No information; no accountability

Andy Mukherjee’s piece in Bloomberg on how HDFC Bank has likely understated its impaired loans based on research done by Hemindra Hazari. That is a bit unfortunate and sad too. It has been easy for all of us to criticise governments partly because (and correctly too) governments are elected and they are deemed accountable. Therefore, we feel that we have a moral right to question the government. With private sector, it is a different ball game. We are afraid of reprisals and it might have to get more specific. Criticism directed at the government is general and there is no specific ‘naming and shaming’.

But, if private sector chose not to live by the rules of transparency and truthfulness that one expects of government, then government over-reach, controls and more scrutiny will be inevitable. Countries will have the worst of both worlds. People are poorer for it.

I checked out a blog post by Hemindra Hazari on independent research on large cap companies. He mentions how he has been denied access by ICICI Bank and Axis Bank and how another analyst was put through the police wringer for his piece on Indiabulls. There is so much outrage in public space world over about rising intolerance and authoritarian populism. But, what does one make of such behaviour in the private sector?

Smartkarma.com is indeed an interesting platform.

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Corporate shenanigans

We had learnt of the gaming of emission tests by Volkswagen. In fact, the charge was made against other German car makers too. In August, all of them agreed to update their software. Of course, we know enough about financial institutions. They gamed everything – interest rates (LIBOR), exchange rates, option prices and precious metals. The saga is endless. See the more recent story about Wells Fargo (a great read) and also note that Australia is appointing a Royal Commission to inquire into the conduct of its banks.

Some think that central bankers – deliberately or not – are gaming the stock market. But, they are public institutions. Let us stick to the private sector.

We learnt of Kobe Steel and now there is another Japanese firm in this inglorious list.

It is quite disappointing that Japanese and German firms are part of the unfolding story line on corporate immorality. Firms in both nations have done a lot of work to acquire reputation for quality. It is sad to see them undo the hard work.

Without moral foundations, a market economy is meaningless.

No more crisis in our life times

Well, that is not what I believe. But, that is what Ms. Janet Yellen, chairperson of the Federal Reserve believes. When I read it in a blog post by Gavyn Davies, I could not believe my eyes. Why would anyone say that? It is bad risk management. If it did not happen, no one would remember the prediction. If it happened, her predictions would be played over and over again. Ask Chuck Prince. Perhaps, he has stopped dancing now.

According to a Reuters story, this is what she said:

Would I say there will never, ever be another financial crisis? You know probably that would be going too far but I do think we’re much safer and I hope that it will not be in our lifetimes and I don’t believe it will be. [Link]

I was glad to find John Mauldin come out with a strong reaction to her remarks:

I disagree with almost every word in those two sentences, but my belief is less important than Chair Yellen’s. If she really believes this, then she is oblivious to major instabilities that still riddle the financial system. That’s not good. [Link]

His entire post, ‘Prepare for turbulence’ is worth reading.

With amazing consistency, the International Monetary Fund wrote in its Article IV assessment of the Eurozone that the European Central Bank should maintain its current easy money policy and that it should not hasten into a tightening. In the same breath, it added that debt-heavy countries in Europe have not utilised the space afforded by the easy money policy to undertake fiscal consolidation and improvement. See this:

Most high-debt countries have so far not saved the windfall interest reductions from monetary accommodation (text figure). It is important to make decisive progress on fiscal adjustment before monetary accommodation is reduced. Otherwise, countries could face dangerous debt dynamics as interest rates rise—running the risk that self-fulfilling expectations could emerge if markets begin to doubt fiscal sustainability. [page 21-22 – link]

Why would they? When we make bad habits less costly for people, they do not stop them. They persist with them. That is what governments are doing. Central banks are not making it easy for governments to shed debt addiction. They are making it easy to stay addicted. Low interest rates remove pressure to reform. No pain; no gain. No pain; no reform.

I enjoyed writing my MINT column for August 1. I said it was time for the queen to ask intellectuals as to why they were failing to stop another crisis coming. By the time she asks the question again, assuming she does, it might well be too late.

Millennials and the hard Left

I came across this interesting article in my mailbox (ht: Vaidy).  It talks about how voters in the age group of 18-24 favour hard Left candidates. That is not quite ‘Millennials’. But, the short-hand works for expository convenience.

It was the case with Bernie Sanders in the American Presidential elections, with Jean-Luc Mélenchon in the French Presidential polls last month and with James Corbyn, now in the UK elections due on June 8. They have made the race a lot tighter than it appeared in April.

There was one sentence that I could not quite understand:

As the world is going against a concrete wall of debt, the youngsters may think accelerating one more time could work.

Was the writer being ‘tongue-in-cheek’? Perhaps. That remains a big risk with hard Left policies.

The young just do not want the Left but the hard Left. That is a bit  worrying because Theresa May’s Conservative Party is not Margaret Thatcher’s Conservative Party. Her speech at the Party Annual Conference in 2016 was a watershed moment. I wrote a column in MINT on it in October last year.

