Satyam: comments on some responses

I notice that outrage over Satyam's abortive deal is not universal:

• Pradosh: wonders whether the media has sensationalised the whole issue
• Anonymous suggests that the seasoned promoters of Satyam would have thought through the merits of venturing into infrastructure.
• On a different note, Gaurav wonders whether fear of being dragged to court in the US was responsible for the deal being called off.

Well, it's always a pleasure to get contrarian views.

To respond to Gaurav first, yes, there does appear to be greater recourse to the law in the US in matters such as these than in India. Here, management can claim- as it has- that it violated no laws: board approval was obtained, norms of inter-corporate investment were adhered to, there was no requirement to obtain shareholder approval, etc. It's a different matter that the government is reported to investigating other aspects such as possible insider trading.

On Pradosh's point about media hype and media pressure, it's worth noting that, according to press reports, Satyam sent out an SMS at 3:45 am on Nov 18 - well before the headlines became available to Indian readers. The Satyam response was based on the hammering of the share in New York. It was not the media response but investor and analyst response that forced Satyam's hand.

Should we give Satyam management the benefit of the doubt, as Anonymous suggests? Well, there are a number of points against the deal:

• No obvious synergies between software and construction/infrastructure.
• Why invest in family enterprises in infrastructure?
• Timing of investment: everybody knows that infrastructure firms are today desperate for cash.
• Valuation: This is dicey at the best of times and these are the worst of times for infrastructure firms. I understand that the valuation rested primarily on the land bank of the two Maytas firms.
  

If Satyam was convinced of the merits of the deal, it should have come up with a proposal, presented it to analysts and shareholders, explained the merits, placed the valuation report in the public domain and sought feedback.

I saw the ISB Dean suggesting on TV that there was no problem with the deal once valuation was okay. What he overlooks is that, given the nature of the deal- transfer of cash from a firm in which the original promoters had a small stake to ones in which they had a large stake- transparency was of the essence.

It's gratifying that a number of high-profile businessmen have come out against the deal (Adi Godrej, Udak Kotak). Godrej went so far as to suggest that we needed more resignations from independent directors. One of the few I remember in a high-profile case is SS Tinaikar, former municipal commissioner of Mumbai, walking out of the Voltas board in the old days.

Still, at the end of it, one cannot resist the feeling that Satyam was a relatively soft target for the media and investors alike. Will they dare to take on bigger names in similar situations?

Welcome fall-out of Satyam move

It's an ill wind that blows nobody any good. The deal proposed by Satyam was a shocker, of course, but it's good that the management has called it off under investor pressure and after severe criticism by the media and the analyst community.

I see several positives in the episode:

• Investor activism: institutional shareholders, domestic and foreign, have been much too passive all these years. It's nice to see them flexing their muscles.
• Pressure for change of management: There is talk of a hostile takeover and also pressure on management to step down consequent to a bad decision. This again is much needed. Management is seldom made to pay a price for bad decisions.
• Focus on independent directors: The independent directors on the board of Satyam (see my post yesterday) have egg on their faces. They have been named (and hopefully shamed) in the media. Great!
  
• Client reaction: One of the best stories I read was in BS about some of the top clients evaluating their relationship with Satyam- they are not sure about sticking to Satyam as there are doubts about the intent of management.

All this is to the good. I would like to see more happening. I certainly want the appointment of independent directors to be looked at. Management inviting their friends to be on boards and paying them a fat fee for nodding their heads is a joke perpetrated on shareholders. We need institutional investors to appoint at least some of the independent directors.

Further, I would like Sebi (or some NGO) to have on their website a link on 'Questionable decisions by management'. Decisions such as the present one should be recorded and also the names of directors involved. Analysts should check to see which other boards these directors are sitting on and take a view on those companies. Other companies planning to appoint independent directors would also benefit from scanning this link while deciding their choice of independent directors.

There is a clear message that needs to be sent out: as independent director, your role is not to play deaf-mute on the board.

Satyam deal is off

I just heard on TV that Satyam has called off its move to invest $1.6bn in two property firms owned by the sons of Satyam chairman B Ramalinga Raju.

Raju and his family own less than 10%of stock in Satyam. The move promised to set off a big storm among the investing community- the share was beaten down by 59% in trading in New York yesterday. I heard a contrite-looking Raju say on TV that the company would not have proposed the deal had they anticipated the adverse investor reaction. That, I am afraid, shows poor judgement.

Poor judgement on Mr Raju's part and also on the part of the board of Satyam which approved the deal. How could the board have even imagined that the company would get away with a deal of this kind? The board's independent directors comprise: M Rammohan Rao (director, Indian School of Business), Vinod Dham(the Silicon valley entrepreneur), T R Prasad (former cabinet secretary) Dr(Mrs)Mangalam Srinivasan ( a retired academic and bureaucrat), and Prof V S Raju (former director, IIT Delhi). It also has HBS prof Krishna Palepu as non-executive director.

The independent directors were paid between Rs 12.1 to Rs 13.2 lakh last year as sitting fee and got between 5000-10,000 stock options. Did the chairman get the board's consent for calling off the deal? Or will the board simply ratify the chairman's decision?

There is no doubt that the Satyam move constitutes a serious corporate governance failure. This should prompt serious thinking on, among other things, the role and appointment of independent directors. I have long argued that such directors should not be appointed by management, they should be appointed by institutional investors and small shareholders.

The controversy will also cast a shadow on the IT sector as a whole. IT companies have been in the forefront when it comes to instituting healthy governance practices. But that was when the going was good. Governance, like character, is tested in times of adversity.It behoves the IT sector to adhere to the highest standards in the difficult times it is going through.

Another scam, another rip-off

Will the bad news for the world's banks never end? As though the losses in the sub-prime crisis was not enough, now comes the news of losses on exposures to an investment fund, rather aptly named Madoff, after its founder Bernard Madoff, former head of Nasdaq.

The investment fund has collapsed reportedly with accumulated losses of $50bn, incurred over several years. Madoff apparently ran a Ponzi scheme in this period, pay off old investors with funds from new investors. The prominent losers mentioned so far:

• HSBC- $ 1bn
• BNP Paribas-$468 mn
• Banco Santander- Euro 17 mn

BBC's double standards

Journalist MJ Akbar has lambasted the BBC for its coverage of the Mumbai riots. The BBC is said to have referred to the attackers as "gunmen" or "militants" and shied away from using the expression, "terrorists". BBC had no compunction in referring to the attackers in the 7/11 attack on London as "terrorists", rediff.com reports. Akbar wrote:

When Britain finds a group of men plotting in a home laboratory your government has no hesitation in creating an international storm, and the BBC has no hesitation in calling them terrorists. When nearly two hundred Indian lives are lost, you cannot find a word in your dictionary more persuasive than 'gunmen'.

....You are not only pathetic, but you have become utterly biased in your reporting. Since we in India believe in freedom of the press, we can do no more than protest, but let me tell you that your credibility, created over long years by fearless and independent journalists like Mark Tully (I am privileged to describe him as a friend), is in tatters and those tatters will not be patched as long as biased non-journalists like you and your superiors are in charge of decisions. Shame on you and your kind."

The BBC wrote back defending its position:

The guidelines we issue to staff are very clear-we do not ban the use of the word terrorist, but our preference is to use an alternative form of words. There is a judgement inherent in the use of the word, which is not there when we are more precise with our language. "Gunman", or "killer", or "bomber", is an accurate description which does not come with any form of judgement. However, the word is not banned, and is frequently used on our output-usually when attributed to people. I heard it being used on numerous occasions during our coverage from Mumbai

."

Lehman CEO to turn advisor?

Richard Fuld, the disgraced CEO of Lehman Brothers, is in no mood to call it quits, according to an FT report, quoted in rediff.com.

The 62-year-old Fuld, who run Lehman for nearly 15 years, is considering to launch a firm to advise small companies on financial and strategic issues.

British daily the Financial Times has reported that Fuld plans a comeback and has told friends that he might launch a small advisory firm to harness his contacts in US companies.

Fuld is in good company. Two other CEOs, who quit in the sub-prime crisis, Chuck Prince of Citigroup and Stanley Oneal of Merrill Lynch, have resurfaced.

Prince joined Stonebridge International, a strategic consulting firm, as vice-chairman in September, while ONeal is believed to be considering an offer from Vision Capital Advisors, a small hedge fund and private equity group," the report added.

Call it the value of networking- you build tremendous contacts in such positions and this will always be valued by the market. Leave it to " market forces", what? Anyway, I don't think we in India have any right to moralise. People convicted by the courts remain active in politics or in celebrity fields such as films.

Dos and Don'ts of Risk Management

There's one question that keeps getting asked again and again in the ongoing crisis: how did the best minds and the fanciest models fail so badly? How could some of the biggest players in the business have messed up risk management so thoroughly?

I'd venture to suggest that it was not so much a problem of flawed mathematical models or faulty assumptions being fed into models. Models do fail in situations of extreme stress but that is hardly the whole of the problem or even the biggest part of the problem.

The problem was that a few people at the top took the basic decisions on risk and that information on risk exposures was not shared widely enough. In other words, autocratic decision-making was a big factor in the downfall of mighty financial firms. Even the boards of these firms did not know- and did not care to ask. I dwell on this in my ET column, Managing risk in today's world and spell out some dos and donts.

