Wednesday, January 28, 2009

Will bank bosses never learn?

I guess you have to give up at some point. Citigroup had to be told by the office of Tim Geithner, the new US Treasury secretary, to cancel a pending $50 mn purchase of executive aircraft at a time when it is on government support. Citigroup was apparently adamant about going about the purchase and its people had to have their arms twisted before they saw sense.

This comes after the news of the $3-4 bn bonus payout at Merrill just ahead of the closure of the acquisition by BofA. Merill's CEO, John Thain, had no qualms about blowing up $1.2 mn on renovating his office (including a $30,000 spend on a commode- one does not know whether this particular purchase was warranted by Thain's heightened nervousness over the future of Merrill under BofA management). Thain has just been issued a subpoena by NY's attorney general which is probing the accelerated bonus payout and to what extent BofA bosses knew about it, FT reports.

Just to round off the bad news on financial firms, Nomura is reeling under the purchase of Lehman - it has posted a loss of $3.9 bn for the last quarter, which includes losses on exposure to Iceland and to Madoff.

Saturday, January 24, 2009

Bonus for non-performance

Do these guys have no shame? It turns out that Merrill Lynch paid out $3-4 bn in bonuses just three days before the closure of its sale to Bank of America. This happened just as BofA sought an additional $20 bn from the US government to help it close the deal.

Merrill's boss, John Thain, was about to seek $10 mn in bonus for himself but changed his mind. No doubt, this was for Merrill's operating loss of $21.5 bn in the fourth quarter. He had also spent lavishly on renovating his office- a fact to which President Obama referred in a speech yesterday. Thain won't be around to enjoy his sparkling office- BofA chairman Ken Lewis has given him the boot.

Citigroup board make over

Citigroup has acquired a new chairman. It is also in the process of a general board makeover. Two of its present directors will leave after putting together a combined 59 years on the board of Citi and its predecessor companies. Incredible! The US limits the president to two terms of four years each but the US corporate world doesn't seem to believe in fixed tenures for directors.

It's not as if these two guys bring invaluable banking expertise to the board- one is a former chairman of Chevron, the oil group, and another ran the Ford Foundation. A third director, coming up for retirement, is a former CEO of AT& T. Maybe the US Fed could borrow a leaf or two from the RBI with respect to the appropriate composition of bank boards, fixed tenures for directors (eight years for banks in India) and "fit and proper" criteria for board members.

Thursday, January 22, 2009

Indian banking looks sound

Three private banks- Axis Bank, HDFC Bank and IndusInd Bank- have reported earnings growth of over 40% in Q3. This, at a time when banks worldwide have collapsed and there is an earnings debacle forecast for non-financial firms in India. How come? Is this sustainable?

Well, the Indian banking situation is very different from that in Europe and the US. There, banks' distress is the cause of the economic crisis. Here, it is a consequence. The Indian economy is hit on two counts- exports have slowed down and so have capital inflows because of international conditions. Indian banks are not directly impacted by the financal crisis because of their low exposure to the sub-prime market.

The slowing down of the economy impacts on banks. But, you have to remember that economic growth of 6% is still pretty good for any banking system. Through the nineties and until 2003, that sort of growth brought about the turnaround in the Indian banking system.

We don't know what nasty surprises the financial crisis will throw up next. But, Indian banking looks pretty sound- and we can expect it to be an outperformer in the Indian economy in FY 2009-10. More on this in my ET column, Banking remains a bright spot.

To nationalise or not?

Governments in the US and Europe have lent support to banks but (in most cases) stopped short of nationalising them. The reasons are partly ideological (government ownership is evil) and partly fiscal (it brings a huge amount of liabilities onto the government's balance sheet).

The problem with muddling along without nationalising is that private banks simply won't lend in the present conditions- risk aversion holds them back. Willem Buiter weighs the pros and cons of nationalisation in his blog:

There are two ways of resolving this problem and of incentivising the capital-deficient banks to lend again. The first is to make the capital cheap (gratis, in the limit) and to minimize the onerousness of the rest of the conditionality. This is the road taken in the US. The US Treasury injected capital into Goldman Sachs at less than half the cost to Goldman Sachs of a capital injection by Warren Buffett a few days earlier. AIG got a tough deal from the Fed and the US Treasury at first, but obtained much sweeter terms less than a month later. The latest capital injection into Citi by the US Treasury (preferred stock with a dividend yield of eight percent) is very cheap.

