Thursday, February 26, 2009

The downfall of RBS

FT carries a gripping account of the rise and fall of Royal Bank of Scotland under its former CEO, Fred Goodwin. After grabbing Natwest and some lesser financial institutions, RBS launched and won a bid for ABN Amro, deciding to plough ahead even after the onset of the global financial crisis in 2007. That one deal finished RBS. It is now virtually under UK government ownership after having received huge dollops of capital. I just heard on TV that the bank has declared $34 bn in losses in 2008- that's Rs 150,000 crore.

The one lesson from failures such as RBS and Lehman seems to be: when CEOs begin to show clear signs of megalamonia, investors had better watch. Such megalamonia manifests itself not just in a hunger for asset growth but in many other ways:

Within the bank, he fostered an intense management culture that prized discipline and attention to detail. Senior executives were set annual income and profit targets and challenged on whether they were meeting them. The chief executive exercised control through a daily 9.30am meeting where he would quiz managers about their divisions and openly question their competence. One morning he reduced a senior executive to tears. “It wasn’t a positive or healthy atmosphere,” says a former executive. “You have to wonder about the decisions people make in that environment.” ......

The chief’s attention to detail extended to attire and furniture. When RBS presented its results, Sir Fred and team would wear white shirts and matching ties with an RBS logo. The bank shipped chairs and carpets around the world so that each of its offices would have the same interior.

Shortly after the Natwest deal, he started planning a new group headquarters near Edinburgh airport and, former colleagues say, was involved in every aspect of the construction. Modelled on Santander City, the Spanish bank’s head office outside Madrid, the £335m building was opened in September 2005 by Queen Elizabeth in a ceremony that included a fly-past of four Tornado jets from a nearby RAF base.

How do companies and their boards indulge such CEOs?

Wednesday, February 25, 2009

Nassim Taleb on bank bonuses

Taleb, writing in FT, highlights a point familiar to readers of this blog: the heads-I-win- tails- shareholders-lose syndrome among bank managers taking risks with other people's money. Taleb says even the Obama administration's proposal for caps on pay not be enough:

The Obama administration has been trying to set compensation limits for banks under the troubled asset relief programme. But this is insufficient. We need to remove the free option. Beware the following situations.

First, those who are taking risks even outside Tarp or society’s protection can still be gaming the system – since their risk-taking can result in a collapse, with the taxpayer having to step in. For instance, Goldman Sachs, the US bank, might want to avoid the limits on executive compensation for its managers. That should be fine so long as society does not have to bail out Goldman Sachs (or, worse, its creditors) in the future.

Second, Vikram Pandit, Citigroup’s chief executive, while claiming to want to earn one single dollar a year in compensation unless the bank returns to profitability, is still getting a free option given to him by society. He does not partake of further losses; we do.

Third, leveraged buy-out companies used the free option by borrowing heavily from the banks and taking monstrous risks: they get the upside, banks (hence we taxpayers) get the downside. These partnerships made fortunes in the past on deals that society will have to bail out. They too should have their past profits clawed back.

Sunday, February 22, 2009

IIMC fee hike

IIM Calcutta has raised its fee to Rs 9 lakh from the present figure of Rs 5 lakh. The fee hike will apply from the batch of 2009-11. IIMA and IIMB had both effected steep increases last year. IIMC had not followed suit and, in fact, had claimed the high moral ground saying that its then fee structure was adequate to generate a surplus.

So, what's changed now? Maybe revenue from training programmes has declined steeply and this necessitated a fee hike? The least IIMC should have done was to explain why it resiled from its earlier stand. The explanation given, namely, that the revised fee merely helps the Institute recover costs is not adequate because last year the Institute had said that was not the line it would like to take.

IIMC's chairman, Ajit Balakrishnan, was a member of the IIMC review committee which submitted its report last year. The committee, while leaving it to IIM boards to decide the fee, had recommended that a particular formula be used for determining the fee. Has IIMC used that formula? Or does chairman Balakrishan differ with review committee member Balakrishnan?

IIMC has not covered itself with glory on the fee hike issue. Market-minded people would say it has merely ended up being behind the curve in raising its fee.

Friday, February 20, 2009

US diplomatic etiquette

I've been reading Jaswant Singh's memoirs, A call to honour. I am not ready to review it yet but I thought I'd share one or two tidbits about American diplomatic- if that's the right word- behaviour.

Singh writes about the build-up to the Pokhran II nuclear tests. The then US ambassador, Richard Celeste, is a bit uneasy about the BJP's intentions. He calls on Singh and tells him he's going away on a longish vacation. He hopes that nothing 'disagreeable' would happen during that time, which would mar his vacation. In other words, India's nuclear plans must be hostage to His Excellency's vacation!