My point is that risk management is a governance issue and is a matter of sound management and regulation- it's not just about models and rocket scientists. You need to get the whole culture of and incentives in a bank right for risk management to succeed. Wide dissemination of information on risk exposures and participation of a large number of people are crucial to risk management.

This last is where Indian public sector banks score. They have officer as well as staff representatives on the board. These people are watching managers all the time. They not only know about lending decisions but also about the lifestyles of managers. When the chairman throws a wedding party, employees are watching- how lavish it is, who attends, what is the body language, what sort of gifts are exchanged. They talk about these things. This sort of employee watchfulness is an excellent risk management tool. Because very often it is not lack of knowledge, but mala fide intent, that underlies bad business decisions.

Corruption in the US

Margaret Alva set off a storm a few weeks ago when she said the Congress was selling legislative assembly seats in Karnataka. But who says this sort of thing happens only in India? The governor of Illinois was arrested- he was carted away in handcuffs-for allegedly trying to auction the Senate seat vacated by Obama. FT reports:

Rod Blagojevich, governor of Barack Obama’s home state of Illinois, was arrested on Tuesday on a raft of federal corruption charges that included an alleged conspiracy to sell the president-elect’s vacant Senate seat for cash – or favours from Mr Obama himself.

The case was described by federal authorities as a “new low” for a state that has seen more than 1,000 people convicted on corruption charges since the 1970s – including the Democratic Mr Blagojevich’s predecessor as governor, Republican George Ryan, now serving six and half years in prison for racketeering.

<>.... ..The complaint appears to portray Mr Blagojevich as overseeing an auction for the Senate seat. “We were approached ‘pay to play’,” he told an associate of one potential replacement, according to the complaint. “That, you know, he’d raise 500 grand. An emissary came. Then the other guy would raise a million, if I made him a senator.”

Mr Blagojevich was also taped discussing whether he could use his power over the appointment to obtain other benefits. He speculated about securing a cabinet position or ambassadorship from the Obama administration or seeking Mr Obama’s help in obtaining a well-paying job at a trade union organisation or corporate board seats for his wife. Mr Blagojevich even mentioned asking Mr Obama to solicit $10m-$15m from Warren Buffett and Bill Gates for a non-profit organisation that the governor could run

Somehow, we think of Indian politics and politicians as uniquely corrupt. I have long pointed out that not just in the US but also in Europe- in France, Germany and Italy, for instance- politics can get really dirty. One thing we can say for Indian politics: it has not been entirely subverted by money power, although huge amounts are required for election finance. What I mean is: elections are not always won by those with the biggest financial muscle.

The prize for political lows goes to Israel: their former president had to quit following allegations of rape.

Fiscal stimulus- not enough

Hmm... so we have a fiscal package at last on top of the monetary stimulus.

• The government will spend Rs 20,000 crore on infrastructure, industry and exports
• Excise duty cuts will cost approx Rs 10,000 crore
• India Infrastructure Finance Company Ltd will raise Rs 10,000 crore in tax free bonds to support spending on highways.

All this is good but, in my view, not good enough. The present situation requires a much stronger response. The government appears inhibited not just by the FRBM provisions and its anxiety to revert to its limits at the earliest but also by impending elections. Let the next government (which, many think, will be a non-Congress government) tackle the mess, the government seems to think. There are also some who seem to believe the economy will somehow right itself in about six months' time, so no big initiatives are required.

I think this is a wrong-headed approach. We must prepare for the present crisis to unwind over two years and plan accordingly. Once you accept a two year horizon, the objections about infrastructure projects being of long gestation get blown away. Also, we need not think only of ports, airports and power. There are umpteen smaller things to be done in the rural areas, not glamorous but essential and labour-employing- warehouses, storage tanks, minor irrigation, etc

I wrote at length about this in my last column in ET, Crisis: bring in the politicians. My sense is that you need grassroots mobilisation in a crisis of this kind. It is at the state and panchayat level that the spending has to take place, it is there that a sense of urgency must develop, plans drawn up, tightly supervised and executed. The politician will take his cut but he will get things done because he is the guy who has to face the mob as the full weight of the crisis descends on the Bharat that is India.

Many in government seem to draw comfort from the fact that even a 7% growth rate sounds good in absolute terms. But, in terms of the impact on the economy and society, a deceleration from 9% to 7% can be as painful as a deceleration from 2% to 0% in the west. Just look at the migrant labour in Mumbai's construction industry heading back home in recent months. Industry is staying its hand on lay-offs but a few more months of a slowdown and you will see lay-offs happening in the organised sector. Job losses in the unorganized sectors, such as textiles, are said to run into thousands.

There is a crisis of confidence. Only a massive burst of government spending can restore confidence. The present stimulus is inadequate, I'm afraid.

India's war on terror

People have taken to the streets to express their indignation over the Mumbai attack and the nation's vulnerability to terror. 'Enough is enough'- says one TV channel. There is a demand for politicians to deliver. In response, there is tough talk emanating from government.

I'm afraid unrealistic expectations are being created all round. There is, first, the radicalisation of Indian Muslims in recent years consequent to the Babri Masjid episode, the Mumbai riots that followed, the Godhra riots, the use or misuse of Pota, the Kashmir issue as well as in response to the outrage of Muslims worldwide over American policies towards Afghanistan, Iran, Iraq, Syria and the Palestinian issue.

There is, secondly, Muslim anger and ill-will from outside the country directed towards India for a variety of historical reasons as well as the factors mentioned above, something that the Indo-US nuclear deal does little to mitigate. The threats emanate most directly from Pakistan and Bangladesh but also from other Islamic countries. It's hard to say what turn the US campaigns in Afghanistan, Iraq and Pakistan will take. What is certain is that this is going to be a long haul and, whatever the outcome, India cannot escape the fall-out.

In short, both domestic and international factors create conditions for an escalation in terrorist violence in India in the years ahead. Of course, we need to strengthen the intelligence and security apparatus to deal with these. But to assume that this will confer immunity from terror is sheer delusion. The more realistic course is to develop greater citizen alertness and public response to terror attacks, including a revamp of emergency hospital services.

Israel does not blame its political class for terrorist attacks- it tries to minimise the damage from these attacks and then seeks to pre-empt these as best as it could. Here in India, we need to find ways to disperse economic activity and, urgently, to reduce the importance of Mumbai and especially South Mumbai so that disruptions from terrorist attacks are minimised.

How to cope with terror and minimise the fall-out should be the priority- not unrealistic expectations about eliminating terrorist strikes. I repeat what I said in an earlier post: discrediting politicians and the political process is emphatically not the answer.

Politician bashing is in fashion

The Mumbai terrorist attack has triggered an outpouring of scorn on politicians. Politicians have provided grist to this by behaving in ways that may not be terribly responsible but the reaction also seems overdone. To wit:

• Maharashtra Dy CM R R Patil was on TV saying that incidents of this kind were bound to happen in a large city like Mumbai. Maybe. But that's not what you say in times such as these.
• Maharashtra CM Vilasrao Deshmukh took his two sons and film director Ram Gopal Verma to inspect the carnage at the Taj. Nothing wrong with that, he said. In normal times, yes. Trouble is that today the Taj is not exactly a picnic spot.
• BJP General Secretary Abbas Naqvi talked of women "in lipstick and powder" taking to the streets to display their anger against politicians. He has a point but, again, timing is the issue.
• Kerala CM Achuthanandan had some caustic remarks to make about Major Sandeep Unnikrishnan's father for the lack of courtesy he showed when the CM came calling. The CM has reason to feel upset but one has to make allowances for the father's terrible state.

These little incidents, duly played over and over again by equally insensitive TV channels, have added fuel to the fire, so to speak. People are lashing out against politicians for neglecting national security. In the process, film stars, investment bankers, ad-men and socialites have all become security experts.

They have questions. Why have the NSG only in Delhi, why not in other cities? Why did it take so long for the NSG to be transported from Delhi? Why can't we give better equipment to police? Why can't we have better coordination among intelligence agencies?

It was left to Mani Shankar Aiyar to point out drily in a TV programme that while many people might be asking these questions in the wake of the attack, these are questions that agencies in government are grappling with all the time. Given competing demands on scarce resources, a determination has to be made as to what is appropriate. The state of the security apparatus reflects the determination that has been made.

Tomorrow, somebody might ask: why NSG only in the four metros? Why not in 20 other cities? There could be perfectly valid operational reasons. Given the kind of training and equipment they need and the coordination, dispersing them may compromise their operational effectiveness. There are several elite forces in other countries (and elite forces in our own army) that are lodged at one place- presumably for the same reasons. 'Common sense' suggestions are often no more than nonsense- good sense, in professional matters, is unfortunately not all too common.

As for displaying contempt for politicians, this can easily spill over into contempt for the political process. Therein lies a big danger. Because from there to legitimising dictatorship, army rule, a police state is a short step. That would give the glitterati plenty of security and gleaming shopping malls but it would turn 95% of the population into terrorists and hence defeat the basic objective. It is well to remember that the same political system that could not prevent the breach of coastal security this time is the system that gave us the NSG that acquitted itself so creditably.

