Friday, 28 November 2008
To
His Excellency Wen Jiabao,
The Premier's Office,
Beijing,
Capital of the Secure & Terrorism-Free China
From
Pradeep Kabra ('The White Tiger')
Still a Patriotic Indian
And an entrepreneur
Presently living in the UK
Sub: From "A Broken State" to "A Dis-integrated State" - My Plan & Proposal
Dear Mr. Jiabao,
I'm a friend of Mr. Aravind Adiga from Mumbai, who introduced you to the famous & rare 'Indian White Tiger' in his last letter. Incidentally, that letter was published and it became a best-seller and won him kudos in the West in the form of the Booker Prize. I'm not looking for any prizes Sir. But I do have a plan & a proposal for you. But first I need to explain the context of my plan.
Oh by the way, I'm sure you might have heard by now the terrible blasts in Mumbai (the financial capital of India) (Luckily, the blasts happened during recession and not during the boom times, otherwise the overall losses would have been terrible. Imagine, human loss and financial loss in billions) Anyway, by now you might also have expressed your sympathies with the Indian Prime Minister and though official thanks will follow, let me express my gratitude for your empathy in these troubled times.
I am very hurt and angry at these senseless killings like any patriotic Indian and any sensible citizen of the world (except of-course my terrorist friends. Oh yes, I can't call them my enemies sir, not yet. Otherwise, they will start targeting me and my family. I can't take that risk. Not yet.)
But sir, I'm different (because I'm that rare 'White Tiger' you see). I don't want to go into the root-cause-analysis. You pickup any newspaper or go to any website, you will get all the reasons and causes for the attacks. I'm a MAN OF ACTION. I would rather go for the Solutions.
I have a 3 decade plan - divided into three parts to solve this problem permanently.
Decade 1 - 2009-2018 AD - 1. Implementing the Rule of Law Internally withing India (irrespective of caste, creed, religion, connections, contacts etc.,) 2. Building up the Infrastructure (including basic facilities like drinking water, electricity, roads, ports etc.,) 3. Providing Education (including atleast basic literacy to all the kids)
Decade 2 - 2019-2028 AD - 1. Sustaining Education (Including basic literacy, computing skills, internet skills and advanced literacy) 2. Speeding up the Infrastructure (Including motorways, Airports, internet access, high-tech facilities etc.,) 3. Maintaining the Rule of Law within India (irrespective of caste, creed, religion, connections, contacts etc.,)
Decade 3 - 2029-2038 AD - 1. 2. & 3. - Sustaining & Modernizing "Education-Infrastructure-Law&Order"
That's all. If it sound's too simplistic to my Indian friends - I suggest - TRY IT!!!
As one of my teachers always used to say, without trying, you would never know if it works or not.
But Mr. Jiabao, the problem in India is, they think (most of them I mean, except of-course the 'White Tigers') that it is 'God's Will' and God will come in the new Avataar to correct these ills. But I differ with them of-course.
The government's official explanation for it's incompetency in implementing this 3-decade development plan is that it is too busy managing the security of the country (unsuccessfully though, as the spate of coordinated multi-city bomb blasts exposes the Congress government's ineptitude)
My proposal is "Why not out-source the country's security" (Japan, Germany, South-Korea have been doing it successfully for the last 6 decades to the Americans and hence they could concentrate on their economy and today as you know Mr. Jiabao, Japan is the second largest economy in the world and largest in Asia. Germany is the largest economy in Europe and the largest exporter of the world).
Where my proposal differs from the past is - Outsource the security of India not to the Americans but to the Chinese.
(Sorry Mr. Obama, though I admire you, I can't give you the first offer because of three reasons - a) I believe in 'Love Thy Neighbor' Policy b) I believe outsourcing should never be far away...just in case c) I believe China will be the next super power by 2025. So get the first mover advantage.)
Don't be so shocked Mr. Jiabao. We Indians are very good students. We always seek knowledge.
First the Moughals came and taught us the importance of beauty (remember Taj Mahal), introduced us to a new religion (Islam), United the whole country (remember Emperor Akbar the Great).
Then we allowed the Britishers (after the 3 way auction between Brits, Portuguese & Dutch) to teach us the Rule of Law, modern infrastructure (remember the great Indian railways), sports (remember cricket) & of-course the pride of India (Indian Democracy)
If you are surprised at my interpretation Mr. Jiabao, I know because you might have been reading the History books from India, where they say, first the Moughals 'looted' the country and then the Britishers 'plundered' it. Utter Nonsense. That is not true at all. We still have the Taj Mahal, the Great Indian Railways, Cricket & the famous Indian Democracy as a proof to prove my point.
