Analyzing The Satyam Affair: Pointers to Business Fraud in India
Arun Kumar
CESP,SSS, JNU, N Delhi 110067.
The Tribune January 24, 2009
Business fraud is nothing new in India. Businessmen are known to go to great lengths to make money through legitimate and illegitimate ways. Clever accountants and lawyers are employed to devise ways to generate higher profits for the businessmen.
The Satyam affair stunned everyone when it’s supposedly `honest’ chairperson admitted to committing fraud over the last several years. Apparently, Satyam has been defrauded of Rs. 7,000 crores but the final tally could be larger. The loss to the share holders and employees would be by a multiple of this sum. In comparison, the Harshad Mehta episode in 1991-92 was estimated by the Jankiraman Committee to be of the order of Rs. 3,900/- crores even though others claimed it to be eight times bigger. Ketan Parekh’s manipulations led to massive losses for the entire community of stock investors. Collapse of Global Trust Bank, Telgi scam and other such cases have erupted from time to time.
By one count, by end of the 1990s, 2,500 companies that had raised money in the Indian stock markets had disappeared with the share holder’s money. The government did not act against these fraudsters and this emboldened the owners of businesses to commit more frauds.
Mostly, managements declare lower profits to escape paying taxes and that is how black incomes are generated. What is curious about the Satyam affair is that according to its Chairperson, Mr Raju, it was supposedly doing the opposite, showing higher profits. That means that Satyam was paying more taxes than it needed to have - a double whammy for the shareholders. Not only was their company less profitable than they thought it to be but it lost money because of excess tax payments.
However, analysts have argued that Satyam could not have been showing higher than actual profits. If Mr. Raju is to be believed, Satyam was operating with margins of 3 to 4%, and this cannot be correct since the margins of comparable software companies are in the range of 25%. So, many believe that Mr. Raju is lying under the garb of telling the truth. The puzzle is that Satyam should have had higher profit margins but its owner, Mr. Raju is claiming that it had lower margins and willingly implicating himself in fraud. Is he trying to cover a bigger fraud?
Why would an owner show higher profits? First, to manipulate the share price since it rises as declared and expected profits rise. This helps in raising the credibility of the company and its management and thereby enables it to raise more funds for further expansion of the company. Secondly, when there are concessions in taxation on profits, it may pay to divert profits from a company not entitled to tax concessions to a company that is entitled to tax concessions and thereby save on tax payments. There was concession under 80 HHC on profits earned in exports and later it was available under section 10A for exports from special zones. Since these provisions were/are for exports, exports have to be over invoiced. Hence more foreign exchange has to be brought into the country than was earned and this way black wealth held outside or profits of other companies siphoned out of the country through havala are brought back – i.e., reverse havala.
Finally, Mr. Raju could be siphoning out funds from Satyam to sister concerns that were dealing in real estate. One can conjecture that given the recent collapse of real estate prices and slowdown of investments in this sector, the sister concerns were in need of funds and possibly in trouble.
Major infrastructure deals had been signed in the last few years involving payment of large sums of money including in black and as cuts to politicians and bureaucrats. This could have been financed through drawing out of funds from the accounts of Satyam. These would have been recouped in the normal process when land was sold for commercial purposes and black funds obtained which would have been put back into the bank accounts and fixed deposits of Satyam. The crisis in real estate and fall in prices and drying up of investments in real estate would have meant that the funds were not coming back.
The purchase of the sister concerns at high and inflated prices would have meant that the fictitious accounts worth Rs. 7,000 crores would have been drawn down and money transferred to the owners of the sister concerns, that is, to themselves and then there would have been no one to ask where is the money. So, by book transfers, the earlier siphoning out of funds would have been covered up and the false entries of the bank balances and fixed deposits reversed/set right.
Mr. Raju thought that his prestige as the pride of Andhra and his political clout would enable him to commit the brazen act. These factors had earlier enabled him to obtain the silence of Chartered Accountants and the independent directors on the board of Satyam. The Satyam story would perhaps have not broken out as yet but for the crisis resulting from the failure of the attempt to buy the two sister companies.