Let us find ways to strengthen the democratic and political process, not turn outrage over a tragedy to turn into outrage against the political system.

Novel set in Kashmir

Over a depressing weekend, I found solace in a terrific novel set in Kashmir, The Homecoming by Sashi Warrier. A couple of years ago, I had read Warrier's novel woven around terrorism, Night of the Krait, and had thoroughly enjoyed it.

Homecoming is set in Kashmir but it's not about terrorism or the Kashmir problem. These form the background but it's really a family story. It's about a Kashmiri Muslim, Javed, whose life begins to unravel just when he thinks of hanging up his boots and settling down with his family in Srinagar after having spent his working life as a trader in carpets in Bangalore.

Javed, a widower, returns to find his younger son carted off by the police on charges of terrorism. Bit by bit, he wakes up to his alienation from his elder son (who helped him with his business in Bangalore), his daughter, his mother, his brother and finally his girlfriend in Bangalore.

There's no viciousness or character defect in Javed to which one can ascribe his tragedy- it's just that he's been so wrapped up in himself that it's rather late for him to connect with his family. They simply have no use for him just when he seems to need them. A very ordinary story, you might think, but Warrier's skill as a writer lies in making an unputdownable novel out of it.

Life deals one merciless blow after another on the hapless Javed and one is filled with a profound sadness as one comes to the end of the story. In the ordinary exchanges amongst Javed and his family members, one discerns the underlying unpleasantness that is the stuff of most human relationships.

Terrorism in Kashmir looms in the background. The tension in Srinagar is palpable throughout the novel with the menacing presence of the army and the high-handeness of the local police. With a few deft strokes- little incidents involving his characters- Warrier captures how ordinary people are caught in the cross-fire between militants and security forces.

I find it difficult to read much of modern fiction. Somehow, the art of simple story-telling seems gone and you have in its place verbal gymnastics and streams of images. You pine for somebody who can tell a nice tale- say, an Ernest Hemmingway or a Somerset Maugham or, in our country, RK Narayan and Khushwant Singh. Warrier belongs to this vanishing species.

Mumbai attack and its aftermath

The recent terrorist attack on Mumbai is being called India's 9/11. In sheer audacity of design, that is true. The US, whose mainland has never been attacked, could not have imagined that a set of planes could be transformed into enormous bombs. Nobody in India thought of a sea-borne invasion of Mumbai- the attackers are said to have hijacked a fishing trawler, steered it towards the Mumbai coast and then landed on motorised dinghies. Not just out-of-the box thinking but meticulous execution has been in evidence in both the cases.

In 9/11, the attackers targeted the World Trade Center, beloved symbol of America's financial capital. In the Mumbai attack, the targets were two high-profile hotels and a Jewish centre in India's financial capital.The objective was the same: to cause dislocation and mayhem in leading financial centres in ways that would capture the world's attention. Smoke billowing out of the WTC is one image that is etched in our minds; so will that of the Taj Hotel in flames. The Mumbai attackers have certainly met their objective.

9/11 changed America. Unilateralism and the doctrine of pre-emption became central to American foreign policy. There was the bombing of Afghanistan and invasion of Iraq thereafter.Also less noticed transgressions of international law such as a missile attack on Sudan, the bombing of a suspected nuclear site in Syria and missile and bomb attacks on terrorist hideouts in Pakistan. T

The US has made clear that it will not be bound by the UN or international law when it comes to the protection of its intersts. The US has also gone after terrorists in several countries and spirited them to other locations for interrogation and incarceration. It did this in Italy a few years ago- an Imam was seized by CIA operatives. An Italian judge has issued arrest warrants for the CIA operatives, a warrant that has no chance of being enforced.

Within the US, the full financial might and technological capability of the country has been brought to bear on preventing infiltration of terrorists. The issue of visas has become more stringent, there is far greater scrutiny of visitors (including strip searches) at airports, stepped up surveillance at home and abroad and an abridgement of civil liberties under the Patriot Act. These have ensured that no terrorist attack has occurred in the US after 9/11.

There have been comparable measures in the UK after its own 7/11. Surveillance through closed circuit TV is so pervasive that the Orwellian prediction of 1984 seems to have come true in the UK. On top of this, tapping of phone calls and monitoring of email has been stepped up- the American journalist Seymour Hersh has said that he would never use pay phone in the UK because there was little chance of the call being confidential.

One other country that has had success in the war of terror- in the sense of limiting attacks on its soil- is Israel. But Israel is unique. Not only can it pour huge finanicial and technological resources towards securing itself, it is willing to use the most draconian methods. A whole wall has been created between Israel and the occupied territories and entry through it into Israel tightly regulated. Palestinians have been beaten into quiesence in the most brutal ways.Above all, there is the intense determination of the Israeli people, military conscrption for all young people and the fact that Israel is a small country.

Where does India stand after the Mumbai attack? One, there is no question that security measures in key places, including hotels, will be at a higher level hereafter, causing no small inconvenience but that is something that people will come to accept.

Two, it's hard to see how the pressure to enact tougher terror laws can be resisted- even PM Manmohan Singh had to mention this in his address to the nation after the attack. This does mean a certain curtailment of civil liberties.

Three, there will be profiling of communities and a crackdown on suspects within these. These will create more alienation and hence a greater susceptibility to domestic terrorism.

Will terrorism decline in India in response to strong-arm measures as happened in the US and Israel? One must be sceptical. We do not have comparable funds or technology but that is not the only problem. We must reckon with the country's size and diversity. Above all, there is the problem of corruption and poor governance.

Key institutions of the state, notably the police and the judiciary, suffer from both corruption and poor governance. Strong anti-terror laws, in such a situation, will simply become weapons for persecution and extortion.

Vulnerability to terrorism, it is worth pointing out, is an aspect of corruption and an indifference to the rule of law. The political class will not prosecute or pursue high-profile cases of terrorism; businessmen will maintain links with the underworld; the police is more concerned with collecting bribes than with maintaining law and order;the media has no qualms about lionising celebrities who have been convicted in important cases. When a political party moots the idea of giving a Lok Sabha seat to the key suspect in the Malegaon case, that is confirmation that India in many ways has the traits of a banana republic.

Without an overhaul of governance, without greater accountability, it is hard to see how terrorism can be fought effectively. It is the democratic process and the rule of law that need to be strengthened for these to happen.

Unfortunately, the knee-jerk reaction to heightened terrorism is in the opposite direction- the abridgement of liberties, greater powers to the police, a contempt for politicians and the political process. On TV, I saw a bunch of ad-men pouring scorn on politicians and asking them to keep their hands off the law-enforcement machinery. That is a prescription for fascism.

The gloomy conclusion that emerges is that India will try to emulate the tough methods adopted by countries such as the US and Israel without having the commensurate governance or enforcement capability. This can only lead on to a downward spiral where terrorism is concerned.

Citigroup- too big to succeed

Citigroup has received a government bail-out, so it lives to fight another day. This has been described as a $306 bn bail-out but that is not entirely accurate. The terms of the rescue are:

• The US government is essentially providing insurance on $306 bn of troubled assets with teh first $29 bn of losses being borne by Citigroup. This is conceptually not very different from any medical or car insurance contract where the first level of losses is borne by the customer.
• In return for this insurance, Citigroup will issue the government $7 bn in preferred shares carrying a dividend of 8%- this is the premium it pays on the insurance the government provides plus $2.7 bn of warrants
• The government will inject another $20 bn in preferred shares (not commn equity) into the financial group.
  

So, the government or the tax payer stand to lose only if Citigroup's bad assets decline more than 10% in value. If the markets recover- and this is a big if- the government is okay and the bail-out is fine. If not, there will be huge costs to the tax payer. Citigroup has $2 trillion in assets and it could under for reasons other than the identified $306 bn in troubled assets.

Citigroup may survive but can it really deliver in its present form? This is a bank with a long history of problems. Ddeveloping country loans, internet bubble, telecom bust- you name it, the bank has been in the thick of every problem in the past couple of decades.

The trouble with firms such as Citigroup, quite simply, is not just that they are too big to fail, they are too big to succeed. It's impossible to sustain good earnings growth on this kind of asset base. Managing $2 trillion in assets is crazy- no CEO or set of executives is equal to the challenge. The complexity is simply too overwhelming.

That's why we had Chuck Prince (the CEO, whom Vikram Pandit replaced) asking his CFO whether everything was ok, only to be told it was- and this when the bank had over $40 bn in toxic assets.The board's great idea was to replace Prince with Pandit, an ex-Morgan Stanley guy with no banking experience. We read that they were on the verge of replacing Pandit too until a Saudi prince affirmed his faith in him. How about replacing the board first?

Banks need to decide what is an optimal size for them. More than $100-200 bn seems to be extravagant. I have also never bought the stuff about universal banking- I once wrote an article deriding the idea as 'universal bunkum'. The idea that one entity can manage everything under the sun- banking, investment banking, insurance, etc - and that it can do a great job of this through cross-selling products is plain stupid. Citigroup never quite managed it. It goes against the idea of 'core competence'.

