A tragedy and a travesty if…

In today’s MINT, Ajit Ranade argues clearly and convincingly against the Government or the Parliament diluting RBI’ norms issued in February for recognition of non-performing debt. He is right and I agree with him. I had written on this right after RBI came out with its NPA recognition norms in February 2018.

This story in MINT on how the ICICI Bank had made an accounting rule change that enabled it to keep its non-performing loan ratio low and that too without disclosing the rule change to shareholders only strengthens the RBI directive issued in February.

It is all about a culture of accountability that is sorely lacking in India. It is missing almost everywhere, especially in public space.

It will be a travesty and a tragedy to dilute RBI norms issued in February.


Dodd-Frank and Matt Taibbi

Matt Taibbi will, forever, be remembered for the label, ‘Vampire Squid’ that he came up with, for Goldman Sachs. No matter what else he writes.  In passing, I should mention that Pratap Bhanu Mehta will be remembered for writing, ‘While we were silent’ in 2013 no matter how many times we disagree with what he writes.

Matt Taibbi’s take on the two major political parties in the United States features flawed logic. In fact, it contradicts his earlier piece on how Democrats helped pass the Bill that diluted the Dodd-Frank Act. More on that later.

The reality is that one can smell Republicans (the political party in the USA)/Conservatives from a distance: they want status quo to continue. No disturbances or perturbations (a jargon that economists love to use) to the staus quo. ‘Do not interfere’ is their message to the government – on social and on economic affairs.

Democrats, on the other hand, were supposed to be the party of the underdogs. Instead, they favoured Wall Street interests. They repealed Glass-Steagall and they helped pass Commodities Futures Modernisation Act that kept many financial products out of regulatory purview. They became a party of elites, by stealth. That is fradulent. In fact, he should go back and re-read his own piece, titled, ‘Obama’s Big sellout’ written in December 2009 or early 2010. It is no longer available in the ‘Rolling Stone’ site. But, I found an extract here.

Hence, calling Republicans a party of ‘open con’ does not cut it. It was and is open, all right. It is no con game. We know their agenda.

He then wrote a piece about “The Economic Growth, Regulatory Relief and Consumer Protection Act (Pub.L. 115–174, S. 2155), signed into United States federal law by President Donald Trump on May 24, 2018.”. It amended the Dodd-Frank Act or the Financial Stability Act, 2010.

He was right on some of the factual details. The word, ‘may’ has been changed to ‘shall’ in one place. True. Some limits have been increased from 50bn. to 100 bn. to 250 bn. US dollars, etc. But, he did omit some key aspects that lead us to a different interpretation.

The amendments do include the following:

(b) Rule Of Construction.—Nothing in subsection (a) shall be construed to limit—

(1) the authority of the Board of Governors of the Federal Reserve System, in prescribing prudential standards under section 165 of the Financial Stability Act of 2010 (12 U.S.C. 5365) or any other law, to tailor or differentiate among companies on an individual basis or by category, taking into consideration their capital structure, riskiness, complexity, financial activities (including financial activities of their subsidiaries), size, and any other risk-related factors that the Board of Governors deems appropriate; or

(2) the supervisory, regulatory, or enforcement authority of an appropriate Federal banking agency to further the safe and sound operation of an institution under the supervision of the appropriate Federal banking agency. [Link]

There is also a provision for ‘globally systemically important bank holding companies’:

(f) Global Systemically Important Bank Holding Companies.—Any bank holding company, regardless of asset size, that has been identified as a global systemically important BHC under section 217.402 of title 12, Code of Federal Regulations, shall be considered a bank holding company with total consolidated assets equal to or greater than $250,000,000,000 with respect to the application of standards or requirements under. [Link]

In plain English, S.2155 does not prevent the Federal Reserve from exercising its authority with respect to Bank Holding Companies where it deems necessary. The real issue is whether the Federal Reserve is keen. See here and here.

Amendments to the Dodd-Frank Act will not cause the next crash. That train has already left the station. If at all they do cause banks to take on more risks, it will be because theri capital requirements have not been raised enough and because the Federal Reserve has allowed monetary policy to remain too loose and interest rates to remain too low for too long.

Ultimately, it is all about appropriate pricing of capital and pricing it too cheaply and way below fair, risk-adjusted level is the biggest gift that the Federal Reserve continues to shower on the financial industry.

In another article, Taibbi makes the case for a Financial Transactions Tax in the United States. I endorse that, wholheartedly. He is right. But, he is pushing the envelope on facts when he writes that the European Union has already ’embraced’ it. That simply is not true. I wish it were true. It isn’t.