The forced reversal of the decision to buy the sister companies and the investment banker’s approaching SEBI with the story of the non-existent balance in the banks was the trigger to the realization that the game was up. There was little time to bring back other black funds and perhaps due to the global crisis they had got stuck. Since the funds did not exist in the Satyam bank accounts he had to cover up by saying that the actual profitability of Satyam was lower and that he had been inflating profits for years - an attempt to portray honesty while committing a fraud. This line may also help in the cases in the US courts, to reduce the severity of the fraud and penalties.
The involvement of managers of banks where the non-existent funds were supposedly held is likely. Similarly, the auditors may have looked the other way rather than questioning why so much cash was being held in bank accounts. The independent directors should have asked why Rs. 5,000 crores was held in savings accounts when in Fixed Deposits, Rs 400 crores could have been earned.
The board consisting of management gurus, former bureaucrats and businessmen could not have been so naïve as to not realize that something was remiss. How could they approve the purchase of two family companies at such exorbitant prices when it was apparent even to the layman that something was remiss? Why did they keep quite as cash in banks piled up? Perhaps, through cozy relationships, they benefited in political and financial terms.
It is now coming out that even employment was being fudged and profits so generated were siphoned out. Shady land deals and support from the various Chief Ministers are being talked about. How many skeletons will tumble out is not clear?
The Satyam affair points to the sharp practices adopted by crooked Indian businesses - siphoning out of profits, fudging of muster rolls, the cozy relations with politicians and bureaucrats and finally, manipulating bankers, `independent’ auditors and `independent’ directors. All this is well known in the context of the rampant black income generation. Mr. Raju’s admission has brought into question the notion of a `respectable’ or `honest’ businessman. As the global crisis deepens and more frauds surface, more reputations maybe dented. In India we are used to wrongs of the high ups emerging with great regularity and then to having amnesia about them – perhaps a cynical view but not far from reality.
arunkumar1000@hotmail.com
Saturday, January 24, 2009
Saturday, January 10, 2009
The Vicissitudes of the Year Past: Relief not in Sight Anytime Soon
The Vicissitudes of the Year Past: Relief not in Sight Anytime Soon
Arun Kumar
CESP, SSS, JNU.
The Tribune, January 1, 2009.
The year 2008 started on a high with the economy doing well, stock markets at a historic high, real estate markets booming, industrial growth running at upwards of 10 per cent and inflation at low rates. The finance minister boasted that the macro economic fundamentals are good and the Eleventh plan target of 9 per cent average growth rate viable. There was little inkling that policy making circles understood that a deep economic downturn had set in India and the entire world.
Contrasting this rosy picture, the year is closing with wide spread reports of declining employment, stock markets down by 50% to the levels of 2006, declining real estate markets, industrial growth and exports showing negative growth and many components of the services sector declining rather than growing. This has happened despite the unprecedented interventions by the government and the Reserve Bank – the infusion of massive liquidity, huge supplementary budget and the announcement of the first package of fiscal stimulus soon to be followed by a second one. FRBM has been given a quiet burial.
The year also saw much turmoil due to a rapid acceleration of inflation from its lows in January to the highs in the middle and now to a rapid decline in the closing weeks of the year. It seemed that the government had lost control because at one point the government admitted that it could do little to keep inflation in check by pleading that it was stable and not rising further.
Internationally, the prices of crude oil which had reached a peak of around $150 per barrel have sharply fallen to around $40 in spite of the threatened cut in production by the oil producers. In fact, many, like, Goldman Sachs had predicted that the price of crude would be around $200 by the end of 2008. Similarly, given the blistering pace of the rise in the BSE experts predicted that it would touch 30,000 - three times the level ruling currently. All this calls into question the expertise of the so called experts and policy makers.