Anyway, now you might be thinking Mr. Jiabao that what can we Indians, possibly learn from China. Well, I can think of two great things along with your 'protection' from the Terrorists of-course a) your fabled discipline b) your Olympic records.
So by now, Mr. Jiabao, you must have got the gist of my 'proposal'. Please don't hesitate to forward the same proposal to our Prime Minister. Our PM is a Harvard graduate, highly educated, open-minded, intellectual chap. (controlled by an Italian of-course). Presently he is discussing the 'Mumbai Attacks' with his Pakistani counterpart Mr. Zardari & the chief of fabled Pakistan Secret Service ISI is visiting India to find out the "root cause" of the issue. I'm sure Sir, he will be open to your 'proposal'!!!
If it works out Mr. Jiabao, please don't forget that it was "my idea" in the first place. I'm open to negotiations on the royalty terms (but you should understand my constraints in the first place. Like any innovative entrepreneur in India, I have to share a large portion of the proceeds with all my politician friends)
I hope you will consider my proposal with the right earnest.
Looking forward to hearing from you soon.
Yours Sincerely
Pradeep Kabra "The White Tiger"
Presently living in the UK
PS: Please respond quickly to my proposal Mr. Jiabao, because I need to take a quick decision on this issue before the terrorists strike again. I can't wait for long because I'm worried that from a 'Broken State' my country will degenerate quickly into a 'Disintegrated State'. As a "Born Patriotic Indian Entrepreneur" I can't allow that to happen Mr. Jiabao.
Also, if you are not interested then let me know, I can then invite the Americans. I'm sure Mr. Obama will be too glad to oblige!!!
Friday 28 November 2008
Friday 17 October 2008
T R U S T
TRUST - This five letter word is the basis of every activity (financial or other-wise) taking place on this planet. Whether we believe in it or not, it is still the bedrock of societies.
In Banking and Finance, it is more obvious because "banks lend long and borrow short" So whatever the technical reason (in the present financial crisis, the reasons are quite a few including easy monetary policies, emergence of China, savings from developing world into developed world, crooked rating agencies, regulators playing catching-up, emergence of technology, last but not the least - greed etc...)for the present crisis, the basis of it is 'LACK OF TRUST'
The obvious solution to this problem is to create conditions to rebuild the trust. One cannot, I insist cannot rebuild the trust by hoping the crooks will reform. This just doesn't happen. One can only rebuild the trust by separating the crooks from the good and then creating a level playing field. (In banking parlance, this means, know the exact position of each bank/financial institution and let the weaker ones go down) Ofcourse this will lead to some short-term intense pain, but it will help to bring the good one's together and create a stronger system for the good of all. And it will be quick & efficient as well.
What then are the great minds across the world doing to solve this problem? They are, in my opinion 'falling in the trap' of 'hope' rather than playing it straight with action as a basis. They are assuming that putting good money (to begin with, 3-4 trillion dollars) behind bad without separating the good from the bad players will rebuild the trust. This is where I believe, they forget the basics. The trust is not built upon money, it is inherent till somebody disturbs it. The only way to rebuilt it is by separating wheat from the chaff. Let the crook banks & institutions go down.
This is not just basics & common-sense but it's the truth. But how so many great minds come together in a room and still take so many stupid decisions is beyond my grasp. It reminds me of what Warren Buffet said once in his MBA Talks 'Why Smart People do Dumb Things' - Ex: The 16 genuinely genuises in 'Long Term Capital', to make the money they didn't have and didn't need they risked everything they had and they need. And that's foolish. Just plain foolish.
http://in.youtube.com/watch?v=C1LiATYSajw&NR=1
Pradeep Kabra
In Banking and Finance, it is more obvious because "banks lend long and borrow short" So whatever the technical reason (in the present financial crisis, the reasons are quite a few including easy monetary policies, emergence of China, savings from developing world into developed world, crooked rating agencies, regulators playing catching-up, emergence of technology, last but not the least - greed etc...)for the present crisis, the basis of it is 'LACK OF TRUST'
The obvious solution to this problem is to create conditions to rebuild the trust. One cannot, I insist cannot rebuild the trust by hoping the crooks will reform. This just doesn't happen. One can only rebuild the trust by separating the crooks from the good and then creating a level playing field. (In banking parlance, this means, know the exact position of each bank/financial institution and let the weaker ones go down) Ofcourse this will lead to some short-term intense pain, but it will help to bring the good one's together and create a stronger system for the good of all. And it will be quick & efficient as well.