This is also why I have steadfastly been sceptical about the idea of bank consolidation in India. My contention is simple: if you can't deliver performance at your present size, forget about doing it when things get bigger and more complex.

PSU pay hike

The government has approved the Justice MJ Rao report on pay packages for PSUs. Good. But why does the media get hysterical about pay rises in the public sector? When the central government pay hike was announced, media reports talked of an increase of "over 40%". I showed through my calculations that the increase was 13%. I am inclined to believe that the media prejudice against all things governmental is so great that they are just not happy to see any pay rise in government.

Now, I have been seeing reports about 100-200% pay hikes for PSUs. Rubbish. The chairman of ONGC will get a basic salary of Rs 1,25,000 per month. Is this five times his earlier pay of Rs 25,000. Yes, but only if you compare basic with basic. What happens in government pay revisions is that the basic and DA get merged and there is an increase over that, with DA starting from zero all over again. This is the increase (new basic plus DA versus old basic plus DA) one must look at- and it comes to 20-25% in PSUs. And this increase is happening after 10 years whereas in the private sector, the annual increment would be 25%.

Of course, there are performance-linked incentives in the new scheme of things but these apply mainly at the top. There is an improvement in public sector pay but it will still lag behind that in the private sector in cash terms. The real benefits in the public sector are of the non-cash variety: job security, pension, medical benefits and housing and the sheer richness of the job.

Should pay in the public sector improve a great deal more? Not necessary. One consequence of the ongoing turbulence is that people here are going to re-evaluate the relative merits of public and private sector jobs- and my guess is that there will be a better appreciation now of the former.

Directed bank lending

Remember directed lending? That was in the bad old days post bank nationalisation when banks were told whom to lend, how much and at what rates. Banks in the west are reluctant to lend despite governments infusing capital into them. Lack of funds is killing the real economy. So what can governments do? Incredible as it may sound, FT wants governments to compel banks to lend, using their newly found clout as owners of equity in these banks and, if necessary, by getting full control over them!

If evidence emerges that banks are not lending because they are hoarding cash to pay off the expensive preference shares taken by governments, the rescue can be restructured. One option would be to give governments more control of the banks; another would be to reduce the short-term costs of the capital.

.....But banks, which have always been dependent on the largesse of taxpayers, could be forced to adopt central targets for new lending. This would overcome the problem of no institution wishing to be the first-mover. And banks would have little choice but to obey; if they are unco-operative, they could end up in public ownership

Why blame Mr Chidambaram for leaning on public sector banks to lend? I, for one, would not fault him for that. My only plea is: don't dictate the lending rate as well, leave that to the judgement of the banks. When banks are asked to expose their exposures to particular corporates, then commercial logic dictates that lending rates should rise, not fall.

Incriminating email trail

Remember Henry Blodget? He was the Merrill Lynch analyst who acquired notoriety during the dotcom bubble when his email showed that he was having views on stocks that conflicted with what ML put out officially for its clients.

Well, credit rating agencies appear to be facing the same problem. Jaimini Bhagwati, writing in BS,quotes a manager at S&P as sending an email to a colleague saying that the rating agencies continue to create an “even bigger monster — the CDO market. Let’s hope we are all wealthy and retired by the time this house of cards falters”. (Source: Summary Report of Issues Identified by the Securities and Exchange Commission Staff’s Examinations of Select Rating Agencies dated July 2008).

As investigations into failed institutions continue, we can expect to see more such email. Strange that financial sector employees don't learn from mistakes made in the past even in elementary matters. The operating rule should have been: never express opinions over email.

Pastry eating competition claims life

This item took my breath away: an engineer at Nokia Siemens Networking in Gurgaon died while taking part in a pasty-eating competition at the office at lunch time.

A lunch-hour pastry-eating competition’ among colleagues at an MNC office in Gurgaon turned into a grim tragedy when one of the contestants’ choked and died after eating too much, too fast. Saurav Sabbarwal, 22, working as solutions engineer with Nokia Siemens Networking , was declared ‘brought dead’ at the Max Hospital after colleagues reportedly found him unconscious in the office

Bail out for India Inc

TOI carried a story yesterday saying that Ratan Tata had written to the PM asking for a special fund to be created for Indian companies that have borrowed abroad in recent times but now face the prospect that loans will either not be rolled over or will be too expensive.

The report says that about $45 bn could become due for repayment by December- and much of this would now have to come from the Indian banking system. This amounts to a bail out by Indian banks for two reasons. First, it is not clear that Indian banks would take this sort of exposure of their own accord. Secondly, the cost cannot be very different from that of the earlier foreign currency loans, which would imply a subsidy.

The danger is that, in dealing with the present funds crisis faced by India Inc, we are left with an enfeebled banking system. A better solution would be to have a special fund supported by the fisc. Alternatively, if the banking system is to provide funds, the implicit subsidies should be borne by the exchequer. The banking system and the tax payer need to be protected from the costs of the excesses indulged in by Indian companies.

Nothing "altruistic" about it

Layoffs are taking place but, perhaps, not in a big way since the PM made it clear to businessmen that they ought to show restraint in the matter. The deal seems to be that government will do what it can by way of bail-outs or interest rate cuts in exchange for industry not resorting to layoffs in the run-up to elections.

Some companies have the taken the route of leaving it to employees to take a year or two off. Some employees may avail of it for family reasons; others might want to try out a new job. This sort of voluntarism is useful- provided it is truly voluntary.

I must confess, however, that I am not bowled over by Infosys' suggestion that employees take time off in order to devote themselves to "altruistic" activities, say, working for NGOs. One report indicated that Infosys was even considering paying upto 50% of salary for those taking a year off.

If the intention is to incentivise certain kinds of leave, then giving 50% of pay to those joining NGOs makes sense. But if the intention is simply to cut costs, then why would Infosys want to specify what employees do with their leave? How does it matter to Infosys whether somebody joins SEWA or Oxfam during his or her leave period or the film industry? It's a good idea not to confuse "altruism" with shareholder wealth maximisation.

Improving bank governance

I have written earlier about how the collapse of big financial firms marks a disaster in governance. The world's leading bank boards did not have a grip on risk management, indeed many boards lacked banking expertise. FT carries an article that proposes radical overhaul of bank boards:

• Board should discuss risk exposures
• Boards should disclose their approach to managing risks

These two roles boards may be called upon to play even now even if they are not done properly. The author adds two more:

• The regulator should have the right to interview non-executive directors to discuss their risk assessments and publish transcripts of these- the idea of these "fiduciary risk reviews" is to give investors an idea of how conversant boards are with their firm's risks
• Regulators should have the right to appoint two or three public representatives as observers on boards so that the tax payer is represented in some way. These public representatives would report to the regulator on how well they think the board has handled risk.

What to make of these proposals? First, they would require a much higher degree of expertise on risk management than most boards today have. Secondly, non-executive directors undertaking such onerous responsibilities would have to be properly remunerated.

In India, I am glad to say, the basic framework for such mechanisms exists.The RBI requires bank boards to have a Risk Management Committee to monitor risks. The minutes of these meetings would be available to RBI inspectors. There is also room for public representatives on boards of public sector banks although these, more often than not, end up being hand-picked by management. There are also officer and employee representatives on PSB boards.

This entire structure, to my mind, is preferable to what the FT article oposes- interviews with non-executive directors conducted by the regualator seem inquisitorial and may not be productive. Besides, the article misses the point about board room reform: independent directors need to be truly independent.

This can happen only if some independent directors at least are appointed by institutional shareholders. You can't have an independent board if all the members are selected by management. It is the lack of independence on the part of the board, not so much lack of expertise, that explains there has been a governance failure in the financial sector.

We must have board members appointed by financial institutions and at least one by retail shareholders. Employee representation on the board is also a healthy check on management- after all, it is employees who best know what is going on in the bank.

Unless and until we have truly independent boards, corporate governance will remain pretty much a farce.

Goldman Sachs practises abstinence

Goldman Sachs top executives will forgo their bonuses for the year, says a report in BS today. That would be in order. The firm is due to post a loss for the coming quarter. Even otherwise, as part of the troubled financial sector, the firm's top brass would have come under fire had they dare to make bonus payouts this year.

Is it enough to forgo bonuses? Goldman is one of the recipients of equity from the US government. It was allowed to turn itself into a bank, giving it access to unlimited central bank liquidity. Surely, there is a cost to be assigned to this? There should be "shadow" costs for subsidies for these kind which should be factored into a firm's annual profit/loss figures. If there is a loss, there is a case for top executives to pay back some of their ill-gotten gains of the earlier years.

This would not be revolutionary in today's context- UBS is said to be contemplating a move get its senior executives to cough back their bonuses from the past. Incidentally, UBS is the first investment bank to implement a model that I have consistently advocated since the outbreak of the crisis- bonuses when the firm is making profitsl and paybacks to the firm when there are losses. Here is the relevant excerpt from an FT report:

For next year, compensation for the group’s top 2-3 per cent of staff will be revised to put more emphasis on long-term performance. Under the changes, bonuses in cash and shares will be staggered over a period of three years. The bonuses will also be adjusted to take into account losses as well as profits. Mr Kurer said the system would set a trend.

Off balance sheet hit for Indian banks?

