NRI profs head for IITs

Outlook magazine has a story on how several NRI profs are beginning to take up jobs at the IITs. The numbers are impressive, very impressive indeed:

In Delhi's IIT, 25 of the 40 faculty members appointed in the last one year are foreign-returned. Mumbai has 40 and the others IITs are recording anywhere from 2-5 faculty members who have come back to serve in India.

What accounts for this sudden surge in interest on the part of NRIs? Outlook lists several reasons:

• They feel culturally more comfortable to live and work in India
  
• There are research opportunities comparable to the west
  
• Greater involvement of industry in R&D means better funding
  
• IITs have a research focus: encouraging environment, space and facilities
  
• The NRIs fee being a part of brand IIT is creditworthy worldwide

Some of the profs interviewed in the story emphasise the facilities and funding for research. It does appear the IITs have done a commendable job on this front. I would that 'India Shining' is part of the motivation- the fact that things are looking up in India, that you no longer are in queue for years to get a telephone or gas connection and also serious consulting opportunities. The IITs' campus environment and decent housing must also count. I also think the salary revision that will happen consequent to the Sixth Pay Commission will make jobs in IITs/IIMs more attractive.

If this trend continues, the newer IITs may not find it that difficult to get faculty- the NRIs will join the established ones while entrants in the doctoral market will head for the newer IITs. The trend is interesting given that the government pay structure has long held to be a factor responsible for the faculty shortage at some of our better known institutions.

Some of the premier institutions have long insisted that as long as they are part of the government framework, along with the salary constraints, they cannot attract quality faculty. Prominent personalities have even contended that quality institutions can hereafter come up only under private aegis because the private sector can pay a lot more (and charge its students a lot more).

As readers of this blog would know, I have always been sceptical about these contentions. It is the overall ambience that counts- and the security, dignity and academic freedom that go with being part of the government framework far outweigh the supposed disadvantages.

Reliance SEZ

I don't know whether the papers carried the report but Outlook magazine has a story on the referendum carried out on the Reliance SEZ in Raighad district of Maharashtra. In the referendum, the first of its kind on an SEZ, the proposal to create a 10,000 hectare SEZ covering 25 villages was apparently voted against by 80-85% of the people who cast votes.

Interesting, since the impression I had got earlier from newspaper reports was that Reliance had made a very attractive offer (Rs 10 lac per ha) and that villages were dying to part with their land. Most of the villages are not willing to provide even conditional consent under which Reliance would pay Rs 1 crore per ha, provide a 12.5% share of the developed land to affected farmers and take the land on a 99 year lease.

Outlook says the vote is not binding on the Maharashtra government. Why not a similar vote in Singur- at least that will tell us where the affected parties stand.

Death of a police inspector

I was among those deeply moved by the story of the death of Delhi police inspector Mohan Chand Sharma in an encounter with terrorists on September 19. It was heart-trending to see the photos of his grieving wife and two children.

Now, it appears this was a 'story' in more senses than one. M J Akbar in his column in TOI today and Outlook magazine in its latest issue cast doubts on the official version. Akbar and the Outlook make several points.

• Sharma was said to have been shot in the stomach but a photo captures him being helped out of the house where the shoot-out took place, with a heavy patch of blood on his upper arm. He had managed to climb down several flights of stairs, which would have been difficult had been shot in the stomach.
  
• An official release later clarified that he had died of a heart attack caused by loss of blood. There are also murmurs in the police establishment that he was killed by 'friendly fire'.
• Outlook mentions that Sharma had gone up to the apartment where the terrorists were said to have been holed up, posing as a telecom salesperson. He then asked his colleagues to join him. So, this wasn't exactly the storming of a hide-out. Lastly, the police claim to have killed two terrorists and said the other two had escaped. Escape was difficult considering there was only one exit which was under police watch.
  

So, was this a staged operation in which innocents were killed? We may never the truth. What we do know is that in the 'war against terror' plots will be busted, 'terrorists' will always be found and jailed or killed.

The test of success, I guess, is whether the police are effective in preventing further acts of terrorism. Israel has shown it can do it. So has the US post 9/11. Not to defend the record of these countries in their dealings with Muslims. The point, however, is that unless the Indian police is able to reduce the level of terrorist attacks, we must remain sceptical about encounters and the resulting deaths or capture of 'terrorists'.