What then are the great minds across the world doing to solve this problem? They are, in my opinion 'falling in the trap' of 'hope' rather than playing it straight with action as a basis. They are assuming that putting good money (to begin with, 3-4 trillion dollars) behind bad without separating the good from the bad players will rebuild the trust. This is where I believe, they forget the basics. The trust is not built upon money, it is inherent till somebody disturbs it. The only way to rebuilt it is by separating wheat from the chaff. Let the crook banks & institutions go down.
This is not just basics & common-sense but it's the truth. But how so many great minds come together in a room and still take so many stupid decisions is beyond my grasp. It reminds me of what Warren Buffet said once in his MBA Talks 'Why Smart People do Dumb Things' - Ex: The 16 genuinely genuises in 'Long Term Capital', to make the money they didn't have and didn't need they risked everything they had and they need. And that's foolish. Just plain foolish.
http://in.youtube.com/watch?v=C1LiATYSajw&NR=1
Pradeep Kabra
Thursday 16 October 2008
Globalization & Protectionism
I agree with the globalization effect remark. Also I think poor/middle-class in West will also suffer. Will that effect politically to bring protectionism? I think that will depend of how deep the recession will be. Whether the policy-makers will throw good money after bad or will allow the bad banks/institutions to go down and let the stronger ones take-over?
The present attitude is not encouraging. thoughThat's why Inspite of throwing almost 3-4 trillion of good money, the markets are still punishing. Let's see. - Pradeep Kabra
--------------------------------------------------------------------------------------------------
Re: Tough times ahead. India and China will suffer more in my ( guarded ) opinion while the poor countries in Africa will get poorer. The world is now so tightly linked through Globalisation. It is like a human body, you prick the base of your foot with a pin, the whole body gets disabled! - Aslam Merchant
The present attitude is not encouraging. thoughThat's why Inspite of throwing almost 3-4 trillion of good money, the markets are still punishing. Let's see. - Pradeep Kabra
--------------------------------------------------------------------------------------------------
Re: Tough times ahead. India and China will suffer more in my ( guarded ) opinion while the poor countries in Africa will get poorer. The world is now so tightly linked through Globalisation. It is like a human body, you prick the base of your foot with a pin, the whole body gets disabled! - Aslam Merchant
Friday 10 October 2008
The 'Inconvenient ' Truth
Dear Friends,
We all are/will be affected by the present financial/economic crisis across the markets of the world. Nobody knows how long will this last or how severe will it be. But are the responsible people doing their jobs correctly?
I thought I will share this fantastic article which explains not just the desperate measures of the 'central bankers' across the world but also offers a simple solution.
I'm surprised to see even most of the 'top economists' falling in the same panic-trap. This analysis is by a former finance minister of 'El Salvador' (yes, that's true) & it is spot on. Though his analysis is based on US actions, EU, UK, rest of the world central bankers/governments are doing something similarly stupid all in the name of 'saving the economy from deep recession'. What a sham. If you don't believe me, after reading this article, listen to any of the videos of 'Gordon Brown' on BBC/Youtube, (The one with Nick Robinson on BBC was a classic) on what actions he is taking to save the economy, and you will see what a fool he is. You will find various versions of Gordons across the world.
The 'inconvenient truth' is that we are in a deep hole (thanks primarily to our 'banker' friends) & the only way to come out of it is to expose & expel the culprits by letting them go down. This is exactly how Mr.JP Morgan sorted a similar scenario in 1909. He called all the bankers in a room, asked/forced them to reveal their exact position (on a piece of paper, remember there were no computers/mobiles then) and then letting the weakest ones go bankrupt. So Simple.
The irony is that one doesn't need to be an economist to come to this conclusion. It's common-sense!!!
Pradeep Kabra
Re: It's Time for Banks To Put Their Chips On the Table by Mr. Hinds in Wall Street Journal, 10-Oct-2008
The Federal Reserve injected $480 billion domestically and globally last week and it doubled the dose Monday, injecting more than $900 billion in one single day. Yet banks are still refusing to lend to each other, and when they do lend they charge a record-high risk premium—which more than cancels out any Fed rate reductions. At the same time, banks have absorbed about $1.5 trillion in cash from the Fed, more than twice the most likely loss in the mortgage markets (about $600 billion).
What we are witnessing is what economists call a rise in the liquidity preference, which was the main factor leading to the Great Depression. Investors aim to increase the share of liquid instruments in their total assets. For the banks it means they want to liquidate loans and transfer the proceeds to very liquid instruments.
This migration depresses the economy by reducing credit. The solution is not to keep on throwing money at the banks, which are inclined to hoard it not lend it. Rather, what is needed is stopping the skyrocketing increase in their liquidity preference and then lowering it. Doing that requires writing off the losses.