Read what he writes here and decide for yourself:

A financial transactions tax might help incentivize Wall Street to once again emphasize true long-term investment, as opposed to spending all day moving piles of money around. As with Medicare-for-all, it might take a while for Americans to accept an idea already embraced in Europe. [Link]

It is still in the works. Lo and behold, Brexit is supposed to have gummed it up, because it will be difficult to enforce in the UK that won’t be part of the European Union and hence financial transctions would migrate there. That is the logic for the dealy. So, FTT in Europe is still coming.

The lesson is that it has become impossible to read anyone and take what they write at face value, without doing some fact-checking oneself. Well, if you are reading this, remember that it applies to this blogger too!

So, caveat emptor!

The twin hats of Andrew Haldane

My good friend Amol Agrawal (what an amazing and inveterate blogger, he is!) had a blog post on a recent speech by Andrew Haldane of the Bank of England (BoE) on the low  or non-existent productivity growth in the United Kingdom. I left the following comment on his blog post. It is slightly updated here.

I can understand you being excited about a speech by Andrew Haldane. He still does not fail to impress and provoke thinking. But, look carefully. What is institutional infrastructure for diffusion? What is the agency or agencies to be created? In the private or in the public sector? Who would fnance it? How would it be assessed? What would it take to judge that it has done a good job (or not) of diffusing innovation? I guess that the speech is silent on these. Otherwise, you might have blogged on it. I confess that I am yet to go through the speech.

But, there is another more important point to make with respect to Mr. Haldane. He failed to connect the dots of his own speeches, research and what went on before 2008. He produced such insightful research on banks and finance before 2012 that it is a great pity that he did not carry those insights wit him on to his new job. He behaved rather differently and disappointingly after he became the Chief Economist of BoE from being the Director in charge of Financial Stability.

He continued to insist on interest rates being kept too low for too long. To what effect? To what consequences? In fact, the lack fo productivity diffusion is an indictment of the low interest rate policy. Where is the incentive to do the hard work on productivity improvements and undertake investments that enhance them when easy money can be made speculating on high-end properties in London suburbs which is what low interest rates facilitate?

He knows of the BoE research that showed very clearly that banks create money. [Prof. Richard Werner at the University of Southampton has done further excellent empirical work on it. He calls the last century of economics teaching and learning wasted effort! Check out his papers.]

He knows again from BoE Research that most middle-class and lower middle-class Englanders have only interest-bearing deposit accounts as their financial assets. Low interest rates hurt them. Low interest rates help those who buy financial assets and real estate assets with debt. They borrow cheaply and big and the discounted value of future cash flows on equities is inflated by the low funding cost. Of course, it is not just the short end of the interest rate curve that remained low for long but even the entire yield curve with BoE Asset purchases.

To what end? How much his research helped him or influenced him to make public policy decisions and choices that enhanced public welfare?

In short, much as I admired and still admire his reserach, his hard work, his evidence based conclusions, etc., he scores rather poorly as a public policy exponent and technocrat.

Please do read Paul Tucker’s ‘Unelected power’. It is dense. I have only done four chapters. Not easy. But, worth it.

Out of logic; out of control

Let us see:

E-Commerce Marketing companies’ marketing expenditure and discounts should be capitalised and not deducted from business income. Mercifully, rejected by the Appellate Tribunal. [Link]

But, the Revenue department was willing to treat loan waivers as business income and tax them. Supreme Court has ruled against it. [Link]

The Income Tax Department asks banks to pay service tax (now GST) on free services, retrospectively since 2012. Some bankers have called it ‘frivolous’ demand. Quite. But, a lot worse than that. This boggles the mind for several reasons. This reveals a perverse and cynical logic, at one level. At another level, it is complete lack of coordination and harmony between different departments of the same Ministry. Very worrying in more ways than one. [Link]

No wonder, India’s Business Optimism Index is at its lowest since 2014 and that India’s ranking has slipped to the sixth place. How will there be a capex cycle? [Link]


Interest rates and growth

This article by Rohan Chinchwadkar of IIM Tiruchi made me happy for more than one reason:

  • It is from a faculty member from one of the newer IIMs
  • It is well and simply written. It does not try to overdo its point
  • It sources a recent piece of international research
  • It shows a faculty member who is in touch with contemporary reserach. Good for students
  • It was well timed – on the eve of the RBI Monetary policy meeting
  • It presented a paper that had turned conventional wisdom on its head

Not much can be asked of an op.-ed.

Kudos to MINT for publishing it.

