.

DOG: Expanded they stand for — pardon the expression — Dump On Government. These are bonds issued by all kinds of special investment vehicles which may or may not have any underlying assets. In case the issuer stops paying interest, the government will be obliged to buy them back.

GOAT: Government Offering for Actual Trading, instruments primarily designed for Indian markets. These are paper issued by the government in lieu of all its payments — subsidy, tax refunds, bank recapitalisation, et al — which can then be traded on the market. This one feature will be the big, big difference. The current lot of bonds — issued to oil companies to make up for the shortfall between cost and market prices, and banks for sterilising dollar purchases, fertiliser companies — cannot be traded on the market and has left treasury heads of all these companies and banks in a quandary.

VIPER: These will be a genre of paper in the manner of “catastrophe” bonds, but issued for insuring disaster in the financial sector, instead of natural mishaps. Called Voucher In Place Exceptions Regretted, these bonds will help insurance companies provide cover against the next generation of banks, which issue exotic derivatives, going kaput.

COBRA: These instruments — Collateral Based on Reducing Assets — will be designed for subscription by conglomerates, especially those which need tax breaks. Imagine a holding company with investments spread across a large number of companies. This portfolio could also include minority interest joint ventures. In such cases where the minority interest company is making a loss, the holding company is unable to take the benefit of a tax write-off. This bond allows the holding company to do that.

CHEETAH: You’ve heard of NINJA — No Income No Jobs or Asset — loans provided to sub-prime borrowers. When the next spell of easy money rolls around — and you can bet your shirt that it will, given the kind of liquidity being pumped in daily by the world’s central banks — the same kind of loan can be rolled off the assembly line, albeit with a different name: Childless, Earning-Exempted, Totally Assetless Homes.

LAMB paper: As soon as Lehman went bust, the impact was felt on all those holding paper issued by the investment bank. The current credit crisis was sparked off when one money market mutual fund woke up one Monday morning and found its asset value wiped out. But, there might be a contrarian — and intrepid — vulture investor, or even a former Lehman trader, who might find some residual value in some of that paper.

Source : Economic Times

We’re all for public ownership now

THIS is a time for rescues of financial systems everywhere. Britain’s plan is considered especially bold. Under the plan, the UK government will inject up to £50 billion in capital into eight of Britain’s largest banks and building societies.

In the first step, the UK has injected £37 billion into three banks. This will give it a 60% stake in one bank and a 40% stake in two banks that are undergoing a merger. The UK government plans to have its directors on the boards of these banks — just when the Raghuram Rajan committee wants the Indian government to exit its own. There appears to be no escape from public ownership of banks in the US as well as Europe. Nothing else will restore confidence in the banking system. Most people accept this. But they also say that public ownership should be a temporary affair. Why so? Because, it is said, public ownership of banks makes them prone to failure. Governments will feel obliged to save them and the costs are borne by the exchequer. This is an astonishing statement to make — and not just because of private bank failures in the present crisis.

Economies worldwide have gone through the same thing over the past several decades. Private banks fail, the government recapitalises them, later restores them to private ownership. Banking failures are costly. They impose recapitalisation costs in the range of 5-45% of GDP. And yet there is a presumption that public ownership alone imposes fiscal costs. There is one distinguished exception to the story of banking failures in recent decades: the Indian banking system. In 1992-93, India opted to retain public sector dominance in banking. The government provided public sector banks (PSBs) with $5 billion in capital — a pittance compared to the sums being talked about now. These two decisions have contributed to stability in Indian banking. Public sector dominance is not the only factor: sound macroeconomic management and strong regulation have helped. But it is certainly a key factor. Seeing the plight today of the nation’s largest private bank, one shudders to think of what might have been, had public ownership been absent.

Critics say this may be true but we have paid a heavy price for stability. The banking system is hugely inefficient. The RBI Report on Currency and Finance(2006-08), which focuses on the Indian banking sector, squarely addresses this criticism. This is a monumental study, bringing to bear on the entire gamut of policy issues a vast body of research. Let me highlight its key findings on ownership and efficiency in Indian banking. One, efficiency in Indian banking has improved, especially since 2001-02, going by several accounting measures. Two, the Indian banking sector compares favourably with banks in both developed and emerging markets on most performance indicators. Three, using economic measures of efficiency, “ownership has no definite relationship with efficiency”.