Coincidentally, only last morning, I had finished reading Kenneth Arrow’s ‘A cautious case for Socialism’, a speech delivered at Columbia University in 1978. Yes, Kenneth Arrow!

While he was not sure if democracy and socialism could co-exist, he said the following about democracy and capitalism:

In a capitalist society, economic power is very unequally distributed, and hence democratic government is inevitably something of a sham. In a sense, the maintained ideal of democracy makes matters worse, for it adds the tensions of hypocrisy to the inequality of power.”

Even more breathtakingly, he said that it was near impossible to have prices for all State-Contingent situations in future because the market for uncertainty was not developed. In other words, he was prepared to throw a big pail of water on his groundbreaking work with Debreu on the allocative efficiency of a competitive market equilibrium.

In practice, it simply did not exist. In that sense, perhaps, we had misinterpreted their work, all along!

I recall my professor in the Grad School at UMASS Amherst back in the 1990s telling us that Modigliani and Miller, they did not set out to prove that capital structure was irrelevant. By showing that it was irrelevant only under extreme assumptions that did not prevail in reality, they actually proved that capital structure mattered. It had stuck with me ever since.

In a way, Arrow and Debrew were doing the same thing. Only by knowing all future States, the state contingent claims and if a market existed that priced all State contingent claims, could the allocative efficiency achieved by a competitive market economy be superior – without scarcity or surplus – to that of a planned economy.

Since those conditions are never met, the case for the superior allocative efficiency of a competitive market economy was never established! Professor Arrow was actually admitting to that in that speech!

The central argument, which implies the efficiency of a competitive economic system, presupposes that all relevant goods are available at prices that are the same for all participants and that supplies and demands of all goods balance. Now virtually all economic decisions have implications for supplies and demands on future markets. The concept of capital, the very root of the term “capitalism,” refers to the setting-aside of resources for use in future production and sale. Hence, goods to be produced in the future are effectively economic commodities today. For efficient resource allocation, the prices of future goods should be known today. But they are not. Markets for current goods exist and enable a certain coherence between supply and demand there. But very few such markets exist for delivery of goods in the future. Hence, plans made by different agents may be based on inconsistent assumptions about the future. Investment plans may be excessive or inadequate to meet future demands or to employ the future labor force.

The nonexistence of future markets is no doubt linked to uncertainty about the future. But this points to an even more severe shortcoming of the actual capitalist system compared with an ideally efficient economic system. The uncertainties themselves are relevant commodities and should be priced in such an economy. Only a handful of insurance policies and, to a limited extent, the stock market serve to meet the need for an efficient allocation of risk-bearing.

In the ideal theory of the competitive economy, market-clearing prices serve as the communication links that bring into coherence the widely dispersed knowledge about the needs and production possibilities of the members of the economy. In the absence of suitable markets, other coordinating and communicating mechanisms are needed for efficiency. These come close to defining the socialist economy, although admittedly wide variations in the meaning of that expression are possible.

Of course, I would admit to a few caveats. He was speaking in 1978, at the height of the period of economic turbulence in the West – wars, oil shortage, stagflation, etc. The weaknesses of the Soviet economy had not been exposed yet (sub-caveat: to a large extent, the Soviet economy was undone by a combination of arms race with America in the Eighties combined with the collapse of the price of oil in the same decade).

Further, many state-contingent financial products were developed in the Eighties and Nineties. But, of course, they did zilch to the allocative efficiency of the economies nor did it prove that financial markets knew how to price uncertainty. To date, the answer is an emphatic NO. Financial markets know next to nothing about how to price risk, let alone uncertainty.

So, who is to say that the hard-Left policy agenda – Sanders, Corbyn, Mélenchon – would be worse, in economic terms? I feel certain about lesser and lesser things these days.

Where the Hard Left worries me is with their their conflation of secularism and appeasement of hardcore Islamists. They are very likely wrong on that one and that would be disastrous for the rest of the society and the country. What has been happening in Britain in the last few months is, perhaps, a culmination or lagged effects of misguided policies of the last several years or even decades. But, that is a separate topic.

[Postscript: I just read two tributes to Kenneth Arrow who passed away few months ago. I liked this one a lot better than this one. But, both do not mention the speech I mention here. Pity. He was teaching a class even at 94. Incredible.]

Trump, Disney and the weather

Walt Disney’s Robert Iger has threatened to resign from the President’s Council of Advisors after President Trump decided to walk out of the Paris Climate Change Accord. I recalled this interesting factoid about Walt Disney Co.,

This past march, Walt Disney Co. settled a claim by the Department of Labor that it had violated the law by deducting the cost of uniforms from employees’ wages—which brought the workers’ pay below the federal minimum wage. The violations, which occurred at Disney facilities in Florida over the past few years, didn’t add up to a lot of money. Disney will pay back wages of $3.8 million to 16,000 workers (about $230 per employee). What made the story galling is that the entire expense is roughly in line with what Robert Iger, Disney’s CEO, earns in a single month. Last year Iger netted $44 million. [Link]

Of course, the CEO of the company that does God’s work has also threatened to leave the Council. Quite.