While on the subject,it's worth noting that the government case againt SIMI, supposedly a terrorist Muslim organisation, was thrown out by the special CBI court (headed, as I recall, by a lady judge). The judge said the government had failed to produce evidence. The matter is now pending in the Supreme Court where the government has challenged the lower court verdict.

Biggest bank failure in US history

Washington Mutual has been acquired by JP Morgan Chase for $1.9 bn. Morgan acquires all assets and deposits but not equity and debt claims. In other words, equity holders and non-deposit lenders get wiped out.

This wasn't a straight acquisition- WaMu was seized by the regulators and then sold. JP Morgan pays $1.9bn to the regulator, not to the existing shareholders. It isn't clear why the regulator is getting paid because there are no costs of deposit insurance the regulator is bearing.

WaMu had assets of $307 bn- far in excess of the $40 bn held by Continental Illinois which failed in 1984. This makes it the biggest bank failure in US history by a wide margin.

Bonuses for Lehman's European staff

Nomura, which has acquired Lehman's equities and investment banking business in Europe, is setting aside $1 bn in bonuses for Lehman staff, FT reports. This is for 2008. For 2009, it has promised a bonus pool as large as the one in 2008, although some of it will be in the form of restricted staff.

Were Lehman staff, who seemed orphaned until the other day, not available in the present environment without such incentives? And what implications do guaranteed bonuses have for future financial stability? If we accept that the design of compensation schemes had something to do with the present financial crisis, Nomura's offer does not seem very responsible.

In UK, the Financial Services Authority is said to be contemplating higher capital norms for firms whose bonus payments are not linked sufficiently to long-term performance. In the US, Congress is contemplating limits on bonuses as part of the bail-out plan. UK's PM, Gordon Brown, has said the present compensation schemes are "unacceptable". Nomura needs to do some explaining.

Responses to comments

I haven't had a chance to respond to some of the comments on my posts on investment banks. I thought I would devote a small post to these instead of putting them in the comments section.

1. Jaipm: asks about Alan Greenspan. This is a vast subject, really. But briefly, I am not persuaded that he was wrong in easing monetary policy or that he did it for too long. Easy monetary conditions helped create one of the best economic booms in the world in recent decades and India was among the beneficiaries. The argument is that the boom led to the present bust. I am not sure.

What the central bank can do to head off asset bubbles is not very clear but the answer cannot be something that slows the entire economic- sector-specific responses (such as increasing risk weights for real estate, favoured by the RBI here) are a bette idea. In other words, better regulation could have helped prevent the worst excesses and the ensuing problems. So, I would say Greenspan wasn't very wrong on monetary policy but he did stumble on regulation.

2. Stevie commenting on the RTC says that distressed assets lose value with time. Not true. The earlier RTC during the S&L crisis made money eventually; so did the consortium of banks who bailed out LTCM in 1998. It's a matter of using public resources to ride out a temporary storm.

3. Adorable guy: sees the RTC as injecting capital into the system. No, it erodes capital because banks will take a hit against the assets they sell at a discount. What it does is to put a floor to the hit- before the RTC, it appeared that asset prices would go sink indefinitely. So the RTC will help contain erosion in bank capital and it will also create the conditions for fresh money to come in

Investment banks, RIP

Well, the inevitable has happened- Morgan Stanley and Goldman Sachs will cease to be pure investment banks. This won't be news to readers of this blog.

The two firms were issued licenses by the Fed to commence banking operations in what must be record time. The Fed acted with alacrity because any delay could have resulted in Morgan and Goldman meeting the same fate as Lehman- the share prices could have quickly tumbled to zero. The ban on short selling may not have saved the two firms. Now that markets have sensed that the investment banking model was doomed, the bottom would have fallen out of their share prices.

This does not mean that the firms can succeed on their own as banks. Not by a long chalk- I can't see that happening without their having a branch network. No, the permission to convert to banks was meant to be a signal to markets: hey guys, please don't view these firms as investment banks, they are going to be banks soon, so there is hope yet. The odds are that both Morgan and Goldman will merge with some bank or find a bank as a strategic partner.