Imagine that you are playing poker with 10 people and that you learn that a minority of them is broke and would not pay you if they lose. You don't know, however, who the ones are who won't pay. Any rational card player would stop making bets until the true solvency position of each player is revealed and the bankrupt ones are expelled from the game. This is what is happening in the banking system—only worse, because in poker you would only fail to collect the pot if you played with an insolvent player, while in the banking system you would lose your bets if you lend to an insolvent bank. Liquidity preference will not subside until the losses are made explicit, written off and absorbed.
To achieve this you simply let the illiquid borrowers and their financiers go bankrupt. This is how financial crises were solved in the 19th century. The method was expensive because commercial banks are central to the operation of the payments system and their uncontrolled failure can cause enormous damage to the economy.
Yet continuing to play poker with failed players, also causes enormous damage. This is because the resources that could be used to spur economic recovery are not allocated due to lack of information. Worse still, resources are taken from the efficient to keep insolvent banks and companies operating.
The $700 billion rescue fund can be used for absorbing the losses and weeding out the failed players. By forcing the failed commercial banks to write off their losses then asking the owners to compensate for the losses with new capital. If they don't do it, the government takes over and recapitalizes the banks by purchasing the bad loans at their nominal value (as if they had not been written off). This no longer benefits the previous owners, who have already abandoned the table. The government then sells the banks, making a loss equal to the write-offs.
The $700 billion rescue fund should not be used to hide the losses in the accounts of the financial system by pretending that the government will recover all of them, as is the case now. This will only prolong the paralysis of the world economy, and ruin an otherwise winnable poker game.
(Mr. Hinds, a financial consultant and former finance minister of El Salvador, is the author of "Playing Monopoly with the Devil: Dollarization and Domestic Currencies in Developing Countries" (Yale University Press, 2006).)
Tuesday 7 October 2008
India 'Shining'
All the talk of 'India shining' is bullshit. This editorial in today's Financial Times captures the exact problem and it's solution facing India. The big question is WHO WILL IMPLEMENT IT? With the explosive mix of 'democracy' (a good excuse to do nothing) & 'corruption' (not just the politicians but also the people's 'chalta hai' attitude') it looks like 'india shining' is far-far away.
OK. If this sounds, very pessimistic, it would be nice to hear what India Optimists have to say on this.
It reminds me of a funny incident - once I was having a similar kind of debate with a friend of mine after many arguments-counter arguments, he said (passionately) - If India was not a 'Democracy' we wouldn't be having this discussion at all. Isn't that wonderful!!!
-- Pradeep Kabra
Re: India's tricky path to industrialisation; Without industry the mass of Indians will always be poor - Financial Times Editorial - 07-Oct-2008;
It should have been a perfect marriage. Ratan Tata, the acceptable face of Indian capitalism, and the Communist party rulers of West Bengal, a late convert to the cause of industrialisation and a friend to India's poor. Instead, the attempt to negotiate a tiny plot of land for India's most imaginative industrial project, construction of the $2,200 per unit Nano mini-car factory, has ended in defeat. Why?
For all its claim to be socially responsible, Tata has taken a don't-look, don't-see approach. It outsourced the task of acquiring land to politicians who, according to one commentator, can be "bought and sold like vegetables".
Peasants in 18th-century Britain were thrown off the land. Enclosure acts reduced the commons, pushing people from the countryside to become fodder for industrialisation. Similarly, China has managed the process of industrialisation reasonably smoothly: by force and without the niceties of land rights.
For better or for worse, India became a democracy before it set off seriously on the road to industrialisation. Moreover, it is a democracy where minority causes, even that of 400 hold-out farmers in West Bengal, can hold the national good to ransom. That, in part, explains why roughly half of the Chinese population is now urban while, in India, just over 22 per cent lives – often in squalid conditions – in the cities.
Make no mistake. If India cannot industrialise, it will never be prosperous. Those who defend the status quo are condemning hundreds of millions of peasants to a life of back-breaking and unproductive toil, and the often violent discrimination of the caste system. Romanticising village life is something villagers cannot afford. The average Indian farmer lives a shorter and more brutish life than the most humble of nouveau-urban Chinese.
So what is to be done? First, clear rules need to be set – and transparently implemented – for purchasing agricultural land. Fair compensation must be paid and, when necessary, alternative work found. If farmers are merely dispossessed in the vague hope that they will drift to the cities, India will inevitably suffer violent peasant revolt.
Second, cities must be made more attractive. India should spend on infrastructure to make towns a bigger draw. If migrants know that urban living offers water, electricity, decent housing and the chance of better health and education for themselves and their children, cities will become places where people want to live. Few were thrown off the land when Japan and South Korea were industrialising. But they came to the cities anyway.