By throwing cheap money with little conditionality at the banks, the Fed and the US Treasury may get bank lending going again. By subsidizing new capital injections, they reward bad porfolio choices by the existing shareholders. By letting the executive leadership and the board stay on, they further increase moral hazard, by rewarding failed managers and boards that have failed in their fiduciary duties. All this strengthens the incentives for future excessive risk taking.

There is a better alternative. The alternative is to inject additional capital into the banks by taking all the banks into full public ownership. With the state as sole owner, the existing top executives and the existing board members can be fired without any golden handshakes. That takes care of one important form of moral hazard. Although publicly owned, the banks would be mandated to operate on ordinary commercial principles. Managers could be incentivised by linking remuneration to multi-year profitability. The incentives for excessive liquidity accumulation and for excessively cautious lending policies that exist for partially nationalised banks and for banks fearing nationalisation would, however, be eliminated.

In addition, full public ownership of the banks would greatly facilitate the creation of a ‘bad bank’ that would hold on its balance sheet all the toxic assets (illiquid assets of highly uncertain value) currently held by the high street banks. The key problem with any bad bank proposal is the price it pays for the toxic assets it acquires from the banks. If all the banks, and the bad bank, are publicly owned, this problem goes away. The toxic assets are simply moved to the balance sheet of the bad bank. They could be valued at anything from zero to their notional value or historic cost (or even higher). It would be a redistribution of wealth from one state-owned entity to another state-owned entity.

Monday, January 19, 2009

A comprehensive failure of regulation

There has been a comprehensive failure of every one of the three pillars of regulation: disclosure to ensure market discipline, adequate capital and effective supervision, says an article in FT.

The author used public domain data in October 2007 to estimate losses for banks. He says he came up with estimates that turned out to be pretty accurate. For Citigroup, for instance, the form 10 Q statement filed with SEC by the bank showed that Citibank’s tier one (equity) capital at the end of the third quarter of 2007 was $92.3bn and the subprime exposure accounted for 242 per cent of tier one capital! Neither market analysts nor regulators used the data to form a coherent picture of the full magnitude of the crisis- so much for market efficiency.

As for regulation and capital adequacy, all the banks that failed were compliant with Basel II. Which clearly means that Basel II is simply not upto the job of containing risks exposed by the sub-prime crisis.

Finally, bank supervision proved inept. In January 2008, the IMF estimated bank losses at $1 trillion. But it took the collapse of Lehman for regulators to wake up to the enormity of the crisis and respond to it.

Clearly, we will need a radical rethink of the entire regulatory architecture. Here's one disconcertingly radical thought: perhaps, as in the Indian banking system, it would be in the interest of systemic stability to have some component of the banking system owned by the state.

Demise of Citigroup?

A $2 trillion bank being allowed to fail? Seems impossible to contemplate. But analysts are beginning to think the unthinkable: the possible demise of Citigroup. The bank's share price is down to $3.5, its market cap of $20 bn is less than its wage bill. How much longer before it goes bust?

Right now, Citi is waging a grim battle for survival. Losses for the year came to around $ 19 bn, taking total crisis losses to a staggering $100 bn, almost the size of ICICI Bank's balance sheet. Last week, it sold a 51% stake in Smith Barney, its brokerage arm, to Morgan Stanley.

It has announced that the company will be split into two separate companies, one housing sound assets of approximately $ 1.1 trillion and another housing bad assets of $850 bn. The idea is to reassure investors about the viability of the core part of the bank. The bad part is to be eventually sold off. The key word is "eventually". Until buyers are found- difficult until as long as the crisis drags on- the bad part will continue to bleed the bank.

A new chairman will be in place soon, according to media reports. CEO Vikram Pandit may make way for a seasoned commercial banker.

Does this add up to a rescue plan? Not by a long chalk. With problems spreading to the real sector, it is a moot question whether the good part of the bank will remain insulated from problems for long. Capital raising is next to impossible- more capital can come only from the governemnt, which has already given $45 bn in addition to guarantees.

If Citi cannot convince the market that it can soon be viable, the last option would be nationalisation. But will the government be willing to pour more capital into a bank that does not hold out the promise of a quick revival?

The prospects look very bleak indeed. Unless buyers emerge for a big chunk of the bad assets and the US economy turns around more quickly than most people expect, the odds are against Citi surviving.