Shows how American diplomats and members of government and also their army commanders are used to throwing their weight around. After the blasts, Secretary of state, Madeline Albright, tells Singh bluntly," You betrayed us".

Strobe Talbott has a slightly different version of the encounter in his Engaging India. He quotes Albright as telling Singh, "You lied to us and that's not what democracies do to each other". Singh has a way with words and was able to hold his own, telling Albright there is a difference between secrecy and deceit!

Singh is honest enough to say that the nuclear option had been kept open by all governments and it was only a matter of when India would test. Narasimha Rao, while demitting office, told Vajpayee that he couldn't do it and he hoped Vajpayee would.

As Singh makes clear, two events more or less clinched the issue in favour of a blast: the indefinite extension of the NPT in 1995; and the commencement of CTBT talks in 1996. Had the CTBT been signed by the US, India would have had to fall in line and that would have foreclosed our nuclear option.

The BJP's achievement was not so much going in for the nuclear tests as managing the fall-out. It was able to persuade the Clinton administration that a nuclear India was not a threat to the US but an asset and that the nuclear capability along with India's economic advancement made India an appropriate partner for the US in Asia. Of course, several other factors contributed to this changed equation, including the end of the Cold War and the rise of China. The Indo-US nuclear deal, negotiated by Manmohan Singh and George Bush, merely built on the formidable groundwork done by Vajyapee and Jaswant Singh.

Thursday, February 19, 2009

Nationalising US banks

Nouriel Roubini of Stern School believes nationalisation is the best of all options open in the present crisis. That's exactly what I have been saying. Roubini argues in a Business Standard piece that other options- such as recapitalisation, creation of a "bad bank" to house toxic assets, guarantees for private purchase of toxic assets- all face the problem of government or the tax payer overpaying the private sector and subsidising shareholders of insolvent or distressed banks.

With bank nationalisation, shareholder and bondholder losses can be immediately recognised and any upside on revival belongs to the tax payer. What about the cost? Roubini estimates losses at $3.6 trillion about half of which is in the American banking system. That means the US governemnt having to fork out $2 trillion.

It's still worth it because of the time factor. Any involvement of the private sector will be long drawn out, its outcome uncertain and losses will mount. Had the government stepped in earlier, it would have probably written a smaller cheque. It all boils down on how long we want the crisis to stretch out.

Responses to readers' comments

1. Subiksha- The question is asked: if it's an unlisted company, why should directors owe anybody an explanation for quitting? Well, I believe directors' responsibility should be viewed in broader terms- they have obligations towards all stakeholders, not just shareholders of the company. Investors in ICICI Venture might want to know what went awry; lenders in Subiksha too would be interested. When directors quit, especially when they do so en masse, citing reasons is a good idea.

2. First Global- My limited concern was about the linkage between the Tehelka exposure and the crackdown on First Global. If First Global or Shankar Sharma violated any securities laws, that is a different matter which I, for one, am not competent to judge. I also hold no brief for any political party and I accept that misuse of investigative and law-enforcement agencies has not been confined to any one party or coalition.

Tuesday, February 17, 2009

And now Subiksha

Subiksha, the Chennai-based retailer, is in bad shape. That's not a big deal in itself. The retail story has gone awry with the downturn and also because of firms having overextended themselves when real estate prices were sky high.

The big deal, if any, is about the accounts of Subiksha. Business Standard reported yesterday that ICICI Venture, which has a 23% stake in Subiksha, has written to the RoC asking for an independent audit of the company's accounts.

Subiksha MD R Subramaniam holds 59% of equity but he apparently contends that the company is actually controlled by ICICI Venture because the latter has the right to appoint a majority of directors. This is an interesting twist because it would imply that if there were accounts or audit issues at Subiksha, ICICI Venture would be responsible.

Incidentally, four of the high-profile directors resigned last week- Renuka Ramnath and Rajiv Bakshi of ICICI Venture, Rama Bijapurkar and Kannan Srinivasan (a Carnegie Mellon prof). What do these resignations imply? We do not know. That is why I have argued that when independent directors quit, they should be asked to furnish reasons.

Our sins, their sins

Today's papers showed Rahul Gandhi nodding off during the finance minister's budget speech. Apparently, he was not the only MP guilty of this. Take heart, my fellow Indians, politicians elsewhere are capable of worse.

Japan's finance minister is due to resign after having appeared drunk at a recent G-7 news conference. The minister denies he was drunk. He ascribes his performance- he slurred and appeared to fall asleep at one point- to cold medicine.