Indian banking, we have been told, is insulated considerably from the sub prime crisis. The FM has reeled off figures for bank exposures to sub-prime and other international assets- these are extremely low in relation to the size of the Indian banking system.

Are we safe, therefore? I am not so sure. I have been going through RBI data and I am beginning to feel that some of the liquidity crunch we are experiencing now may the result of the impact of off-balance sheets items on banks. It is the subject of my last ET column, Mystery of missing liquidity.

Most people think that there is a credit shortage because corporates are substituting Indian credit for credit accessed abroad as foreign funds have dried up. This is, of course, true. But it may not be the only reason for the credit crunch. I notice that in the last three months, there is a huge surge in credit ($37 bn) -quite unusual in a non-busy season. In the same period, there is a huge forex outflow- $53 bn out of the financial year's total outflow of $56 bn.

The international financial crisis is not recent, so why the sudden surge in Indian credit and the corresponding forex outflow? My guess is that the credit surge is dollar-related. And it is not just going towards servicing imports earlier met through suppliers' credit. Much of the growth in credit, I am inclined to believe, is on account of the crystallisation of off-balance sheet obligations in the balance sheets of banks.

Banks have sold forex and other derivatives to corporates left, right and centre. Corporates would incur mark to market losses on thesee. On banks' balance sheets, they would show up as loans to be recovered from corporates. There would be forex outflows relating to settlement of transactions on maturity. There would also be heavy forex outflows involving banks remittting funds to their overseas branches. These would also show up as loans on domestic balance sheets.

Off balance sheets obligations in the Indian banking system have grown exponentially- from 56% of balance sheet in 2004-05 106% in 2007-08. In new private banks, the growth has been larger- from 173% to 301%. Foreign banks had off balance sheet obligations of 1800% of balance sheet in 2007-08. I wonder how the RBI overlooked this sort of growth in contingent obligations. Some of them appear to be coming home to roost.

In the sub-prime crisis, contingent obligations are at the root of banks' problems. There, the exposures were mostly towards securitisation vehicles and credit default swaps. In India, these obligations seem to be more in the nature of forex derivatives. Banks abroad face losses as a result of their exposures; Indian banks are seeing an 'involuntary' expansion in loans.

But the end result is the same: a shortage of credit with all its malign effects on the real economy. We need to quantify the impact of contingent obligations on Indian banks. It would be the ultimate irony if the Indian banking system, which is said to be insulated from the international crisis, were to get infected in a big way by contingent obligations.

Public sector banks and customer service

I had meant to write something under this heading but couldn't proceed beyond writing up the title because my blog got jammed for several days. The title without any write up itself drew several comments- including one saying that the title in itself was a comment!

Wrong. I had meant to compare the public sector favourably with the private sector when it came to private service, quoting from an FT article:

The sheer inefficiency of UK bank bureaucracies in their domestic operations can be compared with public services at their worst. Public services at their best now outperform the banks – so government ownership could actually improve bank performance. The banks should be made more accountable to the public, as public services already are.

Examples come from my own experience but are matched by that of others. Banks use the internet as little as possible to avoid fraud; instead they use the post, in which letters are lost or stolen, and the telephone, which is overloaded and often fails to give results after interminable waiting times.

My bank has three times posted an unwanted cheque book to me in the past year, in spite of being asked not to after a postal theft led to a £2,500 fraud. Alternatives to the Royal Mail are a delusion, because the Royal Mail still does their doorstep delivery – as often as not to the wrong address.

The author correctly identifies cost reduction and the use of channels other than the traditional bank branch as responsible for the decline in service quality. In many private banks in India, it is impossible to meet anybody to discuss a complaint- you can only discuss with an operative at a call centre.

Secondly, public sector banks find themselves obliged to respond because various public functionaries- such as MLAs and MPs and even municipal corporators- will forward complaints. The customer himself or herself has a strong sense of ownership because it is public sector. And public sector banks still rely on branches for customer interaction.

Government versus RBI?

Today's Business Standard has a strong edit on how some recent moves by the government of India have the effect of devaluing the RBI:

First, a new governor of Reserve Bank of India was appointed and, in a symbolic departure from past practice, the new incumbent went across directly from the finance ministry. Then, a new ‘liquidity committee’ was set up, chaired by the finance secretary. Now, a new economic advisor with a strong background in finance has been appointed in the Prime Minister’s office. A day later, the finance minister calls the heads of the state-owned banks with the intention announced in advance that he wants bank lending rates to drop. On cue, immediately after the meeting, one bank chief after the other announces interest rate cuts.

If you thought the country’s monetary authority was RBI, may be it is time to think again. The pattern is too obvious not to be noticed—the real decision-makers are now in the central secretariat in New Delhi. RBI remains the statutory authority, but it is an open secret that the man in charge is P Chidambaram. A peskily independent RBI governor has retired, and a strong-willed finance minister has made sure that he will not be faced with another situation where his views are either ignored or not acted upon....

<>...... With Dr Reddy not on the scene, with Mr Chidambaram having wrested the freedom to impose his writ, and with economists in place who belong to the integration-convertibility school of thought, it remains to be seen how much short-term currency management will swing around, and to what degree longer-term policy will change in the six months that the government has before elections become due. Whatever the answers to these questions, and irrespective of which ideological position anyone may hold, RBI’s autonomy is the casualty of the new constellation of forces and the new institutional arrangements.

<>

BS is right. The government's moves do appear to be intended to cut the RBI to size. This is sad given that the RBI has received so much credit for its success in insulating the economy from the international turbulence- and various people in government too have expressed this view. It cannot be that you give the RBI credit for this and then behave as though the RBI does not know how best to handle the impact on the Indian economy of the present liquidity size.

Subprime crisis: who are the real villians?

I argued in my last post that sub-prime loans per se - and the entire apparatus that made it possible, including low interest rates engineered by central banks, were not primarily responsible. Deregulation was by far the bigger villain.

Ben Heinemann, senior fellow at Harvard's Kennedy School of government and Law School, argues that there has been a serious management failure at financial institutions:

But can there be any question that the root cause was the failure of financial-industry leaders to provide the balance between risk-taking and risk management needed for sound, sustainable growth? In short, there was a failure to fuse high performance with high integrity.

No one made these companies pile on leverage, create incomprehensible financial instruments, sideline robust risk assessment, fail to stress-test portfolios, assume housing values would only go up and award gargantuan compensation for churning paper.

Why did CEOs and business leaders so abjectly fail? Why did good corporate governance, which at its core is about checks and balances, fall short in financial services?

Obviously, public and government trust in industry decision-making has eroded. Now corporate leaders must honestly discuss their mistakes and propose how checks and balances can work before the slow process of rebuilding trust can begin.

Don't blame it on sub-prime loans

That's the title of my column in ET today.

The present crisis has been called a 'sub-prime crisis'. This does suggest that sub-prime loans- loans to not very credit borrowers or financial inclusion- underlies the present crisis. Once you take this view, there is a whole cast of villians available- the US Fed which flooded the world with liquidity; greedy borrowers; greedy bankers; political pressure for financial inclusion.

This, I argue in my column, is rather simplistic. There have been housing bubbles earlier, banks have extended themselves in making housing loans but we have not had a global financial crisis. To complete the chain of causality from a housing bubble through sub-prime loans to a financial crisis, you need to bring in a vital link: the 'marketisation' of loans, that is, conversion of loans into traded securities.

This 'marketisation' was made possible by incorrect credit rating. The securities passed into the hands of non-regulated or lightly regulated entities such as investment banks and hedge funds. These institutions face mark-to-market accounting on their securities portfolios whereas bank loans are not marked to market. This sort of accounting tends to exaggerate losses especially where illiquid portfolios are concerned.

If the financial system had been exposed only to sub-prime loans, we would not have had such a big problem. It is their exposure to sub-prime loans through sub-prime related securities that has created havoc. So, the problem is not financial inclusion, it is poor regulation.

Financial regulation: west on trial now

Kishore Mahbubani, former foreign minister of Singapore and currently Dean of Lew Kuan Yew, University, makes the point that the quality of regulation in western economies will now be closely watched by Asian regulators.

In the past, Asian governments expected western counterparts to be role models of good governance. One story illustrates how times have changed. This year, a European banker consulted the Reserve Bank of India to learn how to get a banking licence in India. He was briefed on the conditions and told that the Indian authorities would also assess his regulator. The European banker smiled and said: “No problem. We have excellent regulation.” The Indian officer replied: “After subprime, we are not sure of US regulation; after Northern Rock, British regulation; after Société Générale, French regulation and after UBS, Swiss regulation.”

This is very different from the times when banks from Asian economies were considered suspect until proved innocent.

Responses to comments

1. Abi: Thanks for the pointer to Brad de Long's blog about multiple objectives for the US Fed

2. Shailender Birla: asks what criteria would be adopted for appointment of non-government nominees of the pan-IIM board. (The board will have five government nominees and 10 non-government nominees). Well, here is the relevant extract from the report:

4.18 The Pan-IIM Board may consist of 15 members. Of these 5 should be nominees of the Central Government. They need not all be serving Government officers. The rest should be made up of independent professionals of eminence and record of success, living in India or abroad. Other things being equal, preference should be given to IIM alumni for appointment to this Board. One third of the Board would retire, by rotation, at the end of each year. A member would be eligible to be re-appointed, provided his/her total period on the Board does not exceed 6 years. Future vacancies would be filled by the Board itself, through recommendations made by a nominations committee of the Board, consisting of four non Government members.