How is it that the Indian experience defies the conventional wisdom that private ownership is superior? There are good reasons. Typically, state-owned enterprises (SOEs) run out of steam because the state’s finances are in a mess and the state is unable to provide capital. These firms are then sold to private (often foreign) owners who bring in capital. Academics compare the performance of firms in years when they were starved of capital under government ownership with performance following the infusion of capital. They find an improvement in performance. They conclude it is privatisation that made the difference. Not many economies have experimented with serious public sector reform: allowing SOEs to raise capital by going public; ushering in improvements in governance; and allowing SOEs to compete with private firms. India has done all of these. The improvements are there for all to see. India’s somewhat unique approach to the issue of public ownership has paid off richly.

Enterprise reform has been complemented by strong regulation. Former RBI governor Y V Reddy has received well-deserved plaudits for his management of monetary policy and exchange rates in the face of a surge in foreign inflows. His contributions towards bank regulation were as substantial. Their value is beginning to be grasped in today’s turbulent conditions. During Dr Reddy’s tenure, the RBI unveiled separate roadmaps for private ownership of banks and for foreign banks in India. These served to ensure that neither private bank nor foreign bank expansion happens in ways that undermine stability in Indian banking. Dr Reddy was roundly criticised for overprotecting the public sector. The Percy Mistry report of 2007 asked that all PSBs be privatised. The Rajan committee wants selective privatisation of PSBs. How ironical that close on the heels of these reports, we should be seeing a world-wide embrace of public ownership in banking even if under duress!
(Author T T RAM MOHAN)

(Source Economic Times)

Don’t Cry For Me, America

The US recession will be severe, but not devastating
Paul Krugman
Princeton: Mexico. Brazil. Argentina. Mexico, again. Thailand. Indonesia. Argentina, again. And now, the United States. The story has played itself out time and time again over the past 30 years. Global investors, disappointed with the returns they’re getting, search for alternatives. They think they’ve found what they’re looking for in some country or other, and money rushes in.

But eventually it becomes clear that the investment opportunity wasn’t all it seemed to be, and the money rushes out again, with nasty consequences for the former financial favourite. That’s the story of multiple financial crises in Latin America and Asia. And it’s also the story of the US combined housing and credit bubble. These days, we’re playing the role usually assigned to third-world economies.

For reasons to be explained later, it’s unlikely that America will experience a recession as severe as that in, say, Argentina. But the origins of our problem are pretty much the same. And understanding those origins also helps us understand where US economic policy went wrong.

The global origins of our current mess were actually laid out by none other than Ben Bernanke, in an influential speech he gave early in 2005, before he was named chairman of the Federal Reserve. Bernanke asked a good question: “Why is the United States, with the world’s largest economy, borrowing heavily on international capital markets — rather than lending, as would seem more natural?”

His answer was that the main explanation lay not here in America, but abroad. In particular, third-world economies, which had been investor favourites for much of the 1990s, were shaken by a series of financial crises beginning in 1997. As a result, they abruptly switched from being destinations for capital to sources of capital, as their governments began accumulating huge precautionary hoards of overseas assets.

The result, said Bernanke, was a “global saving glut”: lots of money, all dressed up with nowhere to go. In the end, most of that money went to the United States. Why? Because, said Bernanke, of the “depth and sophistication of the country’s financial markets”.

All of this was right, except for one thing: US financial markets, it turns out, were characterised less by sophistication than by sophistry, which my dictionary defines as “a deliberately invalid argument displaying ingenuity in reasoning in the hope of deceiving someone”. E.g., “Repackaging dubious loans into collateralised debt obligations creates a lot of perfectly safe, AAA assets that will never go bad.”

In other words, the United States was not, in fact, uniquely well-suited to make use of the world’s surplus funds. It was, instead, a place where large sums could be and were invested very badly. Directly or indirectly, capital flowing into America from global investors ended up financing a housing-and-credit bubble that has now burst, with painful consequences.

These consequences probably won’t be as bad as the devastating recessions that racked third-world victims of the same syndrome. The saving grace of America’s situation is that our foreign debts are in our own currency. This means that we won’t have the kind of financial death spiral Argentina experienced, in which a falling peso caused the country’s debts, which were in dollars, to balloon in value relative to domestic assets. But even without those currency effects, the next year or two could be quite unpleasant.

