Anatomy of a witchhunt

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

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

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

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

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

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

Tribunal for private educational institutions

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

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

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

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

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

How the mighty have fallen!

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

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

Placements on the IIT campuses across the country, which began in January, have suffered due to the economic slowdown, with even IIT Bombay, a much sought-after institute among most companies, seeing lukewarm response from the private corporate world so far. The trend is evident with placement dates being extended till April. Earlier, the placement process at the IIT Bombay used to get over within two to three days.

A reader comments that the report appears to apply to the Management school at IIT Bombay rather than the campus as a whole. But the situation for engineers cannot be a lot better. We are seeing similar problems at the IIMs where recruiters are asking that the placement fee be waived. Many FMCG and manufacturing companies long disdained by the IIM fraternity are taking their time responding- I guess they have a point to make. The IIM average salary, for long artificially inflated by the dollar-paying overseas segment, will now look a lot more modest.

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

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

US curbs on bankers' pay

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

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

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

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

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

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

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

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

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

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

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

Banks under pressure to lend more

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

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

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

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

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

RTI, RIP?

The Right to Information Act was a revolutionary step towards strengthening Indian democracy. There is a lot of good that has come out of it and it does carry a great deal of promise. But, I have always wondered how long the system would put up with it. Some recent developments do give cause for concern as to whether the spirit of the RTI will be observed in all instances:

• The Supreme Court contends that information on assets provided by judges to the Chief Justice need to be made available to the public and also it need not be disclosed whether all judges have disclosed their assets to the CJI.
• The PMO now contends that declarations by ministers are held by the PMO in a fiduciary capacity and need not be made public.
• The CIC itself holds that information commissioners are not obliged to declare their assets- this is, perhaps, the unkindest cut of all.

RTI, RIP? Let's hope and pray.......

Is there a credit squeeze in India?

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

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

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

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

A historian's olution to the banking crisis

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

Ferguson thinks government spending in the US is not the answer because it will take the budget deficit past the danger mark of 10% of GDP. He proposes instead that:

• Government recapitalise banks after losses are fully written down and bond holders take a hit of about 20% or convert debt into equity. This is fine but the solution still involves government spending, doesn't it? For some reason, Ferguson would call this 'restructuring' not 'nationalisation' with a commitment to re-privatise after 10 years. If nomenclature will solve the trick, ideologues can please themselves. To me, it's nationalisation.
• Mortgages be reset at lower rates. This will revive customer confidence. Yes, but it involves a huge hit for banks and holders of mortgage-backed securities. It will also imply a bigger government infusion of funds than otherwise.
  

Ferguson writes, " The best evidence that we are in denial about this is the widespread belief that the crisis can be overcome by creating yet more debt." Will somebody explain to me how Ferguson's proposals will avoid creating more debt? Or has he made calculations that show that the debt increase in his scheme would be lower than in the Obama scheme?

Will bank bosses never learn?

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

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

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

Bonus for non-performance

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

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

Citigroup board make over

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

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

Indian banking looks sound

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

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

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

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

To nationalise or not?

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

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

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

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

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

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

A comprehensive failure of regulation

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

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

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

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

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

Demise of Citigroup?

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

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

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

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

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

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

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

And now Satyam's EMRI service

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

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

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

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

It is telling that neither Ambani brother has emerged with the market’s vote of confidence. Shares in Mukesh Ambani’s Reliance Industries are down 21 per cent since last Tuesday; those in Reliance Communications, the telecoms group controlled by his younger brother, Anil, have fared even worse, slumping 29 per cent.

It is worth mentioning that SEBI has ordered an independent review of the financials of the Sensex and Nifty firms. Investors should keep their fingers crossed.

Independent directors and consulting fees

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

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

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

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

Satyam's ex-independent directors

The plight of Satyam's ex-independent directors must cause other independent directors to shiver in their shoes. They face a show-cause notice from the Company Law Board, probes by SEBI and law-suits in the US. The damage to their reputations has been immense. Let's see..