What happened to all those who proclaimed that these two firms had done a better job of managing risk and would survive? All this talk was baloney. All the top banks were dangerously leveraged, dangerously exposed to toxic securities. That one was more dangerously exposed than another is neither here nor there.

So, the short sellers were right in latching on to Lehman and then to the others. But that does not mean that short-selling of financial stocks in such an environment is justified. This cannot be justified on grounds of price discovery or discovery of information. After all, a central bank may know that a bank is in bad shape but it would certainly not think it necessary to broadcast the news to the world. In times of financial crises- as in times of war- the normal rules of reporting stand suspended. So the temporary ban on short-selling of financial stocks is justified.

One final thought. You could say that the Fed acted with commendable despatch in ensuring that Goldman and Morgan did not meet the fate of their peers. But cynics may take a different view. US Treasury secretary Hank Paulson was CEO of Goldman before moving into government. Does he still own a lot of stock in Goldman? If so, the cynics may take a different view of the Fed's decision......

Resolution Trust Corporation

The US proposal to create an RTC has helped stabilise markets today- or so it seems for now. The RTC would buy bad assets from banks at an appropriate price.It would auction those assets later once markets have stabilised. What does this achieve? It helps stabilise the value of assets of financial firms and prevents the collapse of highly leveraged institutions. Hopefully, the RTC will make a profit later; if not, the government incurs a cost equivalent to the losses on sale of assets the RTC has bought.

Writing in the FT, Raghuram Rajan argues that this is not the right proposal because it ends up rewarding institutions that have taken wrong decisions at a cost to the tax payer. He says it won't address the basic problem which is lack of capital at financial institutions. He suggests intead that these institutions be asked to withhold dividend payments; and stronger firms be asked to make rights issues.

It's doubtful this will work. Shareholders of existing firms lack the incentive to subscribe to rights issues until then are sure that asset prices have stabilised. Secondly, capital will be ready to flow into today's distressed institutions once investors are reasonably sure that the firms' asset values will not decline further.

So, the RTC is indeed the way out. Yes, there is moral hazard. But the world is falling apart, that's not the time to think of moral hazard.

Investment bank fade out

Three of the top five US investment banks have disappeared. Until yesterday, some commentators were insistent that there is still room for investment banks, that the survivors, Goldman Sachs and Morgan Stanley, will actually do better now that competition is less keen.

Well, today's news should cause them to think again. Morgan Stanley is said to be in merger talks with Wachovia Bank and Goldman also exploring possibilities. I argue in my ET column, Wall Street model crumbles that the standalone investment banking model is doomed.

The combination of high leverage and investment on own account in illiquid assets has provd lethal for investment banks. High leverage increases the chance of insolvency; so does dependence on wholesale markets for funding. Alright, say the defenders of investment banks, let's limit leverage through regulation. But, if you take away high leverage, returns in investment bank may cease to be attractive. So, you have to marry leverage with a stable base of funds- and that's where banks come in. That's what the mergers of investment banks with banks are all about.

Not that such mergers don't pose problems. There is clash between the risk-averse culture in banking and the risk-loving approach in investment banking. But, if we accept that the appetite for risk in investment banking will be noticeably lower in the years to come, this gulf can be bridged.

You could argue that investors will not pay a premium for banks diversifiyng into investment banks- corporate finance tells us that what firms can do, investors can do better on their own. So, investment banks will continue to interest investors. But this argument could be applied to diverisification by investment banks too- there should be investment banks specialising in each area: brokerage, advisory services, trading and private equity. Why have full scope investment banks that combine the lot?

Not that every bank will an investment bank will do a great job- JP Morgan Chase may be a success and HSBC too but not Citigroup and UBS. But, at the end of the day, Citigroup and UBS are still standing on their feet while the investment banks have disappeared.

From a regulatory point of view, having investment banks under the roof as commercial banks is looking desirable. After all, banks that are subject to tight capital and other regulatory norms are not the source of the problem today; the problem has arisen in the unregulated part of the financial system featuring investment banks and others.

Can the US afford the bail outs?

