Sunday, May 27, 2012

JP Morgan risk management

JP Morgan has made a change in its risk management committee consequent to its trading loss that is now estimated at upwards of $2 bn, FT reports.

A lady, the president of the American Museum of Natural History, will make way for the former chairman of KPMG.  I don't see this as a reflection on risk management at JP Morgan but I certainly see it as a reflection on how seriously management takes its board. One should not be surprised. Lehman Brothers had a theatre impresario as member of its risk management committee prior to its failure; Citibank had a former spook from the CIA on its board. ( I say this from recollection).

Now, I do not subscribe to the view that merely because one is an expert in a subject, one is effective on the board. You can be the ultimately authority on risk management and still nod your head to whatever the management wants done. But for certain specialised roles, qualifications are a necessary, though not sufficient, condition.

About the $2 bn trading loss itself, it is a lapse, a bad call but it cannot in itself become a condemnation of top management. JP Morgan made a profit of $19 bn last year; it can afford to take a $2 bn loss, especially on a balance sheet of over $2 trillion. JP Morgan's return on equity has been higher than average, so shareholders have little to complain about. If Jamie Dimon is attracting unusual flak, it is because he made the cardinal sin of taking on regulators and policy-makers, he sounded a little too cocky, which is a bad idea for the head of a bank.

You could say that a loss of $2 bn today could become a loss of $20 bn tomorrow, that is why banks should not combine traditional banking activities with trading. But, then,  a bank can run up a loss of $2 bn on credit risk as well. So the JP Morgan loss also does not in itself become an argument for the Volcker rule.  The British proposal to ring-fence deposit-taking activities with higher capital may be a better answer than asking banks to shed trading and other activities. Restricting the scope of banking is not the answer to bank failure; restricting the size is a better way to contain the costs to the tax payer.

Saturday, May 26, 2012

Eurozone impact on India

There is more than element of panic in the reaction to the fall of the rupee this month, methinks. India Inc has been howling ''crisis'' and it blames it on ''policy paralysis". These concerns are misplaced. The fall in the rupee is a natural response to the widening of the current account deficit beyond 4%, exacerbated by the flight of FII capital in the wake of the Eurozone crisis. The decline in the rupee is a natural stabiliser and should cause the CAD to fall this year. Remember, an important reason for the large CAD we are seeing now is huge gold imports. The fall in the rupee should help address this issue.

It may well be that Rs 56 is a bit of an excess but that is to be expected given overshooting in the currency markets. Some intervention may be required whenever there is too steep a fall because FIIs can start pulling out in an even bigger way if they suspect a free fall. The RBI is doing its bit and can be counted upon to do more if required. The government, for its part, is trying to address the fiscal deficit by raising the prices of petroleum products.

It is not at all clear that the flight of FII capital is on account of "policy paralysis". There was little movement on reforms in 2011 but that did not come in the way of nearly $10 bn of FII flows in the first three months of 2012. The present flight of FII flows is a  reaction to the Eurozone crisis and represents the preference for the safe haven of US treasuries in times of crisis. Those who think government inaction has led to foreign investment sentiment must explain why FDI rose significantly in 2011-12 over 2010-11.

I don't see the decline in the rupee as a harbinger of bad times to come. The Eurozone crisis that we are now faced with is no different from what we faced in late 2011. Since we managed growth of 7% then, we can be optimistic about touching 7% this year as well. You think that's bad? Think again. If we touch 7%, we will be the second fastest growing economy in 2012 in the world after China.

More in my ET column, Global recovery is two years away.

Wednesday, May 23, 2012

Quotable quotes in Rajat Gupta trial

The trial of Rajat Gupta, which commenced this Monday, has already produced a couple of quotable quotes from the judge, Jed Rakoff:

"If Mother Teresa were charged with bank robbery, the jury would still have to determine whether or not she committed a bank robbery.".

Judge Rakoff also told Gupta's lawyer "I will not allow you to say that he is world renowned leader", adding that he would not approve of any reference to "Aids, malaria ... or the bubonic plague".

Thursday, May 17, 2012

Storm over executive pay

A fresh storm has erupted on both sides of the Atlantic on the subject of executive pay. There has been a shareholder revolt at Citibank, Barclays and other places. Shareholder vote on pay is non-binding but negative votes do cause boards and managements to pause in their tracks.

Linking pay to performance has proved elusive despite the best of efforts. I am convinced that neither boards nor management will settle for moderation. If  you can loot and get away with it, why not?- this really is the sentiment in boardrooms.