The year began with policy makers and experts suggesting a decoupling between the Asian and the US and European economies. They suggested that the rapidly growing economies of Asia will provide the boost to the advanced economies so that there would be a soft landing for the world. This was based more on hope and hype rather than on analysis (As argued in these columns on February 6, 2008). These economies were already at their peak growth rates and could not double them which was required to compensate for a decline in the rates of growth in the OECD economies. Further, since China is heavily dependent on exports to these economies and India is much more open than earlier, if anything, their rates of growth were bound to fall. These two economies could not move in a direction opposite to that of the bigger economies, as events have borne out. Clearly, all along the policy makers and experts have been hoodwinking by denying reality. They also fooled themselves and did not take timely steps so that the situation became worse than it should have and now everyone is paying for it.
The rich have lost a lot of paper wealth on their financial assets where much of their savings were invested. These people also had substantial amount of their black wealth stashed away abroad because this was also invested in financial instruments. These people were also operating real, nuts and bolts companies or offices and due to the slow down, these are also in trouble. The contagion has spread from the financial markets to the real economy.
All this has impacted the middle classes who have linkages in the organized sectors. Many of them are in the process of losing jobs and their children are not getting the good jobs they expected. Further, a large part of their savings in financial assets – stocks, real estate, mutual funds, etc. - have been wiped out. In recent times they were lured by stories of high returns and greed won over caution. Many NRIs will possibly return as they lose jobs abroad and add to the employment pressures. Remittances that supported many families are likely to dry up leaving families in trouble. Public sector employees with safe employment will have a good time as prices fall.
Some argue that the poor will not be hit by the current crisis because they are marginal to the market and especially the financial markets. This is fallacious because the marginal are coercively linked to the markets in a one way relationship. While they derived little benefit from the high but marginalizing growth they will suffer from the decline. Even if they lose a few rupees a day of income, it will be calamitous for them since they are at the edge of survival.
As unemployment builds up the world over, wages will fall and disguised unemployment will rise. Price fall will help but not enough. Employers in the unorganized sectors and the rich farmers who will be squeezed by the crisis will put the squeeze downwards and affect adversely the incomes of the poor. Government programmes like rural employment schemes can help the poor but corruption moderates its effect.
Agriculture in India has been increasingly export oriented and there has been a shift towards commercial crops and high cost agriculture. The markets for these commodities have declined sharply and the slide can continue unless prices are sharply lowered but then the surplus farmers will lose out. The traders will put the squeeze downwards and the farmers will do the same to the landless workers.
In India, big and medium sized firms buy from the smaller units in the unorganized sectors. As these units face decline in demand, they will be forced to shut partially or wholly , reduce shifts and cut prices which is possible only if they squeeze either the wages or the smaller ancillary suppliers (possibly both) who in turn will squeeze their workers. Thus, wages of workers are likely to decline all around and their employment curtailed.
Governments all over the world have put together huge packages of interventions to prevent their financial sectors from collapsing but done relatively for the real economy and the poor. This has certainly slowed the decline but it is still continuing. The problem this time is different than in 1929 and much deeper, linked to the basics of the world economic system. Merely trying to reflate the economies without any basic change will not work.
In India, the NEP launched in 1991 depended on the proper functioning of the global financial system but because this is now collapsing, the success of NEP is in doubt. While the marginalized sections were suffering and continue to suffer, now the beneficiaries of the NEP are being grievously hurt. In the changed global scenario, NEP need a rethink.
Many companies are close to bankruptcy if not bankrupt, public does not trust the present financial system so it has ground to a halt and due to extreme uncertainty, everyone wishes to remain liquid rather than invest. The crisis has been building from 2006 without our recognizing it and we are still groping for solutions because these have to be out of box and this will take time. If the social and political situation deteriorates with rising unemployment and destitution, then even big economic interventions will not succeed and governments will become helpless. While 2008 is closing on a difficult note, 2009 appears to be heading for deeper trouble.
Arun Kumar
CESP, SSS, JNU.
The Tribune, January 1, 2009.
The year 2008 started on a high with the economy doing well, stock markets at a historic high, real estate markets booming, industrial growth running at upwards of 10 per cent and inflation at low rates. The finance minister boasted that the macro economic fundamentals are good and the Eleventh plan target of 9 per cent average growth rate viable. There was little inkling that policy making circles understood that a deep economic downturn had set in India and the entire world.