What should have been done differently? Some critics say that the Fed helped inflate the housing bubble with low interest rates. But those rates were low for a good reason: although the last recession officially ended in November 2001, it was another two years before the US economy began delivering convincing job growth, and the Fed was rightly concerned about the possibility of Japanese-style prolonged economic stagnation.

The real sin, both of the Fed and of the Bush administration, was the failure to exercise adult supervision over markets running wild. It wasn’t just Alan Greenspan’s unwillingness to admit that there was anything more than a bit of “froth” in housing markets, or his refusal to do anything about subprime abuses. The fact is that as America’s financial system has grown ever more complex, it has also outgrown the framework of banking regulations that used to protect us — yet instead of an attempt to update that framework, all we got were paeans to the wonders of free markets.

Right now, Bernanke is in crisis-management mode, trying to deal with the mess his predecessor left behind. I don’t have any problems with his testimony yesterday, although one suspects that it’s already too late to prevent a recession. But let’s hope that when the dust settles a bit, Bernanke takes the lead in talking about what needs to be done to fix a financial system gone very, very wrong. — NYTNS

(The writer has won the 2008 Nobel Prize for economics. This article was first published in January.)

(Source Economic Times)

Free Market Capitalism?

With the latest round of global market turmoil and the latest set of 'steroids' injected into the financial markets, the problem seems to be far from over. The LIBOR, one of the globally recognised benchmarks for inter bank borrowing/ lending witnessing unprecedented levels, credit markets have come to a grinding halt. All efforts by Central Banks of major developed economies, by way of co-ordinated interest rate cuts and injecting funds have come to naught. Our own RBI is not the be left behind. It has announced decrease in CRR by a massive 150 basis points, in a matter of one week after a period of 5 years of CRR hikes. But all policy action towards providing liquidity and at cheap rates doesn't seem to work on the ground. Reason being the 'skepticism', to put it mildly, among bankers to lend each other. With major institutions going bust week after week, the inter bank lending has dried out. Banks are stashing their deposits in T-bills, leaving little to lend. Be it the commercial paper market, institutional funding or the equities market, all have become non functional, literally. Leaving businesses reeling under the downward credit spiril.

Some have criticised the nationalisation and bailout packages being bundled out by the US, labeling them as socialist in nature and away from the principles of free market & democracy . To the US's defense the role of a democracy is much more then just free markets, its more about the welfare of the people. The debate is not going to die anytime soon thou. But I having turned into a staunch free market fundamentalist believe that the bail out packages being thrown around is not going to bring back confidence which is an essential prerequisite for the banking and financial systems to work. Which is exactly the reason why we find that though the interest rates have been cut, corporates find no takers for their paper and whatever financing is done is at exorbitant rates. The ban on short selling imposed to abate the slide in equities is another such misstep. It can trigger another Pandoras box. Unregulated entities like hedge funds known for shorting aggressively can be caught wrong footed with the ban. Hedge funds, hiterato unscathed can pretty easily find themselves in the midst of all action if things go awry.

May be had it not been for the bailing out of Lehman Brothers, AIG etc, we would have had spiraling systemic problems, no one can ever be for sure as to the right solution to the issue on hand. But one thing is for sure we will witness sea change in the way the financial world is managed and compensations doled out.

Terror debate

Switch on any news channel, three out of ten times, you are bound to find some breaking news on a new bomb blast or new leads into the investigation proceeding. A host of talk and debate shows are aired on television for weeks after each blast, wherein the spokesperson for various political parties turn up and and compare how successful their govt is/was (depending on which side of the table they are) compared to the other govt. The very purpose of such debates is completely zilch, serving no purpose whatsoever. Instead bringing to the forefront the very lack of nationalism, spirit of rising for a greater cause, partisan politics and n no. of such other virtues which the political leaders for any country should display.
There are others who want a ban on other fascist and radical religious groups too, their argument being that you cannot classify and differentiate between terrorism. I don't support or counter the above argument. But I just feel that there is much more which can be done at the political and administrative levels, if police, intelligence and the politicians rise above for a greater national and human cause.

But the winner in all the turmoil are the religious fanatics, the terrorists, who have managed to achieve their goal of spreading terror in the hearts and minds of people on the street and markets. But terror is just a mean to a larger goal, will they actually succeed in realizing the end.... I don't think so. Recent slew of reports suggest how the Indian Muslim's are living under the threat of terror, terror of being picked up as a suspected terror link, terror of denial by follow citizens. The very foundation of Indian Republic, is it's secularism and communal harmony. The people taking up humanity as the only religion, is a dream which looks too distant... atleast in the present scenario.