Why and how Finance sucked up (or, sucks up) engineering talent

I had posted the following comment in response to this article in FT:

Much of the comments on this article focused on the micro behaviour of individuals who chose to join financial institutions and hence were, for the most part, defensive about their behaviour and hence, critical of the article. But, that lens is the wrong one.

The article points to a paper that highlights the attractiveness of finance to engineers as opposed to other jobs that were more suited to their education. It is a social phenomenon and the responses have to be in the policy domain, if it is established that there has to be a policy response. As individuals, engineering graduates who joined the banking industry were doing the sensible thing for themselves and their families. This commentator and Andrew Hill would have done the same, in all likelihood. But, we need to move away from that frame.

Why did finance attract so much talent? A corollary question that poses itself is why was finance able to pay so much that talent flowed to it? Well, finance made so much of profits that it was able to pay. Actually, the attraction of talent, high wages and profits became mutually reinforcing trends later. But, what was the source of profits?

Finance, in modern times (post-1980s because that is when financial liberalisation, de-regulation and liberalisation of capital flows started in right earnest), has not been doing anything unique in comparison to the past.  It facilitated much secondary trading of financial securities. But, the compensation for it has come down considerably and the fees for active asset management have, for the most part, proven to be wasted and wasteful compensation. So, what was the source of it?

Andrew Haldane, in his contribution to the volume, ‘The Future of Finance’ published by the London School of Economics in 2010 (‘Contribution of the Financial Sector: Miracle or Mirage’) has pointed out that finance generated extraordinary profits because it wrote deep out of the money options (think Credit Default swaps and sub-prime securitisation). Deep out of the money options earns premium for the writer but once in a while these options get in the money and the writer has to pay up to the options owner. That is what happened in 2008.  Second source of profits was that much of the profits were risk-unadjusted. One source of risk is that many assets were valued as per models and hence shown at fair value. Second source of risk is high leverage ratios in investment banks’ balance sheets. The third arose out of creating products that, willy-nilly, drew the buyers into the web of financial leverage. In fact, that is where the engineering talent was needed.

High profits were required to maintain stock valuation in deference to the pressures exerted by institutional investors. Second, compensation of higher executives was linked to stock price performance. Hence, showing consistently rising profits was an obligation. That required generation of complex financial products which, though based on complex mathematics, were essentially built on unsuspecting clients assuming financial leverage. Developing these products required engineering talent. Ergo, the phenomenon that the paper and the article cover.

Now, the question for policymakers is whether any of this is welfare enhancing. Evidently, they are not. Their welfare-destruction was evident in the crisis of 2008. Have the policy responses changed the demand for engineering talent and the attraction of finance to such talent? Not much, if at all.

So, this is a socially negative phenomenon even though it is positive at the personal level, somewhat like the paradox of thrift that Keynes had discussed, in a different context.

In this context, it is worth noting that Bloomberg reported last evening that bonuses in Wall Street reached their highest level since 2006.

The Indian banking purgatory – policy proposals – 3/3

I wrote part 2 on March 10. I have been wanting to excerpt Dr. Y.V. Reddy’s extarordinarily candid lecture on February 1st. It contained some definitive recommendations. I copy and paste them below.

In addition, he has spoken about the proximate and underlying causes of India’s bad debts problem in the banking system, etc. He is even questioning if the leitmotif for nationalisation of banks remains relevant nearly fifty years later. You should read the full speech if you are interested in Indian banking.

  1. The first step for improving our banking system is a commitment to reduce SLR and CRR to global levels as soon as possible. We cannot have a globally competitive economy with an over-burdened banking system.
  2. The current policy of ownership and governance in banking needs to be reviewed urgently to correct the outdated and distorted policies. This should be done before our banking system passes on to foreign owners, irrevocably.
  3. A high level internal enquiry within the RBI should be undertaken to fix the responsibility for excesses in NPAs in recent years and, more important, to suggest and adopt measures to improve the system as a whole.
  4. In view of the large amounts of public money involved, the government may put in public domain action taken on Fourteenth Finance Commission’s recommendation for improving the financial system with economical use of tax payer’s money.
  5. A White paper on the future of Public Sector banking may be placed before the Parliament at the earliest in view of their criticality for efficiency in financial sector as a whole, to be able to serve a globally competitive economy.
  6. In brief, the current approach of treating Banks as special and bank depositors as special must be continued, and an assurance to this effect may be extended by the Government.
  7. In view of global developments and emerging Indian economy, there is a case for RBI to internally review the current policy of annual transfer of surplus after determining the needs for addition to reserves and adopt a new policy after due consultation with Government.

The first two parts on Indian banking are here and here.