• M Rammohan Rao has had to quit as director of the Indian School of Business. He has also withdrawn from the panel to select the Dy Governor of the RBI.
• Krishna Palepu, it is reported, is under pressure to quit the board of Dr Reddy's Labs.
• T R Prasad, former cabinet secretary, stuck to his directorship even after all the revelations. He has suffered the ignominy of being booted by the government of India, the very government he had served all his life.

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

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

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

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

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

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

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

Satyam fall out

There is the possible collapse of the firm and its impact on over 50,000 employees; then, the possible folding up of PricewaterhouseCoopers if anything is proved against them. The loss to shareholders of Satyam. There is the impact on brand India and the IT sector, the impact on capital flows into the country especially if any other scandal erupts. All this has been talked about. What else? Well, a few things:

• The future of Hyderabad Metro: this deal was won by Maytas Infrastructure in the face of strong criticism from Delhi Metro chief E Sreedharan, who indicated it had all the makings of a land scam. The project is meant to be a feather in the CM's cap, so he's going to have some sleepless nights over this.
• The Byrraju foundation: this is not your run-of-the-mill NGO. It's a huge thing involving 200 villages and covering one million people, according to some reports. The foundation's CEO recently sent out a letter that says that Raju has thus far contributed Rs 300 crore from his own funds to the foundation.
  
• The 108 emergency project: Raju had signed contracts for PPPs with several state governments to provide emergency services. I heard these are running well. The state governments invest in ambulances and other hardware. Raju takes care of the operations including software, back office and control rooms.

Incidentally, Forbes.com has a nice backgrounder on the rise and fall of Raju.

Satyam fraud: how do we overhaul governance?

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

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

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

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

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

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

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

CJI not exempt from RTI

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

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

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

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

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

How international are US universities?

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

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

Woes of independent directors

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

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

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

Gujarat govt scheme fails at GNFC too

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

Sandeep Parekh has the details at his blog.

Gujarat government charity schme fails at GACL

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

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

Citi execs to forgo bonus

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

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

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

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

Backlash against the financial sector

The sub-prime crisis has caused a backlash against the financial sector- and bankers as well. The joke doing the rounds is that in the City of London, people introduce themselves as, "I am not an investment banker".

The serious part of the backlash is the view that the financial sector has grown too big for its own good and for the good of the economy and that it needs to be pared. We need to go back to the safe and solid real sector.

We do need to rein in bankers and we need better regulation but the idea that finance is evil and that the real sector has more virtue is little basis to it. FT has an edit today that seeks to get the balance right:

It is not that finance is more prone to mania, fraud and collective error. Executives and visionaries drove the internet bubble just as much as venture capitalists; the Enron and WorldCom frauds hit (supposedly) real economy companies; US car companies have all invested in the same varieties of unpopular product. The difference is that the consequences when a financial institution goes wrong are so great. When WorldCom went under the world shrugged its shoulders; when Lehman Brothers failed the world fell to its knees. The danger of finance means it must be regulated, and regulated better – but it should not be proscribed.

Another approach is to ask whether having a large real sector makes an economy more resilient. Japan and Germany are both manufacturing powerhouses, yet they seem just as susceptible to this downturn, partly because they relied on finance-driven consumption abroad to provide demand for their exports. Developing countries, where the financial sector tends to be smaller, are suffering. Commodity exporters – how real is that? – may be in the worst position of all.

Quote of the day

John Kay in FT:

The American political scientist, Philip Tetlock, has studied the prognostications of pundits over several decades. He finds that the better known the forecaster, the less accurate the forecast.

Just think of the army of economists, investment bankers and analysts who have been wrong about the world economy over the past year or so.

Charming book on Mumbai

Suketu Mehta's Maximum City came out a while ago but I got a chance to read it only recently. It deserves the acclaim it has received.

Mumbai is packed with people. A small piece of land supports millions who toil to get the most out of it. Hence the title.

Mehta, an NRI, comes down to Mumbai and takes up residence there along with his family in order to understand better the city in which he grew up. (His family left for the US when Mehta was in his teens). He gets acquainted with Shiv Sena activists who took part in the riots of 1993; with hired shooters from the underworld; with bar girls; with police officers; with Bollywood personalities; with a Jain family that takes diksha or renunciation; and with sundry others who hope to realise their dreams in Mumbai.