What is to be done? I came across two off-beat suggestions in an article by Philip Stephens of the FT:

The effort should start with two simple measures to increase transparency and to frame pay levels in the context of wider society. The first, which should be included in Mr Cable’s legislation, would require chief executives to make a personal statement at the front of the company annual report.
The statement would set out in plain English the total in pay, bonuses, incentives and benefits in kind the CEO had received for the relevant year. It would measure these against short- and medium-term company performance – earnings per share, dividends, the share price and the like. The chief executive would then bring the two together to justify his or her pay. This would be countersigned by the head of the remuneration committee. The whole thing need not run to more than a single sheet of A4. 

....The second measure would further extend accountability by giving an oversight role to MPs. Each year, the Treasury committee, or perhaps the business, innovation and skills committee, would schedule hearings with chief executives to discuss the level of boardroom remuneration.
Invitations would be sent to a cross-section of the richly rewarded but “bureaucratic” performers as well at those at the very top of the pay tree. The focus would be exploring the spread of the something-for-nothing culture more commonly associated with benefit cheats.
The second proposal is especially radical. It seeks parliamentary oversight over executive pay- and in free market Britain, of all places. I can't see the corporate world accepting it. Not in the UK, lesser still in India. But this could well be the answer.

Incidentally, you will surprised how little discussion there is of top management pay in board meetings. The matter of pay is left to a sub-committee of the board and the full board really has little say. Perhaps, the RBI must mandate that pay for the top 10 executives must be discussed and approved by the full board. 

Wednesday, May 16, 2012

Backlash against austerity in Eurozone

France, Greece, the Netherlands- and now in a provincial election in Germany. Voters are telling their masters: to hell with austerity. Does this mean governments can or should spend their way out of trouble? No way. Where is the money going to come from? Not from private investors: any escalation in spending will get a thumbs down from the financial markets. Official flows, from within or outside the EU, will also not be forthcoming. (Germany is not willing to bankroll deficits elsewhere without tough conditions and, indeed, that is the trigger for the current backlash).

So, the idea that new governments can repudiate the fiscal compact signed in March is sheer delusion. Some of the austerity targets can be moved back; there could funding for select projects. Otherwise, the substance of the austerity conditions will stay. This means that Greece will have to leave the Euro because it is one place where austerity has no chance of producing results even over ten years. What then? Spain, Portugal, Italy all will find the going rough weather. And if Greece finds its feet after default, they too would be sorely tempted to exit the Euro.

So, Germany and other pro-Europe countries in the EU face a stark choice. Either they are willing to back austerity with a measure of debt forgiveness, which alone will make the austerity conditions viable. Or it''s The End for the Euro.

More in my ET column, Markets can trump voters. 

Let me add a footnote. What would be the implications of a Greek exit? There would be chaotic conditions in the markets but, on balance, the crisis can be contained using the financial muscle of the EU and the IMF. However, it does mean that in 2012, uncertainty in the financial markets will continue as in 2011. That's bad news for investment in general and in India in particular. Unless the ongoing crisis is quickly contained, our hopes of a modest acceleration in growth will take a beating.

Thursday, May 03, 2012

Economic affairs secretary on S&P warning

R Gopalan mounts a spirited defence of India's economic position in the face of the recent S&P warning in an  interview to ET. The points he makes are very similar to what I have said in my post below: India's debt to GDP ratio has come down and there has been substantive improvement in the fiscal position of the states.

IITs set to improve transparency in JEE

IITs will post the evaluated answer sheets of JEE candidates online, TOI reports:
If a candidate finds any discrepancy, he or she can lodge a complaint online. These evaluated answer sheets will be available online from May 5 to May 10. The facility to submit requests for revision will close at 5pm on May 10 after which representatives of all IITs will meet to consider the requests. If found correct, the responses will be updated by May 14. According to IITD director, R Shevgaonkar, it may happen that the scanner does not pick up correct responses if a candidate has not filled the response bubble completely.
Naturally, the answer sheet will have to be provided for candidates to be able to compare. This is a huge step forward in improving transparency in the JEE and it will reinforce public confidence in the exam, which has stood the test of time. One wonders why such a simple step was not taken earlier- and why others in the business (such as IIMs) have not done likewise.

The big reform in the JEE, which is assigning a suitable weight to the 12th standard exam, has been stymied by concerns amongst IIT faculty about being able to normalise across various boards. This is a legitimate concern but it's worth mentioning that the IIMs have already gone ahead with giving a 30% weight to earlier exams. The underlying principle is unexceptionable: one cannot judge a candidate's merit on the basis of a single test where the difference in scores between one candidate and another is   miniscule.