4.19 The Chairman of the Pan-IIM Board should be nominated by the Prime Minister.

Multiple objectives for the US Fed

Stephen Roach of Morgan Stanley argues in favour of the US Fed having multiple policy objectives. In addition to price stability and full employment, the two objectives it has at present, there should be a third: financial stability.

By adding “financial stability” to the Fed’s policy mandate, I am mindful of the pitfalls of multiple policy targets. However, single-dimensional policy targeting does not cut it in a complex world. As such, the Fed will need to be creative in achieving its mandated goals – using monetary policy, regulatory oversight and enforcement and moral persuasion. Just as the Fed has been reasonably successful in its twin quests for price stability and full employment, I am confident it can rise to the occasion with the addition of financial stability to its mandate.....

In times of asset-market froth, I favour the “leaning against the wind” approach with regard to interest rates – pushing the Federal funds rate higher than a narrow inflation target might suggest. But there are other Fed tools that can be directed at financial excesses – margin requirements for equity lending as well as controls on the issuance of exotic mortgage instruments (zero-interest rate products come to mind)

The methods Roach advocates in the second para above are ones that the RBI has not hesitated to use. And the RBI has long had multiple objectives, including financial stability. I wonder what the Raghuram Rajan committee has to say now about its insistence on price stability as the sole objective for the RBI!

Goldman's overture to Citi

It appears that Goldman Sachs CEO Lloyd Blankfein spoke to Citi's head Vikram Pandit about a possible merger between the two companies. This was soon after the US Fed announced that Goldman and Morgan Stanley would be given banking licenses. Goldman's approach was rebuffed.

This led the US Treasury to include the two in the recapitalisation plan announced soon after. Which, of course, reflected the Treasury's perception that the two would otherwise meet the fate of Bear Stearns and Lehman Brothers.

Soon after the two companies were given bank licenses, I wrote saying that this was intended to send out a signal that the US Fed was solidly behind them. It did not imply at all that the two could successfully convert themselves into banks. The sequence of events described above bears out my conclusion.

Bhargava committee report- at last!

I was getting a little fed up with the tit-bits about the Bhargava committee report on IIMs appearing in the media, so it was a pleasure to finally get hold of the report and read it in full.

Let me highlight what I believe are the most important recommendations:

• Creation of a pan-IIM Board: It will have 15 members, 5 of whom will be government nominees and the others persons of eminence, including IIM alumni. The chairman will be appointed by the PM. This will be the principal goal-setting and monitoring mechanism for the IIMs. It will approve IIM business plans and review performance every two years.
  
• IIM boards to have powers to select director, set fees and propose chairman's name to pan-IIM board.
  
• IIM boards to be reconstituted and comprise 11 members (instead of the present 25 or so). Initial board appointments to be made by ministry, subsequent vacancies to be filled by boards themselves.
  
• Appointment of faculty on contract basis with the freedom to pay market-related compensation.
• IIMs A, B and C to increase PGP intake to 500 by 2011.
• Consulting income of faculty to be limited to 15% of salary

There are many other recommendations and observations. The report requires detailed treatment.

My immediate response is that the creation of a pan-IIM board is a constructive suggestion. The committee observes that with responsibilities being divided between the ministry and the Boards, accountability has become a casualty. In the ministry, officers keep changing and managing six IIMs (with several more to come) is well nigh impossible. The Boards themselves, the committee notes, have not lived up to their monitoring role for a variety of reasons mentioned in the report (one being the perception in the Board that it's the ministry that finally calls the shots).

So some mechanism for setting objectives and monitoring performance in the IIM system is required. A pan-IIM board with the secretariat housed in the ministry is the proposed answer. One of the ticklish issues to be sorted out is the demarcation of roles of the pan-IIM Board and the IIM Boards.

The report says that the pan-IIM Board should not be involved in day to day management of the IIMs. Well, nor should the IIM Boards. A Board's role is primarily in the areas of strategy and monitoring of performance- and both these responsibilities will now be vested in the pan-IIM Board. So, will the IIM Board be confined to selecting the director and other members of the Board and giving approvals to financial proposals that exceed limits delegated to the director?

The reduction in the sizes of IIM boards to more optimal levels is welcome; so also the proposal to limit board memberships to a maximum of two terms of three years each. To me, the puzzle is that the IIM fraternity itself did not make these proposals all these years. Did it require a government committee to make these eminently sensible suggestions?

Bhargava committee on IIMs

The report of the Bhargava committee on IIMs is yet to be released. We have to be content with snippets appearing in the press. The latest bit will not please the IIM fraternity at all:

The IIM Review Committee has suggested that the pan-IIM board’s secretariat should be within the HRD Ministry. It has slammed IIMs for not “reacting to the market need quickly enough”, said that IIM Board directors and chairmen have failed to be effective CEOs, pointed at a ‘lack of mutual confidence and trust between the IIM and the Government’, and recommended that a common interview be held for all IIMs.

Regarding faculty, the committee has called for fixing of “higher level base salaries”, though it has put a cap on the consultancy and executive training programmes. The committee has recommended that time spent on these by the faculty should be limited to 90 days in a year with not more than 40 days during the nine month period when the institute is running post-graduate programmes.

The recommendation on consulting caps it not clear. Does the committee mean a total of 90 days in a year for all faculty or 90 days per faculty? If the latter, that would actually be a relaxation of existing norms which limit faculty to 53 days' consulting.

The committee faults IIM boards for not doing their jobs. These boards, be it noted, include representatives of the central government (and, in some cases, the state government). The committee has judged that one reason for the ineffectiveness of these boards is they are too large- with 25 members or so- and poor attendance on the part of board members. It recommends that the size of the board be pruned to 11 and also that minimum attendance requirements be laid down. That would mean that government nominees on the boards should also take their jobs more seriously.

ICICI Bank draws judiciary's ire

ICICI Bank marketing agents apparently made the fatal mistake of bothering some Delhi High Court judges with their marketing calls. A lawyer, who had been similarly bothered, approached the honourable High Court - and found the judges sympathetic to her cause.

ICICI Bank faces contempt proceedings in the State Consumer Commission, having ignored earlier court injuctions about unsolicited marketing calls. Justice Sen had some strong words:

“I receive calls at all time of the day from ICICI Bank,” Justice Vikramjit Sen said. “I do not know what business you get out of such calls.... You are a nuisance and have to face the music for making these unsolicited calls.”......

Do you think you are above the law?” the judge asked. “Who is your highest ranking officer in northern India... bring him here; let him explain these calls.”

The Express story adds:

On December 26, 2006 the consumer commission had levied a Rs 12.5-lakh penalty on the bank for making nuisance calls. Though the High Court subsequently stayed the Commission’s decision on September 11, 2007, the court had warned the bank against making “unsolicited marketing calls”.

Et tu, Goldman?

Goldman Sachs finally joins the ranks of firms that will slash jobs- a 10% cut in workforce is planned, FT reports. The axe will fall heavily on fixed income and investment banking. Nobody should be surprised- Goldman's reputation for invincibility has been badly dented in the present crisis. Bad news for India's top B-schools, I guess.

And now for British govt support for manufacturing!

I read this piece by FT's manufacturing editor with some disbelief. It is nothing but a thinly disguised call for industrial policy- the targeting of particular sectors in manufacturing by the British government. The author argues that government ownership of UK banks provides just the right basis for such an approach:

The government will have the power to put representatives on the boards of the three banks most affected by the debacle – Royal Bank of Scotland, HBOS and Lloyds TSB. In reviewing these institutions’ lending policies, the government should ensure they take a proactive approach to supporting companies in the manufacturing sector......

There should be an emphasis on lending to youthful, poorly capitalised businesses attempting to commercialise new technologies – especially in promising fields such as zero-carbon energy production, lightweight construction materials and low-power electric motors. In the next 20 years, more UK-based customers will require specially tailored manufactured goods – in fields from home heating systems to aerospace parts – that on the grounds of transport costs and order times are made locally rather than shipped in from China. The new policy should help those UK production companies that have the skills to meet the new demands for short-turnaround “customised” manufacturing.

This is not just industrial policy but a form of directed lending. Maybe the British government can turn to the RBI for advice?

Preview of Bhargava committee report on IIMs

Apparently, the ministry of HRD is close to making available the report of the R C Bhargava committee report on the IIMs. Indian Express carried a story yesterday which offered a preview of key recommendations. The report is right in suggesting that these are unlikely to go down well with the IIMs:

• Creation of a Pan-IIM board
• Reducing the size of IIM boards to more manageable proportions (from 24 or so to 11)
• Initial appointments of boards to be done by a committee comprising Secretary, MHRD, and three professionals
• Annual intake of PGP to rise to 750
• IIMs operating for more than five years to limit their operational surplus to provide for infrastructure and scholarships
• IIMs to go slow on executive training and consulting
• Separation of administrative and teaching functions of faculty

I would not like to comment on the report until I have read it myself. Just a few quick repsonses to the story.