Through these characters, the city comes alive. Politics, crime, business, films all come together in the book and the dividing lines between these are not always clear. There is much that is depressing: for instance, one set of rules for the rich and the powerful and another for the have-nots. If you have money and muscle, you can get away with anything.

But there is also a sense of community, -among the slum- and pavement-dwellers, for instance- a willingness to share and help, tremendous grit in the face of very hostile living conditions and, above all, hope. Mumbai holds out the hope that if you struggle and fight it out, things will work out. That is what draws millions to Mumbai.

The nexus between crime and politics is always present as also the lawless ways of the law-enforcement agencies (such as faked encounter killings). There are places where you get the impression India is another banana republic: anything and anybody can be bought.

This is one of the negatives about the book. It dwells so much on the seamy side of Mumbai that you can easily forget that there are thousands who make an honest living, that there are large businesses in the public and private sectors that are not necessarily run with the patronage of the underworld. It is people who belong to this part of Mumbai who need to read the book because they will have no idea of the other part to which Mehta devotes so much attention.

Mehta has a wry sense of humour and a keen eye for pretence and the narrative never flags although the book is nearly 500 pages long. His book raises the troubling question: how does one sort out the governance mess that is Mumbai? I think I asnwered this question in another context in another post. Writing about the terror attack of November, I suggested that we need alternatives to the dream city that is Mumbai. Making Mumbai better won't help because it will simply draw in people in greater numbers and worsen the governance problem.

L'affaire Satyam

I have a short commentary in Forbes.com

It's becoming increasingly likely that Ramalinga Raju and his family will lose control in Satyam. If they could sell their stakes at a reasonable price, they would have cash to fund their infrastructure ventures. Any transfer of control in Satyam would be truly ironical: thanks to their hoards of cash, Indian IT firms were, until recently, viewed as potential acquirers rather than acquisition targets. It would be quite an anti-thesis to the India Shining story.

ISB director faces flak

M Rammohan Rao, director of the Indian School of Business, has come under fire for his role as independent director on the board of Satyam Computers. There are other independent directors on the board but Rao is attracting more attention than others probably because there are highere expectations of academics. Rao also ended up drawing attention to himself by giving interviews to papers and appearing on TV (and in the latter, his defence appeared very feeble).

Now, a constitutent of the Left front has asked that Rao be asked to quit various government selection committees because his credibility is compromised. One newspaper today reported that the AP government has advised Rao to quit the Satyam board.

Is this excessive, a little too much? Well, I think the underlying principle- that one's role as independent director in a given situation can have serious reputation effects- is salutary. In an earlier post, I had suggested that, if independent directors are found wanting in a given board, then anlaysts and investors should monitor all other companies with which they are associated. There must also be a 'negative' list of directors associated with questionable decisions- and not just on corporate boards but even non-corporate boards.

One aspect of the deal, which hasn't been adequately highlighted, is that the cash transfer to the two Maytas firms was going to be through secondary market transactions- that is, through purchase of the Rajus' shareholding. This would have meant cash going into the Rajus' pockets, not even those of the cash-starved Maytas firms.

Year-end thoughts

The economic slowdown, terrorism and inflation were the three main items of the year. Towards the end of the year, terrorism came centre-stage following the attacks in Mumbai in November.

There has been much bravado -and not a little hot air- following the Mumbai attacks. A sense that we must "get touch" with terror. As I have said earlier, there is little chance of our being able to eliminate terror in the near future- indeed, given the geo-politics of the country and the obvious governance deficit, we must brace ourselves for a longish period of terrorist attacks.

What we can and must do is minimise the impact of such attacks. In general, terrorism, insurgency and even war seem to impact little on economic growth. India, Pakistan and Sri Lanka, among others in the world, have seen economic booms even when afflicted by high degrees of violence. That's because modern economies are decentralised, so attacks in one or two spots, while creating media headlines, have create very little economic dislocation.