Tuesday, January 13, 2009

And now Satyam's EMRI service

Troubles come in battalions. Perhaps because the company's chips are down, its vaunted emergency services are coming under fire. (Kiran Karnik, recently appointed director of Satyam, was on the board of this organisation along with Krishna Palepu, K V Kamath and other distinguished personalities).

ET reports that the NGO is being sued along with 11 state governments for anti-competitive practices.The charge is that it grabbed Rs 3800 crore of contracts without proper tendering being done:

The PIL in the SC, however, has been filed against EMRI, its ex-Chairman Ramalinga Raju and 11 state governments. The petition alleges that: “The process of award of contracts (for running ambulances) is being effected without following the due fair process. The respondent states have either already entered into or is considering awarding the contracts or have tailor-made the EoI to suit EMRI in the name of saving lives using funds under the National Rural Health Mission (NRHM).”

On a different note, FT's Lex column makes the point that the impact of Satyam is not confined to the IT sector (where Infosys has gained in value and Wipro has lost). Family-owned businesses are also feeling the impact:

It is telling that neither Ambani brother has emerged with the market’s vote of confidence. Shares in Mukesh Ambani’s Reliance Industries are down 21 per cent since last Tuesday; those in Reliance Communications, the telecoms group controlled by his younger brother, Anil, have fared even worse, slumping 29 per cent.
It is worth mentioning that SEBI has ordered an independent review of the financials of the Sensex and Nifty firms. Investors should keep their fingers crossed.

Monday, January 12, 2009

Independent directors and consulting fees

Krishna Palepu, HBS professor who served on Satyam's board, was characterised as 'non-executive' director in 2007-08. Presumably, he could not be called 'independent' director because, in addition to hefty sitting fees and stock options, he collected a huge fee for running training programs for Satyam staff. His total fee came to Rs 92 lakh- not bad even for a HBS prof, eh?

What I would like to know was whether Palepu was inducted originally as 'independent' director. If yes, then he should not have accepted any consulting assignment from Satyam. An 'independent' director is defined as somebody who has not had a pecuniary relationship with the company in the recent past. It would be absurd to construe this to mean that a pecuniary relationship in the present is somehow acceptable.

In the Enron and other scandals, independent directors collecting fees (other than sitting fees) was found to be part of the problem, exactly as auditors doubling as consultants was. I do not know if this practice was outlawed thereafter but certainly there was agreement that this was not consistent with good governance.

Perhaps, the time has come to make the legal position clear: if you are independent director, you cannot collect consulting fees from the company whose board you serve on. For a start, let Sebi write to all companies asking them to disclose if any of their independent directors have had a consulting relationship with them and the fees paid. The list of independent directors involved should be made public.

Satyam's ex-independent directors

The plight of Satyam's ex-independent directors must cause other independent directors to shiver in their shoes. They face a show-cause notice from the Company Law Board, probes by SEBI and law-suits in the US. The damage to their reputations has been immense. Let's see..
  • M Rammohan Rao has had to quit as director of the Indian School of Business. He has also withdrawn from the panel to select the Dy Governor of the RBI.
  • Krishna Palepu, it is reported, is under pressure to quit the board of Dr Reddy's Labs.
  • T R Prasad, former cabinet secretary, stuck to his directorship even after all the revelations. He has suffered the ignominy of being booted by the government of India, the very government he had served all his life.

At this point, one needs to distinguish between the aborted investment in the two Maytas companies (which the independent directors approved) and the accounting fraud. So far as the latter is concerned, we have to await the outcome of the investigations to establish if there were any failures on the part of independent directors.

The reason these guys are being pilloried is that they did not oppose the Maytas investments- and there is a presumption that if they could be so supine in that instance, they could not have been effective generally. Had any of the independent directors opposed that move, it is possible that they would have been given the benefit of the doubt in respect of the accounting fraud.

I notice also that most of the fire is focused on the two b-school academics, Rammohan Rao of ISB and Krishna Palepu of HBS. The two other academics (Dr M Srinivasan, former faculty in American universities and V S Raju, director of IIT Delhi) are not facing the heat to the same extent. I guess there is a feeling that b-school academics, who preach good management and governance to the rest of the world, must be held to higher standards. B-school profs on other boards had better watch out!

Incidentally, on the Net, what we are seeing is not just criticism of the independent directors, but abuse, plain galis. Liar, cheat, rascal- these are among the kinder expressions being used. I will refrain from reproducing the harsher ones.