Third, the government must invest in rural health and education. Even if India truly wanted to industrialise, it lacks the human capital to do so. Many of the poorly educated, undernourished products of India's rural idyll are simply not skilled or healthy enough to join the global workforce. Unless they can be made so, India will always lag behind. It will be a country with a tiny minority of computer engineers and call-centre operators and a vast majority of subsistence farmers. In other words, it will be poor, very poor.
OK. If this sounds, very pessimistic, it would be nice to hear what India Optimists have to say on this.
It reminds me of a funny incident - once I was having a similar kind of debate with a friend of mine after many arguments-counter arguments, he said (passionately) - If India was not a 'Democracy' we wouldn't be having this discussion at all. Isn't that wonderful!!!
-- Pradeep Kabra
Re: India's tricky path to industrialisation; Without industry the mass of Indians will always be poor - Financial Times Editorial - 07-Oct-2008;
It should have been a perfect marriage. Ratan Tata, the acceptable face of Indian capitalism, and the Communist party rulers of West Bengal, a late convert to the cause of industrialisation and a friend to India's poor. Instead, the attempt to negotiate a tiny plot of land for India's most imaginative industrial project, construction of the $2,200 per unit Nano mini-car factory, has ended in defeat. Why?
For all its claim to be socially responsible, Tata has taken a don't-look, don't-see approach. It outsourced the task of acquiring land to politicians who, according to one commentator, can be "bought and sold like vegetables".
Peasants in 18th-century Britain were thrown off the land. Enclosure acts reduced the commons, pushing people from the countryside to become fodder for industrialisation. Similarly, China has managed the process of industrialisation reasonably smoothly: by force and without the niceties of land rights.
For better or for worse, India became a democracy before it set off seriously on the road to industrialisation. Moreover, it is a democracy where minority causes, even that of 400 hold-out farmers in West Bengal, can hold the national good to ransom. That, in part, explains why roughly half of the Chinese population is now urban while, in India, just over 22 per cent lives – often in squalid conditions – in the cities.
Make no mistake. If India cannot industrialise, it will never be prosperous. Those who defend the status quo are condemning hundreds of millions of peasants to a life of back-breaking and unproductive toil, and the often violent discrimination of the caste system. Romanticising village life is something villagers cannot afford. The average Indian farmer lives a shorter and more brutish life than the most humble of nouveau-urban Chinese.
So what is to be done? First, clear rules need to be set – and transparently implemented – for purchasing agricultural land. Fair compensation must be paid and, when necessary, alternative work found. If farmers are merely dispossessed in the vague hope that they will drift to the cities, India will inevitably suffer violent peasant revolt.
Second, cities must be made more attractive. India should spend on infrastructure to make towns a bigger draw. If migrants know that urban living offers water, electricity, decent housing and the chance of better health and education for themselves and their children, cities will become places where people want to live. Few were thrown off the land when Japan and South Korea were industrialising. But they came to the cities anyway.
Third, the government must invest in rural health and education. Even if India truly wanted to industrialise, it lacks the human capital to do so. Many of the poorly educated, undernourished products of India's rural idyll are simply not skilled or healthy enough to join the global workforce. Unless they can be made so, India will always lag behind. It will be a country with a tiny minority of computer engineers and call-centre operators and a vast majority of subsistence farmers. In other words, it will be poor, very poor.
Wednesday 17 September 2008
Re: Surviving The Panic - My Disagreements
I am not an Economist, but I disagree with few of the editor's points as marked:
1. "We are not living through some" crisis of capitalism," - Ofcourse we are. No matter how much the press in West tries to defend it, the capitalism in the present form is worse than communism for the poor & middle-class of even the rich world.
2."Or of some lack of regulation, as John McCain asserts" - Ofcourse, the lack of regulation is the main reason for the present crisis. Can't blame the bankers when the fed & treasury went to sleep after putting interest rates at 1%.
3."Exotic creatures have been put back on balance sheets, losses have been taken, and new capital has been raised to absorb those losses. We are moving to a sturdier system." - How can you say that all the losses have been taken and the capital raised is enough and all the exotic creatures are back on balance sheet when one doesn't know the exact nature of the investments? Where is 3 trillion dollars from M/s Goldman Sachs, Morgan Stanley & AIG invested in. Today we know about AIG. What guarantee is that the other two don't have any hidden skeletons?
4."Better to put this bad mortgage paper on the Treasury side of the federal balance sheet." - Just transferring the losses from one account to another will not make them go away. It is like robbing Peter to pay Paul.
5."Energetic emergency plumbing to protect the financial system" - The fact our esteemed editor should accept is there are no short-cut solutions. Let's face it. The highs have to be balanced with the lows. If that means, tough times for the next few quarters, so be it.