SEC now fuels new mark-to-market conspiracy theories

Investors Feel The Regulator Is Giving Companies Leeway For Avoiding Big Writedowns

ONCE again, the Securities and Exchange Commission is fuelling suspicions that it has crafted yet another new accounting loophole for financial institutions trying to avoid big writedowns. Now for the strange part: The confusion, which centres on how the SEC interprets the rules for mark-to-market accounting, is unnecessary. That’s because, this time, there doesn’t seem to be any such loophole.
The SEC could clarify this point. It refuses to do so, choosing to stay silent when asked where it stands. That, in turn, is fanning concerns that maybe the SEC really is trying to give large banks and insurance companies a free pass. Given the SEC’s recent track record, it’s hard to blame investors for thinking this way.
Here’s what happened. On March 28, the SEC’s staff released a much-anticipated letter to unspecified companies that hold lots of hard-to-value financial instruments. The impetus was a new Financial Accounting Standards Board rule called Statement 157, which for most companies took effect last quarter.
While Statement 157 doesn’t expand the use of fair-value accounting, it does require companies to disclose how much of their financial instruments are valued using quoted market prices, how much are measured using valuation models, and how much come from models using inputs that aren’t observable in the market.
In its letter, the SEC’s staff recommended a broad range of disclosures companies should make in the discussion-and-analysis sections of their next quarterly reports, when describing how they calculated the values of those assets and liabilities. That part isn’t what drew the firestorm, though. Rather, it was these two introductory sentences. (The emphasis below is mine.) “Under SFAS 157, it is appropriate for you to consider actual market prices, or observable inputs, even when the market is less liquid than historical market volumes, UNLESS THOSE PRICES ARE THE RESULT OF A FORCED LIQUIDATION OR DISTRESS SALE,” the letter said. “Only when actual market prices, or relevant observable inputs, are not available is it appropriate for you to use unobservable inputs which reflect your assumptions of what market participants would use in pricing the asset or liability.”
The reaction was a flurry of press and analyst reports, concluding that the SEC had cut Wall Street firms a huge break. Here are a couple examples.
“The distress sale caveat looks like an escape clause,” the Financial Times wrote March 31 on its Alphaville blog, under the headline “Marking to moral hazard”. “To wit: if asset prices fall too much, just ignore the price falls. In fact, create, buy or hold, whatever structured rubbish you like in the future because it doesn’t have to lose its value if you don’t want it to.”
Dennis Gartman, an economist in Suffolk, Virginia, and editor of the Gartman Letter, wrote this in a March 31 note to clients: “We’ve asked friends in the business for their take, and after two days we’ve come to the conclusion that markto- market has quietly died with this letter, and with it transparency in financial accounting.” Actually, the SEC’s letter merely repeated what Statement 157 already says. Or so it seems. The standard says “a fair value measurement assumes that the asset or liability is exchanged in an orderly transaction between market participants”. It goes on to say an orderly transaction “is not a forced transaction,” such as “a forced liquidation or distress sale”. That’s the same language the SEC’s staff used.
The reason for this exception? Take a situation like the 2006 collapse of Amaranth Advisors. — Bloomberg

(Source: Economic Times 3rd April)