In yesterday's Indian Express, Sandipan Deb has a comment that captures the sheer depth of sentiment against the independent directors and particularly the b-school profs:

His official CV states that “in the area of corporate governance, Professor Palepu’s work focuses on how to make corporate boards more effective, and on improving corporate disclosure”. Among the executive programmes he teaches is “Audit Committees in a New Era of Governance”. “He also co-led Harvard’s Corporate Governance, Leadership, and Values initiative, launched in response to the recent wave of corporate scandals and governance failures.”
A friend of mine wrote to Palepu. “Evidently,” he wrote, “you are guiding US-based global corporations in such matters. However, in your ‘home’ country, you are helping organisations like Satyam steal shareholders money. My question is simple—does this make you a traitorous hypocrite, or merely a greedy criminal? I’m inclined to the latter, but as an eminent Harvard professor, perhaps you can guide me on the correct terminology? Look forward to your response.”

Guess what? Palepu has not replied. “Greedy criminal”, I would think.

Friday, January 09, 2009

Satyam fall out

There is the possible collapse of the firm and its impact on over 50,000 employees; then, the possible folding up of PricewaterhouseCoopers if anything is proved against them. The loss to shareholders of Satyam. There is the impact on brand India and the IT sector, the impact on capital flows into the country especially if any other scandal erupts. All this has been talked about. What else? Well, a few things:
  • The future of Hyderabad Metro: this deal was won by Maytas Infrastructure in the face of strong criticism from Delhi Metro chief E Sreedharan, who indicated it had all the makings of a land scam. The project is meant to be a feather in the CM's cap, so he's going to have some sleepless nights over this.
  • The Byrraju foundation: this is not your run-of-the-mill NGO. It's a huge thing involving 200 villages and covering one million people, according to some reports. The foundation's CEO recently sent out a letter that says that Raju has thus far contributed Rs 300 crore from his own funds to the foundation.
  • The 108 emergency project: Raju had signed contracts for PPPs with several state governments to provide emergency services. I heard these are running well. The state governments invest in ambulances and other hardware. Raju takes care of the operations including software, back office and control rooms.
Incidentally, has a nice backgrounder on the rise and fall of Raju.

Thursday, January 08, 2009

Satyam fraud: how do we overhaul governance?

In my ET column, I list some governance reforms that we could think of in the wake of the Satyam fraud.

This is not a collapse triggered by the sub-prime crisis but the disclosure of the fraud may not be entirely unnconnected with the crisis. There is pressure on volume growth and margins in the current environment. That would have caused Ramalinga Raju to give up hopes of closing the gap of Rs 7000 crore on the balance sheet.

But this is very different from the collapses of financial firms that we have seen. In those cases, you could argue that they were all highly leveraged institutions intrinsically prone to failure, that they dealt with complex products that neither management nor the board could fully comprehend. This is a collapse that has occurrred in the IT sector and entirely on account of internal fraud.

One of the regulatory lessons being drawn from the financial sector crisis is that large institutions need to be regulated, whether they are banks or non-banks. I think the basic principle may have to be applied to all large firms, irrespective of the whether they are in the financial sector or not.

If you are large, you are systemically important. Not that we have will have the entire panoply of regulations that we have in the financial sector. But a second layer of audit that I propose in my column is essential. For banks, there is regulatory audit in addition to statutory audit.

One fall-out of the Satyam affair, as indeed of the ongoing financial crisis, is that we are beginning to see the virtues of public sector companies. You can be more sure of accounts in a PSU than in a private firm- there are fairly elaborate checks and balances on fudging of accounts. Being an independent director on a PSU is less tension-ridden than being one on a private company- and you can also be more independent because independent directors are appointed by the ministry, not PSU management.

Above all, in a PSU, you have the one thing that Indians still prize above everything else at the workplace- job security. Think of the 50,000 employees of Satyam and the worthless stocks and stock options many must be holding. Do not be surprised if, on a long view, there is a re-rating among investors and employees alike of the relative merits of the private sector and PSUs.

Wednesday, January 07, 2009

CJI not exempt from RTI

A three member bench of the Central Information Commission has ruled that the Chief Justice of India is not exempt from the purview of RTI, TOI reports.

An RTI activist has asked to know whether SC judges had been regularly declaring their assets to the CJI since 1997, as rquired by an apex bench resolution at that time. The SC had taken the position that the information was not with the registry but with the CJI's office and the CJI himself was exempt from RTI, hence the information could not be provided. The CIC has rejected this contention as well. It has ruled:

“If any information is available with one section of the department, it shall be deemed to available with the public authority as one single entity.”