Writing in the FT, Harvard Prof Kenneth Rogoff estimates that the US government will end up coughing up close to a trillion dollars in bail-outs for its trouble financial sector. Upto now, the cost is around $200-300 bn. Can the US afford this kind of cost? Rogoff thinks it is very steep and will impose costs in terms of higher interest rates, inflation and lower growth.

We should be careful not to get carried away. A trillion dollars is under 8% of US GDP. That is big but still falls in the lower end of bank recapitalisation costs consequent to economic crises- the range is 5-45% of GDP.

US public debt, at $ 4.4 trillion, is 32% of GDP, pretty much on the low side considering that the limit for EU economies under the Maastricht Treaty is 60% of GDP (India has over 70% of GDP in debt). That means there is room for another $4 trillion of US debt. So, even if the bail-outs were to amount to $1 trillion, the US and the world economy can take that cost in their stride.

AIG blows up

John Gapper of the FT expresses the financial market watcher's anger and utter surprise over how some of the large financial institutions have been managed:

But AIG takes the biscuit. Here was a huge multinational insurance group with a reputation for solid underwriting and risk management that decided to diversify from insuring risks it knew well – car crashes and fires – to covering derivatives it did not understand.

Of course, it thought it understood them. In presentations to investors this year, it emphasised how thoroughly its AIG Financial Products arm assessed the risks of insuring CDOs. It ran all the data and decided that, in the worst case, it risked losing $2.4bn on the portfolio.

Well, $24bn of write-downs later – a mere 10 times its maximum estimate – the company has burned through its equity, spread financial chaos to all corners of the earth and humiliated the US Treasury. The job of insurance companies is to guard others against catastrophes, not cause them.

The word “irresponsible” does not begin to describe AIG’s behaviour

Is higher capital the answer in investment banking?

There is a sense that investment banks too will become subject to requirements of regulatory capital- at present, only commercial banks are subjected to the requirements imposed by Basel I (and hereafter Basel II). FT doesn't think this is a great idea:

There will now be renewed calls for more regulation, and understandably so. But it is naive to think that the right regulatory response is obvious. From poor governance to flawed incentives, incompetent risk management to foolish strategies, the failures of the financial system have been so widespread as to ren­der a coherent regulatory riposte impossible. The likely outcome is that tight capital requirements will be forced to serve as a catch-all res­ponse to risk. If so, the banking system will look more like that of the 1960s – a low-risk, low-return utility business. The ambitious and the avaricious will no doubt seek more exciting hunting grounds with hedge funds and private equity groups.

FT's criticism is misplaced. Many of the problems the quote above mentions- flawed incentives, poor governance, bad risk management- have their roots in high leverage. In the face of high leverage, managers will take all kinds of bad decisions- they will take excessive risks, for instance, knowing that the payoffs will be large if they succeed and costs to themselves pretty low if they don't.

So, while a great deal needs to be tackled by way of regulation, higher capital is an important starting point.

'The worst crisis in the last century'

The quote is from Alan Greenspan. And there is no dearth of other doomsayers. But how bad is the economic situation following the collapse of Lehman and the sale of Merrill? Just a couple of quick points.

First, failures in investment banking and also banking are inevitable (although it is mainly the smaller banks that will be allowed to fail). In key products such as sub prime mortgages and securitisation, demand has shrunk and we will never see anything like the old volumes again.
That means that capacity must also shrink. This happens through bankruptcy or consolidation.

Two, I take heart from the US authorities' decision to let Lehman fail. (It's said that the US treasury secretary was adamant on this issue but I imagine the Fed chairman backed him). The decision reflects confidence in the managers of the US financial system as to the ability of the economy to withstand the fallout.

Let's face it: the US economy is in better shape today than most people had expected at the beginning of the year. (Greenspan was amongst those saying the probability of a recession was higher than 50%; now he's quoted as saying the chances are under 50%). A big chunk of banking losses has already been made good through fresh infusions. Major participants have had enough time to unwind risky positions.

Putting these two points together, the financial markets should stabilise in the near future and the survivors will emerge strengthened by the fall of rivals. So, it's not quite the end of the world.....

Lehman in dire straits

Lehman Brothers, the 158 year old investment bank, is battling for life. Perhaps its future will be known by the time the weekend is over.