Sign up for the ‘Teach Neta’ campaign

Looks like the whole country and its youth want to become master-jis and masternis. We thought that they only wanted to be Paanchvi Pass or take part in Ekta Kapoor’s new tele-dance contest, but instead they have been signing up in droves for the TOI’s ‘Teach India’ campaign. Strange. They haven’t even been offered a free Dubai shopping holiday, let alone an invite to the Tiger Balm Filmfare Awards Nite. On the contrary, they have to do all the free giving, two hours a week to teach underprivileged kids. Miss, Miss, i am not understanding this lesson. Young-young peoples in colleges and bigbig peoples in corporates want to help smallsmall kids instead of hanging out at in lounge bars? They’ve gone mad or wot?
Yet it’s a fact. ‘Teach India’ has sparked a huge response, and i’ve been trying to figure out what has really caused this Buzz of the Spelling Bee. On the surface, the campaign might appear to be the long-awaited answer to the common dilemma of ‘I want to climb out of my selfish life, but don’t know where to find the ladder.’
It’s all very grand to turn the whole of India into a classroom without walls and windows, not just without blackboards, but you can’t fool me. It can’t be as simple as that. There has to be some hidden agenda behind this altruistic giving of time and talents. Remember, we are now in the India which has flung out its socialist baggage, and drooling-ly jumped aboard no-malls-barred materialism. Face it, baby, no one ever got a foothold on that train by giving someone else a leg-up.
My theory is that this whole campaign is not about Illiteracy Hatao, but about hataoing ethically illiterate politicians. I suspect that ‘Teach India’ is secretly about teaching our leaders a lesson, creating a huge mass of empowered citizens who will be able to sternly order them,‘Get out of the ruling class!’; ‘Stand in the corner!’; ‘Stand on the bench. No, not on the Opposition Benches!’
What i can’t figure out is, why did the TOI have to resort to this elaborate ‘Teach India’ guise? Why didn’t it khullam khulla and straightaway launch a ‘Teach Neta’ campaign? The public would have signed up even more eagerly because this is the glaring need. Once again our leaders have shown that they are lacking in even the basic 3Rs. The Left cannot read the writing on the wall, and every party thinks arithmetic is a zero sum game. They keep waving their numbers as if they are the Tambola Queen of the Karol Bagh kitty party circuit.
The BJP urgently needs memory-strengthening lessons because even its head boys can’t remember what they wrote in their previous nuclear test. The CPM needs a lesson in chemistry instead of going hammer and sickle at whoever it supposedly supports. The Congress does not need any more physics lessons on the correlation between external pressure and hot air. The SP and the BSP strangely seem to be in the same spirituality class because, for both of them, it’s nothing but Maya.
Fortunately, the hard-pressed ‘Teach Neta’ campaign can defer its Einstein’s formula lessons to the next term. In any case, that entire school knows that Elections=Manipulation, Corruption 2 times over.
So, it is obvious that the TOI campaign first needs to educate the political Class of 2008. Or those notorious netas will turn ‘Teach India’ into ‘Leech India’. Just as they have been distorting their mandate of ‘Lead India’ into ‘Bleed India’.
Alec Smart said: ‘‘What’s the new Sinhalong? ‘Old Manmohan has a deal. IAEA-O!’’

(Source: Times of India)

Arming Sebi to regulate DVR share issues

Market Regulator’s Inability To Act On Differential Voting Rights Can Land Minority Shareholders In A Spot

CLASS WAR: More equal than equals?