One, what would be the role of the pan-IIM board? Two, chairmen of IIM boards are even now made by the MHRD, so what is proposed would not be much of a departure. Reducing the size of IIM boards makes sense- indeed, I had suggested this myself to the Bhargava committee. No point in having boards where half the members fail to show up for meetings.

Quote from Montek Ahluwallia

BS quotes Planning Commission Dy Chairman Montek Ahluwallia as saying:

The belief that the financial markets are somehow very efficient and that the American financial system invented all kinds of new instruments that were bringing about tremendous efficiency gains which deserved to be emulated..... I think this view has been totally discredited".

Hmmm.... so what does this bode for the Percy Mistry and Raghuram Rajan committee reports on financial sector reforms?

Ahluwallia's views are a bit of a revelation considering that the Rajan committee was sponsored by the Planning Commission.

Treasury funds for US banks

So Hank Paulson has finally bit the bullet. The US Treasury will put $250 bn in capital to banks as part of the $700 bn bail out. Clearly, asset purchase alone will not impress the markets. In the first staeg, $125 bn will offered to a list of banks that reads like a who's who of survivors, mind you, not the battered ones: Bank of America, JP Morgan Chase, Wells Fargo, Citigroup, Merrill, Goldman, Morgan Stanley and two others.

What does this mean? Well, the word 'strong' is a highly relative term in today's context. Bank of America and JP Morgan Chase, Wells and Citigroup which were in the business of acquiring weak banks, are now certifiably in need of capital.

The banks would question this saying they never asked for capital and could have ridden out the storm. But the Treasury wants the top banks to do more than sit out the crisis. It wants them to lend so as to keep the economy from going under. So, this bout of recapitalisation is not so much about preventing bank failure as preventing a serious downturn arising from what the Treasury regards as inadequate capital.

The coupon rate of 5% on convertible preferred stock for the first five years, incidentally, involves a subsidy at today's rates.

Soros' plan for US bail out

Soros spells out details of how he would like the US's Tarp (troubled asset relief programme) to work:

• The regulators must work out how much capital banks would need to meet 8% capital adequacy
• The government must infuse required capital through 5% convertible preferred shares
• Fed should guarantee interbank borrowings by banks eligible for recapitalisation
• Capital adequacy requirements should be lowered to facilitate fresh lending
• Home mortgages need a plan to limit foreclosures

This is pretty much along the lines of what the UK has done. I am not sure that lowering capital adequacy requirements is desirable until the storm has blown over. Banks must have enough capital to prevent another bout of loss of confidence in the event of some fresh problems.

Bank nationalisation in UK

The UK government stands to own up to 30% of equity in the top four banks- not very different from the level of 33% recommended by the Narasimham committee for public sector banks in India. We are not talking of small, insignificant players. The banks include: LLoyds TSB, Royal Bank of Scotland and Barclays. So far, HSBC, Banco Santander and Standard Chartered have said: thanks, no.

The British government intends to have its nominees on boards of banks where it will acquire an equity stake. It could end up being the biggest stakeholder in these banks. And it has already said it will have limits on executive pay and bonuses.

Somebody, please tell me: is this beginning to look like the Indian banking system or not?

PS: After I put up this post, the details of the capital injection have been finalised. The government will inject 37 bn pounds into RBS, Lloyds and HBOS (the latter is being acquired by Lloyds). The move would give the UK government a 60% stake in RBS and 40% in the combined Lloyds-HBOS. The Treasury is expected to appoint 3 new RBS directors and 2 directors to the board of the combined Lloyds-HBOS. There will be restrictions on dividend payments until the banks have repaid 9 bn pounds in preference shares they are issuing to the Treasury.

ICICI Bank's woes

ICICI Bank is paying dearly for its international forays and for its reputation for aggression in general.

I have long been sceptical about the merits of Indian banks going abroad. I have always contended that banks need to make the most of domestic opportunities and develop a solid repertoire of skills before thinking of an overseas presence.

Setting up a subsidiary abroad as ICICI Bank has done would involve tapping into the following opportunities:

• India-related retail opportunities: NRI remittances and deposits, for example, and investment in Indian stocks, mutual funds and real estate
  
• Corporate banking: serving Indian companies with an overseas presence
• Local market in overseas location: selling mortgages and other products to locals, Indian and non-Indian

India-related retail opportunities can be catered to without a foreign presence. They can be handled through correspondent relationships with overseas banks. Corporate banking does present opportunities but major ones such as overseas funding for acquisitions can be better done by foreign banks. As for grabbing a slice of the local market, what strengths do Indian banks bring to the table? Can they offer a higher rate on deposits or a lower rate on loans? How?

When you look at it very carefully, the Indian market growth is so high and the margins so attractive that going abroad does not seem attractive. There are also significant downsides to going abroad.

One, the overseas subsidiary may get into risky investments that happen to be the flavour of the moment (as in the case of ICICI Bank). Two, the regulatory risks can be high- it's hard for management in India to be keeping tabs and if there is a slip-up, there would be a heavy cost in reputational and other terms. As a result, the overseas operation can make disproportionate demands on management time.

ICICI Bank had set a target for international operations of 20-25% of overall revenue. What was the proportion in terms of profit? Going by its last annual report, PAT for the bank was Rs 4158 crore. ICICI Bank, UK, earned a mere Rs 155 crore while ICICI Canada and ICICI Bank Eurasia were in the red. Losses on investments in the sub-prime crisis can be expected wipe out the cumulative profit of ICICI Bank's overseas operations to date. It is not obvious that the international foray has been worth it.

ICICI Bank's general reputation for aggression is also part of the problem. That sort of reputation is a double-edged sword: at the top of the business cycle, it can boost your price-earnings multiple but, on the downside, it can undermine confidence. Many no doubt think that ICICI Bank, with its reputation for taking risks, is concealing more than it has revealed. This concern may be misplaced but it's there. The bank is heavily dependent on wholesale deposits. These would be the first to flee at the sign of trouble.

Interestingly, the bank's CEO, K V Kamath, has ruled out international acquisitions given "global challenges". Only a few weeks ago, top management was saying it was scanning the horizon for such opportunities.

Depressing times for Modi baiters

Heaven knows there is enough depression out there in the financial world but baiters of Gujaratr CM Narendra Modi have more reasons to crib.

First, the Nanavati commission report on the Godhra riots. The commission made two very important points:

• The fire in the train was the result of a conspiracy, it was not a reaction to teasing carried out by kar sewaks after the train arrived at Godhra
• There was no indication that the post-Godhra riots were planned. They appeared to be the result of outrage caused by media reports.
  

Both these contentions undermine the entire basis for the denunciation of Modi for his alleged role in the riots and of Sangh parivar in general. To be sure, there are judicial commissions and judicial commissions and people are selective in which report they want to accept. The Nanavati report has been castigated by many. But that does not alter the findings of the officially constituted probe into the riots.

The other blow is the Tata group's decision to locate Nano in Gujarat. The photo of Ratan Tata and Narendra Modi with their arms wrapped around each other while announcing the decision cannot have gladdened Modi's critics. What will they do now? Will they dare to criticise Tata's decision? They should spare themselves the trouble. Long before the Nano project, several businessmen, including Tata, have forged close ties with Modi over several Vibrant Gujarat summits.

Soon after the Godhra riots, the CII attempted a mild condemnation of Modi. There was a revolt in the Gujarat chapter. Tarun Das of CII had to rush to Gandhinagar to make amends and he was seen embracing Modi at the time. As Modi himself has pointed out in an interview with ToI today, businessmen's preference for Gujarat has little to do with which party is in power. But it is also true that businessmen are not going to be deterrred by what social activists think of a particular government.

Chew over this one!

The sub-prime crisis is producing its own genre of funny and unfunny stories. Here's one I read about Lehman Brothers in London.

When news came of the firm's bankruptcy,its staffers collected their belongings, of course,and carried these out in cartons. The financially more alert souls also made sure they encashed their pre-paid 100 pound cards at the in-house vending machines for candy- you never know, the machines might be empty later.That must have translated into hundreds of bars per capita- no doubt, it gave the staffers something to chew over.

Didn't the staffers pause to ask what all that candy might do to their systems? We know the people there missed some financial risks but one would have thought they might have been a little more wary about cardiac risk.

Bail out of the real sector too!

I quoted in my post yesterday (Rethinking government ownership) from an article in FT that urged government to extend its ownership to the real sector as well. The writer needn't have worried: it's already happened in a small way in the US.

Somewhat unnoticed in the current financial storm, the US has extended a $25 bn loan guarantee to the Big Three in the automotive sector- General Motors, Ford and Chrysler. The Economist reports:

The Big Three have been hit by petrol prices pushing towards $4 a gallon, by more demanding federal fuel-economy rules and by the credit crunch wrecking consumer finance. But the federal government came to their aid this week when George Bush signed an energy bill that includes $25 billion in loan guarantees to ease their pain. Supposedly this is to allow the Big Three to retool their factories to produce more economical vehicles.....

The rules are still being worked out, but the deal means that car companies—blessed with the government guarantee—should get loans with an interest rate of around 5% rather than the 15% they would face on the open market in today’s conditions.....