Well, even if the man had too much sake, you can't really blame him, can you? The Japanese economy turned its worst performance in 35 years, shrinking by 3%. Enough to make any finance minister hit the bottle.

'IT industry facing unprecedented crisis'

That was a headline in Indian Express today. The quote was acribed to Nandan Nilekani of Infosys. I read on to see what was meant. Nilkeani is quoted as saying:

....the compounded growth rate was 30 per cent and more and now it is reduced to 20 per cent due to economic slowdown.
Well, I guess that's the sort of 'crisis' most industries would love to have!

I do not, by the way, wish to understate the impact of a slowdown of this magnitude on the jobs market in India, especially the impact on the fresh crop of graduates from engineering colleges this year.

Wednesday, February 11, 2009

Anatomy of a witchhunt

In March 2001, the BJP government presented what many regarded as the real "dream" budget- I remember one industry spokesman ecstatically giving it a perfect score of 10. Unfortunately, the stock market did not think so. It tanked.

Hell hath no fury like finance ministry scorned. It was convinced that the market fall was engineered and it was determined to find out who was behind it. Ten days later the Tehelka corruption expose emerged and it turned out that one of the journal's promoters, Shankar Sharma of First Global Stockbroking, had short positions in the stock market.

The law enforcement agencies descended on Sharma. He was arrested and jailed for a long period without any charges being established against him. In September 2002, Sebi cancelled Sharma's stockbroking license. Eventually, Sharma was acquitted of all charges. Sebi's order was set aside by the Securities Appellate Tribunal in 2004.

There was much scepticism about the charges against Sharma even then. Sharma recently used the RTI to obtain the trading data for the relevant period. It turns out that First Global was not even among the top 50 short sellers ! Business Standard has strong words on the way the Sebi conducted itself:

It has long been suspected that the cases against Mr Sharma and his company were not a result of wrongdoing on their part, but as punishment for having been involved with Tehelka. The fact that the cases were dismissed (one on technical grounds) supports this view of what happened. Further evidence to buttress this view has now been produced by Mr Sharma, suggesting that the stock market regulator had no reason to suspect the activities of First Global in the first place. Using the Right to Information law, Mr Sharma has obtained the trading data maintained by Sebi for the period in question. These data show that First Global does not even figure in the list of 50 largest sellers, from the middle of February to the middle of March 2001. That raises the question as to why this data was ignored by Sebi before it passed orders against First Global. Indeed, the prosecution lawyer was so unhappy with the case being made out that he withdrew from the case, in itself a telling comment.

If so, several questions arise. On what grounds did Sebi take action against First Global? Why do the concerned people show reluctance to address the issues that have been raised? Sebi’s continued silence on this matter will only undermine its standing as an independent regulator that acts without being influenced by the government’s political motives. Cases of state vendetta against individuals are not unknown, but this is the first case where the political authority seems to have influenced stock market regulators. Is it coincidental that First Global received Sebi’s adverse verdict during the tenure of the Vajpayee government? And that the appellate tribunal set aside that Sebi order a few months after the Vajpayee government completed its tenure?

Tuesday, February 10, 2009

Tribunal for private educational institutions

The government plans a National Teachers Tribunal (NTT) to look into grievances of teachers and students at private educational institutions, Outlook reports.

The ministry has set up a committee headed by higher education secretary R.P. Agrawal to finalise the blueprint for the project that officials admit is likely to meet opposition from private educational institutions, who could see it as government intervention in what they consider their internal affairs. According to sources, the tribunal is expected to adjudicate in cases involving employment and selection of teachers and admission malpractices and unfair labour practices.

This is a welcome move. But much depends, as Prashant Bhushan points out, on the quality of people appointed to it. Malpractices abound in private educational institutions and teachers and students alike are at the receiving end. For instance, teachers are forced to sign pay slips for amounts in excess of what they get; they are often not paid on time; and capitation fee is a thriving cottage industry. Part of the reason these issues have not been addressed is that many of the institutions, especially professional colleges, are run by politicians themselves, so there is no serious interest in reform.

I am not sure, though, that such an authority should be only for private institutions. Public institutions too could be covered by them- it is not as if all is hunky-dory there and there are appropriate grievance redressal mechanisms. For the central educational institutions, such as IITs and IIMs, it may be a good idea to mandate the setting up of CAT (central administrative tribunal)- like bodies with a defined composition and clearly specified powers.

However, such an authority cannot mix teacher and student issues- that would be too much to handle. Let us have the NTT for teachers and a regulator for education as the NKC has recommended, which can look into admissions, fees and other issues.

How the mighty have fallen!