IT IS perhaps the most important development in recent years concerning listed companies and minority shareholders. Differential voting rights (DVR) will change the promoter-minority shareholder equation in the years ahead. Tata Motors' proposed Rs 7,200 crore rights issue comprises DVR shares (including convertibles) worth up to Rs 5,000 crore. This issue will be watched closely as it will set precedents for subsequent issues to follow. That's because there are no clear Sebi guidelines for the issue and pricing of DVR shares by listed companies. And, more surprisingly, Sebi's ruling in the Jagatjit Industries case indicates it cannot regulate the issuance of DVR shares.
In India, companies have hardly felt the need for DVR shares. Promoters usually own sizeable stakes in companies and hostile takeovers are rare. Still, the government obliged big business by amending the law to allow such issues. Voting rights are crucial for investors. They come into play when critical meetings are held, be it board meetings, shareholder meetings or voting through postal ballots. In India, so far all shares have conferred equal voting rights, the only exception being banks. DVR shares were legalised after an amendment under Sec 86 of the Companies Act, with the rules notified in 2001.
Under these rules companies should, among other things, have a three-year profit record, the articles of association should allow issuance of such shares, and shareholder approval is needed. DVR shares cannot exceed 25% of the total capital. They are not convertible, so Class A shares, for example, cannot be converted into Class B shares and vice versa. Now, all share issues by listed companies are regulated by Sebi. So, for DVR shares too, Sebi would safeguard minority shareholder interests.
But the Jagatjit Industries case casts a cloud on that. The case deals with the issue of DVR shares to promoters in 2004, in which the legality of the issue has been questioned by a co-promoter. While the shares have been issued, they have not been listed as the stock exchanges did not accept the listing application.
Without going into the details of the case, which are not relevant here, in its order, Sebi asks a question to which it then responds. The question is: "Whether under the provisions of the Companies Act, 1956 and the Sebi Act, 1992, Sebi has the power to decide the legality and propriety of allotment of DVRs and take action for violations?"
The answer is quite startling. Sebi's powers have been carved out of some sections of the Companies Act, 1956, on the issue and transfer of securities of listed or to be listed companies. Section 55A of the Companies Act lists those sections, which come under Sebi. Section 86, which deals with DVR shares unfortunately is not among these sections. The Sebi order says: "Therefore, under the present statutory provisions, Sebi does not have any power to regulate the issuance of the DVR shares." So, in the Jagatjit case, the Company Law Board will decide whether the issue of these shares was legal.
Sebi's lack of jurisdiction does not mean it can do nothing about the issue of DVR shares freely. It can influence the listing of such shares and the takeover regulations can also be used, if there is any violation. Most companies would follow the prevailing guidelines for share issue, to avoid falling foul of Sebi. In 2004, for example, Reliance Infrastructure (earlier known as Reliance Energy) had issued 80 lakh shares with zero voting rights to its promoters. That went through without causing much furore. The Sebi order also says that the issue and listing will 'attract the applicability of the DIP guidelines and the listing agreement'.
But Sebi needs powers to govern the issuance of DVR shares. Apart from applying DIP guidelines that are applicable to all share issues, these shares will require some special provisions. Pricing these shares is a key issue, for example. Internationally, if one class of shares can be converted into another, the conversion factor can be used as a benchmark. Say, if one Class A share can be converted into 10 Class B listed shares with a market price of Rs 10, one Class A share price will be worth Rs 100.
But the current guidelines stipulate that conversion is not possible. In that case, it becomes tricky because voting rights will have to be used to determine the premium or discount. Higher voting rights should automatically mean a premium, usually to be paid by the promoter for retaining a larger share in the company. If a promoter can increase his stake from 30% to 51% through a DVR issue, how will the control premium be determined? In the submissions made to Sebi, Jagatjit says that as there were no specific guidelines for pricing of DVR shares, existing guidelines were used to the extent applicable.
The other aspect that needs to be studied is how DVR can affect various issues like restructuring of companies and takeover regulations. For example, say Class A shares are held by promoters and Class B shares are held by the public. If Class A shares are sold leading to a change in control, how will the open offer price for Class B shares be decided? Moreover, when restructuring of companies, involving reduction of share capital, which requires shareholder approval, appropriate checks need to be in place to ensure that minority shareholders don't get shortchanged. Even now, buyback of shares are passed off in the guise of a reorganisation of capital under the Companies Act.
In 2002, in fact, Sebi's Primary Market Advisory Committee had made recommendations on various issues, including DVR shares. That committee had concluded that Sebi's equity issue guidelines apply to such shares too. While that is in doubt now, it had made several other observations, including prohibiting an IPO of DVR shares, they should be compulsorily listed, and they will have to fulfil all listing agreement conditions. These are, of course, recommendations but bring to light the impact on other crucial areas like IPOs.
More issues will come to the fore once companies start issuing DVRs, if a Sebi framework is not in place soon enough. For example, Jagatjit said in its submission to Sebi that initially it did not intend to list these shares. Instead of having patchwork solutions, it would be better if the market regulator moves the government to include Section 86 under its ambit, and frame a discussion paper on guidelines for the issue of DVR shares. That would make minority shareholders feel more secure.

Source: Economic Times
Ravi Ananthanarayanan, Mumbai.

Can India Inc swallow the ‘poison pill’?

The reason for utilising the poison pill defence is to protect shareholder value and interest while stalling entities such as asset strippers