Lehman must find a buyer quickly or declare bankruptcy. Finding a buyer is complicated by the fact that the US government is said to be unwilling to provide support to a rescue- as it did with JP Morgan's acquisition of Bear Stearns. Moreover, the authorities are less intimidated by the prospect of bankruptcy than they were in the case of Bear Stearns- they reckon that the fallout can be borne by counterparties because these have had enough time to prepare.

Well, we shall see.... it looks as through the government's reluctance to support a rescue will eventually push Lehman towards a sale at a very low price- bad news for its shareholders including executives holding stocks and stock options in the firm.

And to think that only a few months ago, analysts and media commentators were singing the praise of Lehman and waxing eloquent about how well its CEO had handled its problems, including the challenge of 'communicating' with the markets. When the chips are well and truly down, communication isn't of much help, I guess.

Looking ahead, the big question markets will be asking is: who next? Lehman is not such a big player itself but the message now is that no one is really safe. It's not Lehman's disappearance so much as the possibility of bigger players going under that will give the markets jitters in the weeks to come.

US opts for nationalisation!

Nationalisation and government ownership may be dirty words in the US but this is not time to fuss about ideology- the crisis in the financial markets required drastic action. So the two secondary mortgage institutions - Fannie Mae and Freddie Mac- will go under "conservatorship" which, for all practical purposes, means government owernship.

The government will infuse equity as required and it will also provide debt finance by subscribing to the mortgage backed securities floated by the two institutions. Banks and financial institutions are holding paper issued by the two, so a collapse would have had serious consequences for the already troubled financial sector. The housing market would have seen another fall. Hence the government is stepping in.

FT estimates the cost of the rescue at around $200 bn - or nearly 1.5% of GDP. S& P places the cost at 2.5% of GDP. That's smaller than the $300 bn (in today's terms) that it cost to save savings and loans institutions in the US in the eighties. Still, the amount is not exactly small change. In India, the government has spent a total of $7.5 bn to recapitalise the banking system- or under 2% of GDP. But this was roundly condemned at the time. The same editorial writers (in India) are lauding the US government for its rescue act today- what's good for the US is evidently not good enough for us Indians.

The rescue should calm frayed nerves in the US banking system and elsewhere. It should also help put a floor on housing prices for the US. So it's good news for the world economy. The US economy has grown against all odds in the first two quarters and it increasingly appears that it's the UK economy that stands to suffer most in the present crisis, not the US.

Nuclear deal- is it such a coup?

The media seems convinced we are on to a terrric deal- I refer to the NSG waiver given to India. This is one of those issues where it's really hard to make an accurate judgement. The key is the right to test in future. Now, it's not that we have abjured the right to test. But, the terms of the Indo- US accord are such that the economic costs could turn out to be prohibitive.

I read that the US and other suppliers may ask for all equipment and materials to be returned. If so, the cost would be sufficiently high to deter Indian policy makers from going in for a test. The tricky part is whether in the evolving world scenario, the US and others will want to enforce those terms, given that India will have grown in stature and is also perceived as a reasonable player that will not test without reason. So, I guess this is one of those things that time alone will tell.

A second issue is that we don't seem to be getting full cooperation in the nuclear energy field. Brahma Chellaney has some caustic remarks to make in Rediff.com:

Today, there is not even the pretence that the deal offers 'full civil nuclear energy cooperation' or that India is to 'acquire the same benefits and advantages' as the US. But why blame the US? In his desperation to secure the deal, Prime Minister Manmohan Singh [Images] has repeatedly moved the goalpost.

For example, he has breached his assurance to Parliament on August 17, 2006 on 'the removal of restrictions on all aspects of cooperation and technology transfers pertaining to civil nuclear energy'. He had added: 'We will not agree to any dilution that would prevent us from securing the benefits of full civil nuclear cooperation as amplified above'.

Dr Singh also has reneged on his July 29, 2005, promise in the Lok Sabha: 'We shall undertake the same responsibilities and obligations' and 'we expect the same rights and benefits' as the US. As is apparent, the NSG waiver is neither clean nor unconditional. If anything, it is messy. Yet Dr Singh was quick to hail it as 'a forward-looking and momentous decision', even claiming that 'It marks the end of India's decades-long isolation from the nuclear mainstream and of the technology-denial regime'.