The logic of bailing out Wall Street is that finance underpins everything. Detroit cannot begin to make that claim. But, given its successful lobbying, can it be long before ailing airlines and failing retailers join the queue?

On a related note, Goldman Sachs is not the only firm to benefit from legendary investor Warren Buffett's munificence. GE is getting a timely infusion of $3 bn from him. It can use the money given the problems arising from GE Capital:

Most of GE’s recent problems have come from its financial arm, GE Capital, which it has belatedly decided to shrink somewhat. As well as some exposure to subprime mortgages and problems in its vast credit-card portfolio, there are growing concerns about its exposure to commercial property, which has been pretty solid so far but is vulnerable to a sharp economic downturn. Investors have also worried about what would happen to GE’s hybrid industrial-financial business model if it lost its cherished triple-A rating. Happily S&P, one of the leading rating agencies, said Mr Buffett’s investment and the decision to raise more cash reinforced the triple-A rating.

UK bail out plan

Britain has unveiled a bail out plan that commentators recognise as more comprehensive and hence more likely to succeed than the US plan. Two distinctive elements:

• Recapitalisation of British banks upto 50 bn pounds.
• A 250 bn pound guarantee on wholesale funds raised by banks

The latter is important because provision of short-term liquidity by the central bank is not enough. Banks have a serious problem with getting term finance.

The first step is even more critical. Shoring up bank capital is critical to protecting them against failure and ensuring that credit flows resume. The US plan attacks this problem indirectly by putting a floor on their assets. But banks will need more capital- and it may take time for private investors to regain confidence in banks. So government recapitalisation must be a critical component of any bail-out plan in today's conditions.

This should have happened much earlier. If it had, the turmoil in the financial system would not have been as great. But, in the western economies and in the US particularly, there is a huge mental block against government ownership. There is also the issue of how much capital can be given to which private party. That's why governments have dithered.

In contrast, recapitalisation of India's banks has not posed a problem because they are predominantly government-owned. The government's readiness to recapitalise as required plus the fact of government backing of deposits are two reasons why the Indian banking system today stands out in today's crisis.

Rethinking government ownership

The pendulum is really swinging the other way, isn't it? The present financial crisis has focused minds on regulation, alright, but it is also causing a rethink of sorts on government ownership in the financial sector. At a minimum, people think that, in a crisis, government takeover troubled banks is okay.

Richard Sennett, writing in FT, goes further. He wants government to infuse equity into real sector firms in order to safeguard employment in the western world. He even writes approvingly of the role of public investment in certain sectors in India:

We are entering a period of financial socialism, by which I mean that the government is buying enterprises which cannot survive in the free market – Fannie Mae and Freddie Mac, the $700bn credit bailout in the US, Northern Rock and Bradford and Bingley in the UK. Most observers look at such financial socialism as an emergency measure – and a bad thing. To me it is a good thing; indeed, public ownership needs to be extended from the financial sector to the manufacturing and service sectors.The reason for this is that Europe and the US have many industries and service businesses which cannot survive in the global economy....

Regulation, of the kind the financial sector is now experiencing, is largely irrelevant to expanding the number of jobs. The point is not to restrain risky action, but to encourage investment and innovation. That agenda requires money, more money than can be justified by the austere calculus of the market. This extra cash is where public investment comes in.

If this seems too much to swallow, consider India. Much of its construction, information technology and healthcare sectors have been – on a western calculus – over-staffed and inefficient, supported by government grants. Public investment has, however, developed these industries and as they have grown the need for government aid has declined.

Is it really a bail out?

Writing in Business Standard, Percy Mistry contends that the Treasury plan cannot be called out a bail out because the Treasury stands to make profits ultimately on the assets it buys. Assets will be bought at distress prices. Asset prices should improve later. Hence the profit. Banks that have provided for a higher loss than indicated by the Treasury's purchase price can write back provisions. So, it's win-win for Treasury and the banks. Where is the bail out, he asks?

Well, we are quibbling here, aren't we? When we talk of a government bail out, what we mean is that, absent government intervention, firms would fail. A bail out is any move that saves firms from failing through the operation of market forces. By this definition, the Treasury's initiative certainly constitutes a bail out.

If we go by Mistry's interpretation, there was no bail out of LTCM by private parties in 1998- the parties ultimately ended up making a profit on their investment. More to the point, the Indian government's investing Rs 20,000 in public sector banks in1992-93 and the subsequent infusions into Indian Bank and UTI do not constitute a bail out because the government has made a handsome profit on these investments.

On a different note, what is the cost of a banking crisis? Government purchase of assets or infusion of equity capital may not constitute costs to government because these are eventually recouped. Besides, once a loss happens in the banking system, government infusion of capital is merely a transfer- it is not an additional cost because the cost has already happened.

The true cost of a banking crisis is the loss of an economy's output. So, you compare potential output without a bail out with the cost with a bail out and measure the difference. It cannot be Mistry's case that the US economy will not suffer a loss of output if government does not intervene.

Outsider as head of Unilever

Here in India, Unilever gets a great press- cradle of star managers and all that. Interesting, then, that the firm has decided to pick an outsider as its new CEO, somebody who worked for rivals P & G and Nestle.

FT has a story in which it notes:

The news came as a welcome surprise to investors used to complaining, as one puts it, of an “insular executive team” that ran the business “like the civil service”. It was even more startling to those who know the group from the inside. After years of underperforming its peers, had Unilever finally found the man to return it to its former glory?

Unilever has been something of an underperformer in India too lately. But that doesn't keep its managers from getting rave reviews in the media. Incidentally, I remember reading that M S Banga and Harish Munwani were in the running for the top job. They seem to have lost out as Keki Dadiseth had earlier.

A kind word or two about investment banks

Wall Street fact and fiction. That's the title of my last ET column. I explore some of the loose comments on investment banks in the media, especially the belief that they were undone by high leverage. No, high leverage in itself is not a correct measure of financial risk in financial firms. It was the combination of high leverage, illiquid assets and dependence on short-term funds that proved fatal. I explore other misconceptions as well.

Now, readers of this blog would know that I am no starry-eyed admirer of the go-getting culture of investment banks, no believer in their superior risk-taking skills or their repertory of talent. But I do think they had several things going for them.

• They had a more egalitarian culture than most firms. Managing directors were to be found hundreds in Morgan Stanley and other places. You did not a big budget and an army of people under you to be called Managing director. The amount of business you did and the profit you raked in was enough. A star trader hooked to a terminal could be an MD.
• They had greater employee ownership than most firms- at Bear Stearns, employee stock ownership was around 40%, at Lehman's 30%. As I have said earlier, the stock options schemes might have been better designed, they ought to have vested over longer periods. But the principle of large numbers of employees (down to secretaries) being owners is a good idea (although it's not such a great idea, from their point of view, to have all one's savings in one's own firm).
• They were quite sensitive to operating costs (other than employee costs where they went overboard). Otherwise, business divisions operated on the principle of return on capital allocated. Since their bonus numbers were linked to this, they went all out to slash costs wherever possible.
• They were more meritocratic in their orientation than firms in other sectors. Performance was recognised quickly and rewarded. Two reasons for this. Performance was easily recognisable- if you brought in an investment banking deal, everybody knew what that translated into; traders' profits are easily measured (although not always the capital to be allocated to them). Secondly, firms could not afford to disregard performers- they would simply leave in what was a highly competitive market for people.
  
• They had high burn-out rates among employees and the work-life balance was terrible. But these places gave you at least a theoretical chance of quitting when you were 40 or so and turning to other things- collecting art, kayaking, setting up a nursery. And many did.
  

Who gained, who lost in sub-prime crisis?

I've been travelling a bit, hence this lull in posts on the blog.

There's a lot of stuff on losses and gains in the sub-prime crisis. Let me explore two contentions.

1. Executives of financial firms are big losers, they have been punished heavily for their sins: The point being made is guys like Richard Fuld of Lehman and Jimmy Cayne of Bear Stearns have seen their personal fortunes in the form of stocks tied up in their own firms plummet in value, so it's not as if they have not been punished for their follies.

Well, yes, they have suffered losses on their stocks. But, this is not the complete story. These are people who base pay is huge- say, upwards of $20 mn. Many executives also get cash bonuses. Last, many have cashed out some portion of their stocks. One needs to add up all these to get an idea of the accumulated rewards. The value of their stock holdings at the time of their firms' demise, while large, is only one component of their overall reward. Now, this total is not small in absolute terms. It could typically amount to over $200-300 mn- no mean sum f0r destroying shareholder value.

The short point: top executives will be big losers only if base pay is kept smaller and variable pay comes in the form of stocks that vest over a very long period, say five to ten years.

2. Shareholders of firms such as Fannie Mae and Freddie Mac have paid a price because they've got nearly wiped out, so it's not that they gained from implicit government support: As a shareholder in such firms, you would be wiped out only if you invested at the beginning and held on till the end. Let's say one set of shareholders, who bought at the beginning, sold out at the peak. They would have made huge gains. Another set of shareholders who bought from the first at the peak would have lost heavily.

Shareholders as a class would have made zero gains (not a loss) but that does not mean that individual shareholders did not make huge gains when the going was good.