But for us Mumbai poses a headache because financial activity is concentrated there and that too in the southern tip. We need alternative growth centres to Mumbai- we simply can't afford to have Mumbai drawing in more and more people and becoming more ungovernable. We should seriously consider creating three or four new cities with first-class infrastructure- China plans to add 20 new cities eery year over a twenty-year period. More on this and the year that went by in my ET column.

NY Times how YV Reddy saved Indian banks

The New York Times thinks that it former RBI governor, Y V Reddy, made the difference between the banking scenario in the US and that in India today:

Unlike Alan Greenspan, who didn’t believe it was his job to even point out bubbles, much less try to deflate them, Mr. Reddy saw his job as making sure Indian banks did not get too caught up in the bubble mentality. About two years ago, he started sensing that real estate, in particular, had entered bubble territory. One of the first moves he made was to ban the use of bank loans for the purchase of raw land, which was skyrocketing. Only when the developer was about to commence building could the bank get involved — and then only to make construction loans. (Guess who wound up financing the land purchases? United States private equity and hedge funds, of course!)

Then, as securitizations and derivatives gained increasing prominence in the world’s financial system, the Reserve Bank of India sharply curtailed their use in the country. When Mr. Reddy saw American banks setting up off-balance-sheet vehicles to hide debt, he essentially banned them in India. As a result, banks in India wound up holding onto the loans they made to customers. On the one hand, this meant they made fewer loans than their American counterparts because they couldn’t sell off the loans to Wall Street in securitizations. On the other hand, it meant they still had the incentive — as American banks did not — to see those loans paid back.

Seeing inflation on the horizon, Mr. Reddy pushed interest rates up to more than 20 percent, which of course dampened the housing frenzy. He increased risk weightings on commercial buildings and shopping mall construction, doubling the amount of capital banks were required to hold in reserve in case things went awry. He made banks put aside extra capital for every loan they made. In effect, Mr. Reddy was creating liquidity even before there was a global liquidity crisis.

Private sector bankers who were harshly critical of Reddy in those days now acknowledge his contribution:

Now that those risks have been made painfully clear, every banker in India realizes that Mr. Reddy did the right thing by limiting securitizations. “At times like this, you tend to appreciate what he did more than we did at the time,” said Mr. (Rana) Kapoor. “He saved us,” added Mr. (Deepak) Parekh. (First names in parantheses inserted by me )

IIT Madras director appointment set aside

The Madras High Court has set aside appointment of Prof M S Ananth as IIT Madras director. Ananth got a second term after he had completed the first term of five years in December 2006. The appointment was challenged by an alumnus. A single judge bench had dismissed the petitition but the alumnus pursued the matter with a division bench of the HC which then asked a judge to hear the matter.

I have scanned several newspaper reports. I must confess I am still not entirely clear about the judgement. From what I could make out, the HC believes that due process was not followed. First, the appointment was made, not by the IIT Council, but by a search committee appointed by the MHRD. It appears the Council alone has the right to make such appointments. Secondly, the post was not advertised- the HC appears to have said that the requirement of equality of opportunity cannot be met unless this is done. The HC has also noted that the contract between IIT M and Prof Ananth for a second term was signed even before formal approval from the President had been obtained.

I understand the judgement will have implications for some other IITs where too a similar process for appointment of director was followed. One of the reports on the judgement quotes the judgement as saying that since the appointment was for a fixed tenure, the question of an extension of tenure or re-appointment did not arise. If that is so, it would have implications for institutions other than IITs as well.

One thing we must applaud is the insistence of the court on the post being advertised widely. (The court went on to point out that there are distinguished Indian academics scattered across the globe and every attempt must be made to tap this pool of talent). There was a huge uproar in the IIM community when the director's post was advertised in 2007. They saw it as a sinister machination to bring in an "outsider" (as though the appointment of an outsider is a crime). The uproar died down when it was pointed out that a newspaper advertisement was a technical requirement for appointments made by the Appointments Committee of the cabinet.