Guess whom IIT Bombay is looking towards to bail out placement? PSUs! Until last year, the top graduates there were targeting investment banks and private equity. The financial crisis has changed all that. ET reports:

Seeing the poor response by traditional recruiters in the first month of placement, public sector units such as IOC, ONGC, GAIL, BPCL, HPCL, BHEL, MTNL, NTPC and SAIL are being contacted by the student placement cell of IIT Bombay, inviting them to visit their campus for recruitments.

Placements on the IIT campuses across the country, which began in January, have suffered due to the economic slowdown, with even IIT Bombay, a much sought-after institute among most companies, seeing lukewarm response from the private corporate world so far. The trend is evident with placement dates being extended till April. Earlier, the placement process at the IIT Bombay used to get over within two to three days.
A reader comments that the report appears to apply to the Management school at IIT Bombay rather than the campus as a whole. But the situation for engineers cannot be a lot better. We are seeing similar problems at the IIMs where recruiters are asking that the placement fee be waived. Many FMCG and manufacturing companies long disdained by the IIM fraternity are taking their time responding- I guess they have a point to make. The IIM average salary, for long artificially inflated by the dollar-paying overseas segment, will now look a lot more modest.

I believe the corrections to the excesses that are now taking place are entirely welcome. Both the financial sector and the IT sector had created huge distortions in the graduate markets. Manufacturing companies and public sector companies were the big losers in the talent contest and we had the ridiculous spectacle of whole batches from engineering colleges veerring towards IT as though none of the other engineering disciplines mattered.

The debacle among banks and investment banks has taken the fluff out of the financial sector. The slowdown on the American economy and the Satyam episode is causing a reassessment of the IT sector. After the Sixth Pay Commission, government and public sector jobs, with their combination of decent pay, housing, job security and post-retirement benefits are beginning to look attractive. Whatever the problems it may have created, we should thank the financial crisis for restoring balance to the Indian job market and to aspiring young Indians.

Saturday, February 07, 2009

US curbs on bankers' pay

The US will cap bankers' base pay at $500,000. Big deal. They will still continue to receive variable pay in the form of stock options. Moreover, the cap applies only to about 25 firms that have received extraordinary emergency assistance. It also does not apply to people down the line. This is just tokenism. I guess it's necessary tokenism given public fury over tax payer money being lavished on failed banks. Besides, if you are under part government ownership, you must accept government pay scales.

Base pay has always been a relatively small component of pay payckages on Wall Street. The real moolah is in variable cash and stock option payouts. My quarrel has never been with the absolute size of these payouts. It has always been about the design of compensation schemes.

Performance in a bank can never been accurately measured at a point in time. What is performance can be known only over the entire business cycle. It follows that variable pay should never be handed out in full at the end of the year. Only a portion of the variable cash component can be paid out- the rest goes into an account. If there is a loss in the next year, there will be a negative entry in the CEO's account. And so on for a period of seven or ten years, which is the length of the typical business cycle. At the end of the period, variable cash pay will be handed out. Similarly, stock options can vest only over a very long period- say, 10 years.

Remember, Lehman and others recorded their historical best peformances in the years preceding their downfall. Making bonus payments in all those years was absurd because that so-called performance also contained the seeds of future downfall.

The salary cap apart, there is much drama being enacted in the US over executive use of corporate jets for travel. For the forthcoming Congressional hearings, top bank execs are going to extraordinary lengths to avoid courting controversy. FT reports:

Weary travellers trying to negotiate New York’s La Guardia airport on Tuesday night or Wednesday morning should not be surprised to bump into Goldman Sachs' Blankfein or Morgan Stanely's John Mack.

Vikram Pandit, Citigroup’s chief executive will also be on one of the NYC-DC air shuttles. After being castigated by the US Treasury for wanting to take delivery of a $50m jet – a decision subsequently reversed – Citi is in no mood to antagonise its government benefactors.

As for Jamie Dimon, people close to the JP Morgan Chasechief did not disclose his means of transport other than to say it will be public.

The banks’ spin doctors argue that commercial travel is often the preferred choice for New York-based executives because of the frequency of flights between the Big Apple and the nation’s capital.

But even John Stumpf, who runs San Francisco-based Wells Fargo , is going to have to stand in line at security before he embarks on his coast-to-coast jaunt.

Ken Lewis, the Bank of America chief who is trying to sell three corporate jets and an helicopter acquired with the takeover of Merrill Lynch, will cover the 400 miles between Charlotte, North Carolina, and Washington by train.

Thursday, February 05, 2009

Banks under pressure to lend more

I just don't get this. Credit has grown by 24% over the year. This is also the target for credit growth the RBI has set for the coming year. Yet, there are complaints that banks' aren't doing enough.