Re: Surviving the Panic - Editorial in Wall Street Journal - 17-Sep-2008
We're happy to report that theworlddidn'tendMonday, though sometimes it was hard to tell. A major Wall Street banking housefiled for bankruptcy, U.S. taxpayers didn't come to the rescue, and financial markets lurched but didn't crash. Amid the current panic, this is a salutary lesson that our fate is in our own hands and that a deeper downturn is far from inevitable.
The immediate priority is tocalm markets and prevent a crash, and to do so it helps to recall how we got here. We are not living throughsome"crisis of capitalism," unless policy blunders make it so. Nor is this largely the fault of theBushAdministration, as BarackObamaclaims, or of some lack of regulation, as John McCain asserts. These politically convenient riffs do nothing to reassure the public.
The current panic is the ugly aftermath of the credit mania that took flight in the middle years of this decade. As students of economic historian Charles Kindleberger know ("Panics, Manias, and Crashes"), financialmanias throughout history have shared one trait: the excessive expansion of credit. This bubble was no different.
The Federal Reserve kept interest rates too low for too long, creating a subsidy for debt and a global commodity price spike. The excess liquidity andcapital flows this spurred became the fuel for the wizards on Wall Street and in mortgage-finance who created new financial instruments that in turn fueled the housing bubble. As long as it lasted, nearly everyone inhaled the euphoria of rising asset prices and soaring profits. Normal risk assessment gavewayto the excesses that always attend manias.
Enter the panic stage, or the great deleveraging that began some 13 months ago. Fear now trumps greed, while the short-seller and cash are kings. The core of theU.S. financial problem, as Treasury Secretary Hank Paulson said Monday, is that these mortgage instruments are underpinned by real-estate assets whose value keeps declining. Until home prices stabilize, no one knows how large the losses will be. Thus no one is sure which financial companies are truly endangered, or how many.
Amid this turmoil and uncertainty, the challenge for policy makers is twofold: Protect the overall financial systemfromthe fallout of individual bank failures, and protect the larger economy fromrecession caused by financial distress. They eachrequire different policy levers.
On the finance side, there has already been much progress, albeit not enough. The banking system is reforming itself right before our eyes, without the advice of Congress or new regulation. The days of banks running with leverage at 30 or 40 to 1 are over. The companies that took those risks have either failed (Bear Stearns, Lehman) or been absorbed by others (Merrill Lynch, Countrywide). The SIVs, CDOs and other exotic creatures have been put back on balance sheets, losses have been taken, and new capital has been raised to absorb those losses. We are moving to a sturdier system.
On that score, Lehman's bankruptcy filing is another sign of progress. The Treasury and Fed have signaled they can say no. While Lehman's failure has spooked markets, the lesson that a storied investment house can fail without a federal rescue is its own crash course in risk management. The weekend decision by a group of major banks to establish a common fund to borrow against is also hopeful. The banks, which each anted up $7billion to be part of this private lending fund, realize that acting in concert can serve their selfinterest—a lesson that J.P. Morgan would have applauded in the Panic of 1907.
And yet the financial system will remain fragile as long as asset values keep declining. More major bank failures are a certainty, including some very large ones. That means more Sunday soap operas like this month's, with all of the anxiety that inspires among the public. The longer these melodramas continue, the greater the risk of a recession.
Which leads us to suggest another Resolution Trust Corp. as one more tool to calm financial markets. The first RTC helped to buy, stabilize and liquidate troubled assets amid the savings and loan mess of the late 1980s. Then it blessedly went out of business. Former Fed Chairman Paul Volcker endorsed an RTC II Monday in a speech in Naples, Florida, and we suspect the idea willgainmore traction. Hesaid he "reluctantly" embraced the idea for "dealing with the market breakdown, breaking the logjam of mortgages and other assets of uncertain value [and] restoring a sense of reasonable valuation and market confidence."
Yes, this would require a Congressional appropriation, and in that sense it would cost taxpayers. But by now it should be clear that some taxpayer money is going to be needed, if only to pay off insured depositors at failing banks. The Federal Deposit Insurance Corp. has already said itmayneed to borrow from its Treasury line of credit, and that's based on what could be optimistic estimates about home prices.
The taxpayer is also currently at risk through the Fed, which has become ever more creative with its use of the discount window. Its new lending facilities have been necessary amid this crisis, but they have also meant that the Fed is accepting ever-dodgier paper as collateral. Over theweekendit agreedtotake non-investment grade paper. The danger is that all of this will put the Fed's own balance sheet at risk—which would mean even bigger trouble. Better to put this bad mortgage paper on the Treasury side of the federal balance sheet.