THE contemporary global history of mergers and acquisitions may be tidily divided into two eras marked by the introduction of the defence strategy called the poison pill and the subsequent landmark ruling of the Delaware Supreme Court in 1985 which upheld its legality. Before that, hostile acquirers repeatedly struck terror in the hearts of corporate boards. If these wealthy dealmakers wanted to take over a company in a hostile acquisition, bite it into pieces, and then spin those pieces off for a profit, there wasn’t much that the boards of a target company could do to stop the massacre. The poison pill quickly transformed the takeover law and fortified the preemptive defences of companies.
The classic poison pill strategy (aka the shareholders’ rights plan) is one wherein the target company gives existing shareholders the right to buy stock at a bargain price if a hostile acquirer purchases more than a predetermined amount of the target company’s stock. The purpose of this move is to devalue the stock worth of the target company and dilute the percentage of the target company equity owned by the hostile acquirer to an extent that makes any further acquisition prohibitively expensive for him. There are many equally effective variations of the classic poison pill defence. This article examines the applicability of the poison pill in the present legal and regulatory framework in India.
The SEBI (Substantial Acquisition of Shares and Takeovers) Regulations 1997, commonly referred to as the Takeover Code, makes it difficult for the hostile acquirer to sneak up on the target company. It forewarns the company about the advances of an acquirer by mandating that the acquirer make a public disclosure of his shareholding or voting rights to the company if he acquires shares or voting rights beyond a certain specified limit. However, the code does not present any insurmountable barrier to a determined hostile acquirer.
In fact, the code, vide Regulation 23, imposes a general prohibition on the corporate actions of a target company during the offer period, such as transferring of assets or entering into material contracts and even prohibits the issue of any authorised but unissued securities during the offer period. However, these actions may be taken with approval from the general body of shareholders.
Regulation 23, however, makes an exception to the above situation by permitting the target company to issue shares carrying voting rights upon conversion of debentures already issued or upon exercise of option against warrants, as per predetermined terms of conversion or exercise of option. It also allows the target company to issue shares pursuant to public or rights issue in respect of which the offer document has already been filed with the Registrar of Companies or stock exchanges, as the case may be. However this may be of little respite as the debentures or warrants, contemplated earlier must be issued prior to the offer period. Further the law does not permit the board of the target company to make such issues without the shareholders approval either prior to the offer period or during the offer period (as it is specifically prohibited under Regulation 23). During a takeover scenario it may be critical for the board to quickly adopt a defensive strategy to help ward of an hostile acquirer or bring him to a negotiated position. In such a situation, it may be time consuming and difficult to obtain the shareholders’ approvals especially where the management and the ownership of the company are independent of each other.
We have to read the Takeover Code along with the SEBI Disclosure & Investor Protection Guidelines 2000, which are the nodal regulations for the methods and terms of issue of shares/warrants by a listed Indian company. They impose several restrictions on the preferential allotment of shares and/or the issuance of share warrants by a listed company. Under the DIP guidelines, issuing shares at a discount and warrants which convert to shares at a discount is not possible as the minimum issue price is determined with reference to the market price of the shares on the date of issue or upon the date of exercise of the option against the warrants. This creates an impediment in the effectiveness of the shareholders’ rights plan which involves the preferential issue of shares at a discount to existing shareholders.
The DIP guidelines also provide that the right to buy warrants needs to be exercised within a period of eighteen months, after which they would automatically lapse. Thus, the target company would then have to revert to the shareholders after the period of eighteen months to renew the shareholders’ rights plan.
Without the ability to allow its shareholders to purchase discounted shares/ options against warrants, an Indian company would not be able to dilute the stake of the hostile acquirer, thereby rendering the shareholders’ rights plan futile as a takeover deterrent.
As seen above, for the poison pill strategy to work best in the Indian corporate scenario certain amendments to the prevalent legal and regulatory framework are required. Importantly a mechanism must be permitted under the code and the DIP guidelines which permits issue of shares/warrants at a discount to the prevailing market price. These amendments would need to balance the interests of the shareholders while allowing the target companies to fend off hostile acquirers.
That said, history is ripe with examples of how a little legal ingenuity and a few pre-emptive strategies can fend off the advances of the most ardent hostile acquirers. One of the advantages of the poison pill strategy is that there is no rigid structure to it and it can be tailored to suit the particular needs of a company. As a result, Indian companies are not restricted to adopt the classic version of the pill i.e., the shareholders’ rights plan.
For example, DIP guidelines do not prescribe any pricing restrictions on the issue of non-convertible preference shares, nonconvertible debentures, notes, bonds and certificates of deposit. Thus, we may consider structuring a poison pill in place whereby backend rights which permit the shareholders to exchange the rights/shares held for senior securities with a backend value as fixed by the board, are issued to existing shareholders when the hostile acquirer’s shareholding crosses a predetermined threshold. As most takeovers are carried out through borrowed funds, the use of backend rights reduces the profitability of the takeover because of the mounting interest rates on borrowings; thus deterring the hostile acquirer and more importantly sets the minimum takeover price, which is the price at which the shares have been exchanged for senior securities.
Further, company could put in a provision in its articles whereby a hostile acquirer who succeeds in taking control of that company and/or its subsidiaries is prohibited from using the company’s established brand name. It is believed that different Tata companies have in place an arrangement with the Tata Sons holding entity, whereby any hostile (or otherwise) acquirer of any of those entities is not permitted to make use of the established Tata brand name. Consequently, the bidder might be able to take over the target Tata company but will be shortchanged as it will not be entitled to a significant bite of its valuation — the valued brand name!
Another variation of the poison pill that may be explored in India brings the Employee Stock Options Scheme (ESOS) into action. ESOS is governed by the SEBI guidelines of 1997, whereby a company granting options to its employees pursuant to ESOS has the general freedom to determine the exercise price, subject to the adherence to the accounting policies prescribed under the SEBI guidelines in this regard. Thus, an effective poison pill defence may be achieved by issuing ESOS at a discount, which would serve to dilute the share value of the hostile acquirer over the target company.
Indian companies need to shift from desperate defensive play to sitting ready on the offensive. It is time we introduce the poison pill to the Indian business world and adapt it to make it our own. However, the reason for utilising the poison pill defence is to protect shareholder value and interest while stalling entities such as asset strippers that do not have the best interest of the company in mind or add any value to it. LTTE cadres swallowed the cyanide pill around their necks and committed suicide as a last resort. Given the parallel between the LTTE’s cyanide pill and the corporate poison pill defence, companies need to ensure that this defence is not misused by errant management. So a company is welcome to utilise its benefits but warned not to convert it into its Achilles’ heel.

