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

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

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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 '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).)

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.