Meanwhile, a new RTC would provide a buyer for securities for which there is no market, set a floor under the market, hold the securities until markets stabilize, and liquidate them in an orderly fashion, perhaps at a profit. Failed institutions and managers would not be bailed out. There's always a risk that the politicians will meddle, which is one reason for the Bush Administration to do this now so it can insist on enough political insulation.
As for the larger economy, the last 13 months are a guide to what not to do. The Fed recklessly cut interest rates, while Congress and the White House dropped "rebate" checks from helicopters. The rate cuts ignitedanother oilandcommodity spike that walloped middle-class consumers, while the rebates did nothing to change incentives or lift investment.
We hope the Fed heeds this lesson and holds firm on rates. Monday it injected $70billion in liquidity to stabilize the fed fund rate at its peg of 2%, as it should in a crisis. But that money can be withdrawn over time as the crisis eases. Meanwhile, a more cautious monetary policy overall will help the dollar, which in turn will mean lower oil prices and more capital flows to the U.S.
What the economy really needs is a big pro-growth tax cut, the kind that will restore confidence and risk-taking. This is an opportunity for both candidates, but especially for Mr. McCain. Instead of focusing on an extension of the Bush tax cuts, the Arizonan should offer his own tax cut to revive capital markets and prevent a recession. Democrats will claim he's helping "the rich," but our guess is that every American who owns a 401(k) will figure he's one of those "rich."
One great lesson of past panics is that they needn't become crashes, if policy makers make the right decisions. Thirteen months into this crisis, the best choices are thesameas theywere lastAugust: energetic emergency plumbing to protect the financial system, steady monetary policy to defend the dollar, and a tax cut to spur growth. It's also the kind of agenda—and leadership—that could win an election.
1. "We are not living through some" crisis of capitalism," - Ofcourse we are. No matter how much the press in West tries to defend it, the capitalism in the present form is worse than communism for the poor & middle-class of even the rich world.
2."Or of some lack of regulation, as John McCain asserts" - Ofcourse, the lack of regulation is the main reason for the present crisis. Can't blame the bankers when the fed & treasury went to sleep after putting interest rates at 1%.
3."Exotic creatures have been put back on balance sheets, losses have been taken, and new capital has been raised to absorb those losses. We are moving to a sturdier system." - How can you say that all the losses have been taken and the capital raised is enough and all the exotic creatures are back on balance sheet when one doesn't know the exact nature of the investments? Where is 3 trillion dollars from M/s Goldman Sachs, Morgan Stanley & AIG invested in. Today we know about AIG. What guarantee is that the other two don't have any hidden skeletons?
4."Better to put this bad mortgage paper on the Treasury side of the federal balance sheet." - Just transferring the losses from one account to another will not make them go away. It is like robbing Peter to pay Paul.
5."Energetic emergency plumbing to protect the financial system" - The fact our esteemed editor should accept is there are no short-cut solutions. Let's face it. The highs have to be balanced with the lows. If that means, tough times for the next few quarters, so be it.
Re: Surviving the Panic - Editorial in Wall Street Journal - 17-Sep-2008
We're happy to report that theworlddidn'tendMonday, though sometimes it was hard to tell. A major Wall Street banking housefiled for bankruptcy, U.S. taxpayers didn't come to the rescue, and financial markets lurched but didn't crash. Amid the current panic, this is a salutary lesson that our fate is in our own hands and that a deeper downturn is far from inevitable.
The immediate priority is tocalm markets and prevent a crash, and to do so it helps to recall how we got here. We are not living throughsome"crisis of capitalism," unless policy blunders make it so. Nor is this largely the fault of theBushAdministration, as BarackObamaclaims, or of some lack of regulation, as John McCain asserts. These politically convenient riffs do nothing to reassure the public.
The current panic is the ugly aftermath of the credit mania that took flight in the middle years of this decade. As students of economic historian Charles Kindleberger know ("Panics, Manias, and Crashes"), financialmanias throughout history have shared one trait: the excessive expansion of credit. This bubble was no different.
The Federal Reserve kept interest rates too low for too long, creating a subsidy for debt and a global commodity price spike. The excess liquidity andcapital flows this spurred became the fuel for the wizards on Wall Street and in mortgage-finance who created new financial instruments that in turn fueled the housing bubble. As long as it lasted, nearly everyone inhaled the euphoria of rising asset prices and soaring profits. Normal risk assessment gavewayto the excesses that always attend manias.
Enter the panic stage, or the great deleveraging that began some 13 months ago. Fear now trumps greed, while the short-seller and cash are kings. The core of theU.S. financial problem, as Treasury Secretary Hank Paulson said Monday, is that these mortgage instruments are underpinned by real-estate assets whose value keeps declining. Until home prices stabilize, no one knows how large the losses will be. Thus no one is sure which financial companies are truly endangered, or how many.