- Author is Rajiv K Luthra
Economic Times

The Tight Rope Act

Walking the Tight Rope

With inflation hitting new highs, the regulators have a daunting task of keeping the growth engines running and controlling inflationary conditions.

With fears of an economic slowdown looming large and with US already in recession, the last tranche of bad news needed was a spiraling interest rate. The rising interest rate phenomenon has been witnessed across most emerging market economies. And the men who has been left asking for a fine balancing act is the RBI governor, Mr. Y.V Reddy and the Finance minister, Mr. P. Chindambaram. The sub 7% interest rate number is way above the RBIs comfort zone. The FM has already come out all guns blazing saying that the govt. will introduce a slew of monetary and fiscal measures to control inflation. So where does this leave us and what are the various tricks the govt. has in its sleeve ?

The government has a very tough task on its hand. If the central bank were to raise interest rates further, it would lead to a slowdown on the economic growth front with the credit growth already dwindling. The sale for various credit sensitive items has already taken a beating over the past year on the back of high interest rate regime. And each time we increase the interest rates, the interest rate differential between India and other developed economies increases further, encouraging arbitragers and other investors to pour in dollars leading to a weaker dollar. The export sector has already been pressed hard to make ends meet and a further strengthening in rupee would be the last thing they could have asked for. A developing economy like India which has been running a rather huge current account deficit cannot afford to hurt exports of goods and services which would have serious ramifications for the sustainability of the growth in the future. The interesting thing to watch out for would be the instruments which the central bank uses, in the hope of deflating the inflation bloat.

Another move the govt hopes to make use of is reduction in import duties. A reduction in import duties coupled with a stronger rupee might make imports competitive but I doubt if it could result in any meaningful reduction in prices because of high price levels being witnessed in the global commodity markets. The global commodity prices have hit the roof on back of low food grain surplus, if any and on concerns of continued availability of non renewable energy resources in the distant future. The real solution to taming inflation in the long run lies in improving our agricultural productivity and removing infrastructure bottlenecks for which lies no easy make fix solutions. But for now the persons at the helm of the affairs have been left with walking the Tight Rope to reign in inflation.

Split Wide Open

The Community of Economists and bankers are in splitsville with opinions differing significantly on the effectiveness of the policy actions mentioned above, in controlling inflation. One sect of economists houses the view that the present inflationary conditions which are being witnessed is because of supply constraints and hence increase in interest rates cannot address such an issue. Infact it would have a negative impact by effecting demand adversely, and when the inflationary pressures have really bottomed out in the form of improved supply, the demand for them would have taken a beating. All this would derail the economic growth engine. At the same time another group of Economists believe that the central bank should act swiftly, and justify the first mentioned approach to tame inflation.

It remains to be seen as to which path the central bank threads to control inflation. And hence walking the fine line of inflation and growth is becoming a daunting challenge.