BTW, did you know that

European countries that pursued aggressive reductions were engaging in economic masochism. According to a 2014 Manhattan Institute study, the average cost of residential electricity in 2012 was 12 cents per kilowatt hour in the U.S. but an average 26 cents in the European Union and 35 cents in Germany. The average price of electricity in the EU soared 55% from 2005 to 2013.

Yet Germany’s emissions have increased in the last two years as more coal is burned to compensate for reduced nuclear energy and unreliable solar and wind power. Last year coal made up 40% of Germany’s power generation compared to 30% for renewables, while state subsidies to stabilize the electric grid have grown five-fold since 2012. [Link]

STCMA – 1.6.2017 Edition: The emperor is almost naked

Michael Schuman thinks that China’s time to pay the debt bill is now.

I do not know if Saudi Arabia had enough economic reserves of strength to handle another year or two of below-$40 oil prices. Counterfactuals are impossible.

Tyler Cowen proves that he is a true intellectual. The sign of it is open-mindedness and capacity for reflection. A great piece on the Trump budget proposal to reduce federal grants for research overheads. There are both sides to the story. Private donors would be very familiar with the dilemma.

A good piece on how North Korea provides cover to China’s South China Sea antics.

Coming from a self-avowed Sinophile, this is big deal. Well, make it, very big deal.

The quintessential definition of chutzpah. The Chinese do it with a straight face. Incredible.

Ajit Ranade stresses de-centralisation and devolution. Hard to quarrel with that.

Sonal Varma says that inflation in India has not really been put to bed. I think she is right.

Mridula Ramesh hits a century on debut. Brilliant first column on water harvesting in Rajasthan and the situation in Madurai now.

Walt Disney Co., deducted the cost of uniforms from employee wages of 16000 workers. The amount was USD3.8mn, the monthly salary of its CEO. Boggles the mind. Where is the revolution?

Stunningly rapid descent into extreme political correctness in America.

Andy Mukherjee has a delightful piece on the pinch on the wrist that the Monetary Authority of Singapore administered to Credit Suisse.

Staying with Andy Mukherjee, he has a very good piece on the debt woes of Anil Ambani’s Reliance Communications. If one connected the dots that Andy so beautifully plots in the piece, one has to conclude that the emperor (aka ‘the Indian economy’) has very few clothes.

India has released its advance GDP estimate for 4Q2016-17. But, that deserves a separate comment. May be, the emperor is (almost) naked.

Only one firm matters

An extraordinary proportion of people with training and experience in finance have worked at the highest levels of every recent presidential administration. Four of the last six secretaries of the Treasury fit this description. In fact , all four were directly or indirectly connected to one firm: Goldman Sachs. This is hardly the historical norm : of the previous six Treasury secretaries, only one had a finance background .

In 2001, following revelations of accounting irregularities, Enron verged on collapse, which meant that Citigroup, a major lender, would lose a significant amount of money. Fulfilling a request made by Michael Carpenter, head of Citigroup’s investment banking unit, Rubin called Peter R . Fisher, then undersecretary of the Treasury and asked him to consider advising the bond – rating agencies against an immediate downgrade of Enron’s debt. In other words , Rubin (a Democrat ) lobbied Fisher (a Republican ) to help bail out Enron. ( So much for Washington’s ideological divide.)

What Rubin did was technically legal, as The Economist explained, only because Bill Clinton , in his last days as president , had canceled an executive order that barred top officials from lobbying their old departments for five years after leaving office.

Source: Zingales, Luigi. A Capitalism for the People: Recapturing the Lost Genius of American Prosperity (p. 68). Basic Books. Kindle Edition.

Today, of course, there is far more money riding on the models than in the 1980s – and when it comes to positive feedback, size matters. Indeed, another example of positive feedback is the relationship between the financial sector and regulators. As the sector increases in size, it gains more influence over the government; this allows it to change regulations in its favor, which allows it to grow even larger, and so on, until it becomes Goldman Sachs.

  • Sometimes called Government Sachs, because of the remarkable ability of its alumni to go straight into senior levels of government, perhaps related to the fact that the firm is a leading corporate donor to political campaigns (Baram, 2009). It is even better represented at central banks. Four of the Federal Reserve’s 12 regional banks  are currently headed by former Goldman Sachs executives. Only five banks have voting power, in a rotating fashion, and in 2017 ex-Goldmanites will hold four of these votes. Together with Mark Carney at the Bank of England and Mario Draghi at the European Central Bank, this means that interest rate decisions for much of the world’s economy are made by people who came from a single firm. Nothing to see here, move along.

Source: Wilmott, Paul; Orrell, David. The Money Formula: Dodgy Finance, Pseudo Science, and How Mathematicians Took Over the Markets (Kindle Locations 4524-4527). Wiley. Kindle Edition.