For the coming year, let's assume GDP growth of 6%. Add an inflation rate of 4%. That gives us nominal GDP growth of 10%. Is credit growth of 24% not adequate to support nominal GDP growth of 10%? Alright, I understand that various other sources of funds have dried up- the capital market, overseas borrowings etc. But RBI data show that in the year to date, total flow of resources to the commercial sector is only 3% lower than in the same period last year. I'm not sure that qualifies as a 'credit squeeze'.

The RBI's credit policy statement shows that credit growth has been high only for public sector banks. Credit growth in PSBs has risen from 20% last year to 29%. Private banks and foreign banks show an appreciable deceleration in credit growth- from 24% to 12% at private banks and 31% to 17% at foreign banks.

Either the private players are market-savvy and are right in slowing down credit - as many have always claimed they are- or they are more risk-averse than public sector banks. Which statement is true? Again, there has meaningful decline in lending rates only among PSBs. Rates remain rigid for private and foreign banks. This again underlines the fact that, in a crisis, even if you want to stimulate credit growth, it helps to have government ownership. Governments in the US and Europe are rediscovering this truth.

Government and industry want banks to lend more and reduce rates (which in itself is a bit of a contradiction). There are structural limitations to both credit expansion and rate reduction. I elaborate on this in my latest column, Should banks be lending more?

Tuesday, February 03, 2009


The Right to Information Act was a revolutionary step towards strengthening Indian democracy. There is a lot of good that has come out of it and it does carry a great deal of promise. But, I have always wondered how long the system would put up with it. Some recent developments do give cause for concern as to whether the spirit of the RTI will be observed in all instances:
  • The Supreme Court contends that information on assets provided by judges to the Chief Justice need to be made available to the public and also it need not be disclosed whether all judges have disclosed their assets to the CJI.
  • The PMO now contends that declarations by ministers are held by the PMO in a fiduciary capacity and need not be made public.
  • The CIC itself holds that information commissioners are not obliged to declare their assets- this is, perhaps, the unkindest cut of all.
RTI, RIP? Let's hope and pray.......

Is there a credit squeeze in India?

They say that Indian firms face a credit squeeze because non-bank sources of credit, including overseas sources of credit, have dried up. Banks are lending more than they did last year: commerical credit grew by 24% in the period upto Jan 2009 compared with growth of 22% last year. But, it's the lack of funds from other sources that's the problem- so we hear.

Well, the RBI's latest credit policy statement has comprehensive data on total flow of funds to industry, from bank as well as non-bank sources, including financial institutions, NBFCs, capital markets, ECBs, FCCBs, ADRs/ GDRs, FDI and short-term credit. In 2007-08 (upto Jan 4), total funds to the commercial sector was Rs 499,000 crore. This year, it was Rs 484,000 crore- a shortfall of 3% with respect to last year. How does this qualify as a squeeze that is throttling Indian industry? Somehow, the numbers don't bear out the sense of a huge credit crisis.

There is one possible explanation, though, one that I ventured earlier. Some portion of what appears as bank loans could be merely 'loans recoverable' against mark-to-market losses of firms. This is not really credit for productive purposes. To that extent, official figures for bank credit growth would overstate supply of credit.

I have said that the RBI needs to quantify this item. Only then will we know how real is credit growth- and, of course, we will also have some idea of what sort NPAs banks are likely to face on account of firms' mark-to-market losses. Much of this has gone into litigation or is being sorted out through negotiations.

A historian's olution to the banking crisis

A few things kept me away from blog over the past few days.... I return with the recommendations of historian Niall Ferguson on how we might tackle the banking crisis.

Ferguson thinks government spending in the US is not the answer because it will take the budget deficit past the danger mark of 10% of GDP. He proposes instead that:
  • Government recapitalise banks after losses are fully written down and bond holders take a hit of about 20% or convert debt into equity. This is fine but the solution still involves government spending, doesn't it? For some reason, Ferguson would call this 'restructuring' not 'nationalisation' with a commitment to re-privatise after 10 years. If nomenclature will solve the trick, ideologues can please themselves. To me, it's nationalisation.
  • Mortgages be reset at lower rates. This will revive customer confidence. Yes, but it involves a huge hit for banks and holders of mortgage-backed securities. It will also imply a bigger government infusion of funds than otherwise.
Ferguson writes, " The best evidence that we are in denial about this is the widespread belief that the crisis can be overcome by creating yet more debt." Will somebody explain to me how Ferguson's proposals will avoid creating more debt? Or has he made calculations that show that the debt increase in his scheme would be lower than in the Obama scheme?