Amid this turmoil and uncertainty, the challenge for policy makers is twofold: Protect the overall financial systemfromthe fallout of individual bank failures, and protect the larger economy fromrecession caused by financial distress. They eachrequire different policy levers.
On the finance side, there has already been much progress, albeit not enough. The banking system is reforming itself right before our eyes, without the advice of Congress or new regulation. The days of banks running with leverage at 30 or 40 to 1 are over. The companies that took those risks have either failed (Bear Stearns, Lehman) or been absorbed by others (Merrill Lynch, Countrywide). The SIVs, CDOs and other exotic creatures have been put back on balance sheets, losses have been taken, and new capital has been raised to absorb those losses. We are moving to a sturdier system.
On that score, Lehman's bankruptcy filing is another sign of progress. The Treasury and Fed have signaled they can say no. While Lehman's failure has spooked markets, the lesson that a storied investment house can fail without a federal rescue is its own crash course in risk management. The weekend decision by a group of major banks to establish a common fund to borrow against is also hopeful. The banks, which each anted up $7billion to be part of this private lending fund, realize that acting in concert can serve their selfinterest—a lesson that J.P. Morgan would have applauded in the Panic of 1907.
And yet the financial system will remain fragile as long as asset values keep declining. More major bank failures are a certainty, including some very large ones. That means more Sunday soap operas like this month's, with all of the anxiety that inspires among the public. The longer these melodramas continue, the greater the risk of a recession.
Which leads us to suggest another Resolution Trust Corp. as one more tool to calm financial markets. The first RTC helped to buy, stabilize and liquidate troubled assets amid the savings and loan mess of the late 1980s. Then it blessedly went out of business. Former Fed Chairman Paul Volcker endorsed an RTC II Monday in a speech in Naples, Florida, and we suspect the idea willgainmore traction. Hesaid he "reluctantly" embraced the idea for "dealing with the market breakdown, breaking the logjam of mortgages and other assets of uncertain value [and] restoring a sense of reasonable valuation and market confidence."
Yes, this would require a Congressional appropriation, and in that sense it would cost taxpayers. But by now it should be clear that some taxpayer money is going to be needed, if only to pay off insured depositors at failing banks. The Federal Deposit Insurance Corp. has already said itmayneed to borrow from its Treasury line of credit, and that's based on what could be optimistic estimates about home prices.
The taxpayer is also currently at risk through the Fed, which has become ever more creative with its use of the discount window. Its new lending facilities have been necessary amid this crisis, but they have also meant that the Fed is accepting ever-dodgier paper as collateral. Over theweekendit agreedtotake non-investment grade paper. The danger is that all of this will put the Fed's own balance sheet at risk—which would mean even bigger trouble. Better to put this bad mortgage paper on the Treasury side of the federal balance sheet.
Meanwhile, a new RTC would provide a buyer for securities for which there is no market, set a floor under the market, hold the securities until markets stabilize, and liquidate them in an orderly fashion, perhaps at a profit. Failed institutions and managers would not be bailed out. There's always a risk that the politicians will meddle, which is one reason for the Bush Administration to do this now so it can insist on enough political insulation.
As for the larger economy, the last 13 months are a guide to what not to do. The Fed recklessly cut interest rates, while Congress and the White House dropped "rebate" checks from helicopters. The rate cuts ignitedanother oilandcommodity spike that walloped middle-class consumers, while the rebates did nothing to change incentives or lift investment.
We hope the Fed heeds this lesson and holds firm on rates. Monday it injected $70billion in liquidity to stabilize the fed fund rate at its peg of 2%, as it should in a crisis. But that money can be withdrawn over time as the crisis eases. Meanwhile, a more cautious monetary policy overall will help the dollar, which in turn will mean lower oil prices and more capital flows to the U.S.
What the economy really needs is a big pro-growth tax cut, the kind that will restore confidence and risk-taking. This is an opportunity for both candidates, but especially for Mr. McCain. Instead of focusing on an extension of the Bush tax cuts, the Arizonan should offer his own tax cut to revive capital markets and prevent a recession. Democrats will claim he's helping "the rich," but our guess is that every American who owns a 401(k) will figure he's one of those "rich."
One great lesson of past panics is that they needn't become crashes, if policy makers make the right decisions. Thirteen months into this crisis, the best choices are thesameas theywere lastAugust: energetic emergency plumbing to protect the financial system, steady monetary policy to defend the dollar, and a tax cut to spur growth. It's also the kind of agenda—and leadership—that could win an election.
Subscribe to:
Posts (Atom)