I am also of the view that fixed-term appointments for institutions such as the IITs and IIMs are a good thing. There is no dearth of talent, so I can't see why one person should continue for more than one term. Two, limiting the term makes for greater accountability- the incumbent knows that his decisions will be reviewed when he steps down after five years. This sort of built-in check on the office of director is required because market-based mechanisms that operate in the US are largely absent in India.

Tatas and Singur: who will pick up the tabs?

The Tatas have exited from Singur and made a soft landing in Gujarat. Between Sanand and Pantnagar in Uttaranchal, Tata Motors will be able to roll out the Nano car even if somewhat behind schedule. So the Tatas are taken care of. What happens to Singur and the state of West Bengal? D Bandyopadhyay dissects the issue in an article in EPW. He makes several important points:

• The government of West Bengal can acquire land for a private company only through a procedure laid down in the Land Acquisition Act. It perpetrated a fraud by acquiring 1000 acres of land through WBIDC ostensibly for public purpose and then leasing out 643 acres to Tata Motors.
• Now that the "public purpose" for which land was acquired will not materialise (since Tata Motors has exited), the expenditure on the project incurred by the government has gone waste.
• The author makes an estimate of the cost on various counts: land acquisition, cost of construction of 18.75 km boundary wall, provision of police protection for two years, cost of subsidised land transferred from government agencies. The cost adds up to Rs 532 crore. He says this cost should be recovered from Tatas after the CAG has carried out a more careful estimate.
• The leases given to TML and ancillary units should be cancelled. About 400-450 acres of land should kept for the development of an automobile factory for which a global tender for expression of interest should be floated. The rest of the land acquired must be returned to those from whom it was acquired or to the local Panchayat.
  

None of these nuances have been captured in the mainstream media. There is only scorn for the West Bengal government and Mamata Banerjee and a sense of triumph at Tatas managing to find an alternative site in Gujarat.

RBI Governor on issues raised by sub-prime crisis

RBI governor D Subba Rao flagged five important issues arising from the sub-prime crisis in a speech at a seminar in Hyderabad earlier this month:

1. How do we manage global imbalances?

2. Is self-insurance a viable policy option for emerging economies?

3. What are the flaws of the current regulatory regimes? How do we fix them? In what ways can international cooperation be fostered in this regard? How do we address the black swan systemic risk events?

4. How do we address the problem of regulatory arbitrage?

5. How do we keep the financial sector in line with the real sector?

Long term outlook for oil prices

Oil prices have dropped to under $34 a barrel despite OPEC's announcement of the large single output cut ever last week. There is talk of prices dropping further to $25. This may seem terrific news in a slowing global economy but it has unwelcome long-term implications. It could derail plans for oil exploration and it also constitutes a huge setback to the quest for alternative fuels. Too low prices for oil are as bad as too high prices.

But I have to wonder: where are the geniuses who forecast ever-climbing oil prices just a few months ago? Arjun Murty, the Goldman Sachs wonder-kid, was said to have forecast an oil price spike of $200. Other said that climbing oil prices merely reflected an emerging scarcity of a limited resource. I was among the few who said that the sharp rise in oil prices appeared speculative and that prices should drop below $100 before the end of the year.

Now, is the fall in oil prices temporary? Should we see soaring oil prices once global growth beccomes normal. The World Bank doesn't think so. Here is what the latest Global Economic Prospects report says:
<>

The strength, breadth (in terms of the number of commodities whose prices have increased), and duration of the current commodity boom have prompted speculation that the global economy is moving into a new era characterized by relative shortage and permanently higher (and even permanently rising) commodity prices. This outcome does not appear likely. Over the next two decades, slower population growth and weaker (though still strong) income growth are projected to cause trend global GDP growth to ease …. and, with it, the demand for commodities.

<>
Although the absolute quantity of fossil fuels and metals in the earth’s crust is declining and the quantity that is extracted each year is rising, there appears little likelihood that the world will run out anytime soon. Historically, proven reserves of both metals and oil have tended to rise even more rapidly than production, remaining surprisingly constant in the case of oil at about 40 years of production.

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.