This is a valuable ruling indeed because no government institution can now withhold information on the ground that the particular department or official from which information is sought does not have keep the information- if information is available anywhere within the institution, it has to be provided.

Significantly, the application to the SC had not sought copies of declarations of the assets themselves. This is a more thorny issue. On this, TOI reports, the CJI has taken the position that this is information obtained by the CJI in a "fiduciary relationship" and that it was "personal information", hence details of judges' assets need not be made available to the public.

Tuesday, January 06, 2009

How international are US universities?

The US outperforms other countries in the international student market, the Economist reports, with a share of 22% of international students. But foreign students are just 3.5% of total students on US campuses although the absolute numbers are large. There is scope for raising the latter number. Apparently, it has not happened because US universities are averse to soliciting custom by appointing agents. Universities in other countries have no such qualms, so agents lead students to non-US universities.

The story does not mention this but US universities are also not disposed towards going overseas. The top b-schools do not have many overseas locations. Resistance to foreign entry may be one factor but a more important reason could be that US universities think the best students will come to them anyway, helped by generous scholarships. Another reason could be that faculty and education quality may be difficult to maintain over dispersed locations.

Woes of independent directors

Independent directors at Satyam came out with their reputations tarnished. M Rammohan Rao of ISB has since resigned from the search committee to select the Deputy Governor of RBI. But these reputation effects are small beer compared to what can happen when things go seriously wrong with a company.

Nimesh Kampani, chairman of JM Financial and a highly respected figure in the Indian financial community, faces an arrest warrant for having served on the board of Nagarjuna Finance, a now defunct Hyderabad-based NBFC, in 1999. The company defaulted on a fixed deposit after he resigned. But the Andhra Pradesh police will have none of it. Presumably, Kampani is being held responsible for FDs collected in his time.

The ET report on this yesterday mentioned the Supreme Court rulings to the effect that independent directors cannot be held responsible for lapses in day to day management. It could also be argued that in matters such as default on fixed deposits, any liability should be civil, not criminal unless mala fide intent or culpability for misuse of funds ( in the sense of illegal use) is established. I mean, companies, including NBFCs, can go under. Does this mean independent directors should face criminal charges?

Sunday, January 04, 2009

Gujarat govt scheme fails at GNFC too

I noted in my last post that a resolution authorising the company to donate upto 30% of pre-tax profit to a social sector fund proposed to be created by the state government, a Gujarat PSU, had failed to muster the necessary shareholder support. The same thing has happened at GNFC, a company in which the Gujarat government has an indirect 41% stake.

Sandeep Parekh has the details at his blog.

Thursday, January 01, 2009

Gujarat government charity schme fails at GACL

ET today reported that the proposed move to use 30% of pre-tax profit at PSUs in Gujarat has failed to get the shareholders' nod at GACL. The proposal required approval of three-fourths of shareholders. The proposal failed to muster the necessary votes at GACL thanks mainly to opposition from institutional shareholders.

There has been criticism of the charity move on the ground that it is inimical to the interests of non-government shareholders. But the state PSUs hardly have the profile of a Satyam, so the coverage of the issue has been rather small.

Citi execs to forgo bonus

Citigroup CEO Vikram Pandit, advisor and director Robert Rubin and other senior executives are to forgo bonuses this year, FT reports. I can't see why this makes news. The group has announced huge losses and has been kept afloat by a $300 bn government bailout. The terms of the bailout require the US government to approve bonus packages.

But, perhaps I am being too naive. In the top banks and investment banks, the firm as a whole may be making losses but individuals can still get rewarded if their divisions have made profit of they, as individuals, have made profit. The culture is that you can't penalise high performers because others have stumbled badly; if you don't handout bonuses to performers, they will leave.

The FT report only mentions that some senior execs will forgo bonuses. It is not that there will be no bonuses at all. So, the 'culture' stays, even if there is some departure from it in these troubled times.

I was a little surprised to see mention of a 'clawback' clause in compensation schemes. But this refers to only to bonuses obtained through false information, not to bonuses being clawed back when people do badly in a given year after having done well in the previous years. As readers of this blog would know, the scheme I have urged is that just as there are bonuses against profit, there should be clawbacks or negative bonuses against losses. The adjustments of pluses and minuses should be made over the business cycle with the residual payout happening at the end of the cycle.