He again pegged his newfound interest in commercial nuclear power to 'environmentally sustainable economic growth' and to meeting 'the challenge of climate change', although one of the first things to be knocked out of the US-drafted waiver text at the earlier August 21-22 NSG meeting was Section 1(e), which read: 'recognize the world's need for clean and reliable sources of energy for sustained growth and prosperity'.

Not many NSG members buy the spiel that nuclear energy can help reduce global CO emissions or be a cost-effective answer to the growing electricity demands. The path to energy and climate security lies through carbon-free renewable energy, which by harnessing nature frees a nation from reliance on external sources of fuel supply. Yet such is the nuclear power hype that few Indians know that their country today generates much more wind power than nuclear energy.

Olympic medals

Reams have been written about the stellar performance of countries such as China and the US at the Beijing Olympics and the lacklustre performance of others, including India. Economist Gary Becker highlights the determinants of Olympic success in his blog, based on a journal paper:

The article "A Tale of Two Seasons: Participation and Medal Counts at the Summer and Winter Olympic Games", published in 2004 in the Social Science Quarterly by Professor Daniel Johnson of Colorado College and a co-author, examines the determinants of how many medals were won by different countries in the summer and winter Olympics since the end of World War II. Their regression analysis shows that two very important variables are the total population and per capita incomes of different countries. Also important are whether a country has an authoritarian government-such as communism- a country's climate, and whether a country is the host country for a particular Olympics. These five variables taken together predict closely the total number of medals won by different countries in the winter as well as summer Games.

Rising interest rates? Not to worry!

Most forecasters have lowered their forecasts for Indian economic growth for 2008-09. The RBI thinks growth will end up slightly under 8%. The PM's Economic Advisory Council projects growth of 7.7%. Many investment banks think growth will be even lower.

These forecasts rest on two things: the adverse global economic environment and lower global growth; and rising interest rates in response to inflationary trends.

Yes, weaker global growth will moderate India's growth but higher interest rates, I think, are not such a big worry. This is the subject of my ET column, Interest rate rise not a big worry.

Why do I say this? Briefly:

• Lending rates have risen but remain below levels in the nineties.
• Corporate leverage is much lower than in the nineties, so higher interest rates do not threaten corporate profit to the same extent
• Consumer borrowing has been impacted but housing demand should revive once property prices correct
• Banks' capacity to make loans remains unimpaired despite four years of rising interest rates. Even NPA levels in the aggregate are not a problem because five years of high growth are causing past corporate NPAs to revive, far from adding to fresh NPAs in a big way.
  

Novel on Zia ul Haq's death in air crash

I've just finished reading A case of exploding mangoes, Mohammed Hanif's novel based on the mysterious air crash that killed Pakistani rules Gen Zia ul Haq. Also killed in the crash were a Lt Gen in the army and the US ambassador to Pakistan. Hanif is a former air force office now residing in the UK.

It's a terrific read, a thriller of sorts. Hanif is South Asia's answer to John Le Carre, I daresay. The story cuts between the interrogation of a suspect in the assisination plot and Zia's own life in the months leading up to the crash. The protagonist, an air force officer, wants to assasinate Zia in reprisal for the murder of his father, a former Colonel in the Pak army.

Col Shigri was a key figure in the funneling of arms and money to the Afghan militia in their war against the then Soviet Union. The sums involved were large and a good deal went into the pockets of Pak army men. Shigri inteferes- and is found hanging in his own house. For the record, his death is described as a suicide.

The novel shows that the CIA wanted Zia out of the way and ambitious army officers were eager to carry out its bidding. It shows that the US diplomat's death in the crash was the result of a mishap but probably the sort of price that people in Washington are willing to pay when they want a job done. A Major Kiyani figures prominently in the story- I wonder if that is the present Chief of the Pak army.

Zia's paranoia makes for hilarious reading. The novel is tightly written, with a wry humour that never fails to find its mark. The murky goings-on in the Pak army are well chronicled. I said to myself after reading the novel: if a former Pak air force officer can write with such ironic detachment and so well about his country and the armed forces, there must be something very right with that country. Pakistan a failed state? No way, if this novel and its author are anything to go by.