Contrasting this rosy picture, the year is closing with wide spread reports of declining employment, stock markets down by 50% to the levels of 2006, declining real estate markets, industrial growth and exports showing negative growth and many components of the services sector declining rather than growing. This has happened despite the unprecedented interventions by the government and the Reserve Bank – the infusion of massive liquidity, huge supplementary budget and the announcement of the first package of fiscal stimulus soon to be followed by a second one. FRBM has been given a quiet burial.
The year also saw much turmoil due to a rapid acceleration of inflation from its lows in January to the highs in the middle and now to a rapid decline in the closing weeks of the year. It seemed that the government had lost control because at one point the government admitted that it could do little to keep inflation in check by pleading that it was stable and not rising further.
Internationally, the prices of crude oil which had reached a peak of around $150 per barrel have sharply fallen to around $40 in spite of the threatened cut in production by the oil producers. In fact, many, like, Goldman Sachs had predicted that the price of crude would be around $200 by the end of 2008. Similarly, given the blistering pace of the rise in the BSE experts predicted that it would touch 30,000 - three times the level ruling currently. All this calls into question the expertise of the so called experts and policy makers.
The year began with policy makers and experts suggesting a decoupling between the Asian and the US and European economies. They suggested that the rapidly growing economies of Asia will provide the boost to the advanced economies so that there would be a soft landing for the world. This was based more on hope and hype rather than on analysis (As argued in these columns on February 6, 2008). These economies were already at their peak growth rates and could not double them which was required to compensate for a decline in the rates of growth in the OECD economies. Further, since China is heavily dependent on exports to these economies and India is much more open than earlier, if anything, their rates of growth were bound to fall. These two economies could not move in a direction opposite to that of the bigger economies, as events have borne out. Clearly, all along the policy makers and experts have been hoodwinking by denying reality. They also fooled themselves and did not take timely steps so that the situation became worse than it should have and now everyone is paying for it.
The rich have lost a lot of paper wealth on their financial assets where much of their savings were invested. These people also had substantial amount of their black wealth stashed away abroad because this was also invested in financial instruments. These people were also operating real, nuts and bolts companies or offices and due to the slow down, these are also in trouble. The contagion has spread from the financial markets to the real economy.
All this has impacted the middle classes who have linkages in the organized sectors. Many of them are in the process of losing jobs and their children are not getting the good jobs they expected. Further, a large part of their savings in financial assets – stocks, real estate, mutual funds, etc. - have been wiped out. In recent times they were lured by stories of high returns and greed won over caution. Many NRIs will possibly return as they lose jobs abroad and add to the employment pressures. Remittances that supported many families are likely to dry up leaving families in trouble. Public sector employees with safe employment will have a good time as prices fall.
Some argue that the poor will not be hit by the current crisis because they are marginal to the market and especially the financial markets. This is fallacious because the marginal are coercively linked to the markets in a one way relationship. While they derived little benefit from the high but marginalizing growth they will suffer from the decline. Even if they lose a few rupees a day of income, it will be calamitous for them since they are at the edge of survival.
As unemployment builds up the world over, wages will fall and disguised unemployment will rise. Price fall will help but not enough. Employers in the unorganized sectors and the rich farmers who will be squeezed by the crisis will put the squeeze downwards and affect adversely the incomes of the poor. Government programmes like rural employment schemes can help the poor but corruption moderates its effect.
Agriculture in India has been increasingly export oriented and there has been a shift towards commercial crops and high cost agriculture. The markets for these commodities have declined sharply and the slide can continue unless prices are sharply lowered but then the surplus farmers will lose out. The traders will put the squeeze downwards and the farmers will do the same to the landless workers.
In India, big and medium sized firms buy from the smaller units in the unorganized sectors. As these units face decline in demand, they will be forced to shut partially or wholly , reduce shifts and cut prices which is possible only if they squeeze either the wages or the smaller ancillary suppliers (possibly both) who in turn will squeeze their workers. Thus, wages of workers are likely to decline all around and their employment curtailed.
Governments all over the world have put together huge packages of interventions to prevent their financial sectors from collapsing but done relatively for the real economy and the poor. This has certainly slowed the decline but it is still continuing. The problem this time is different than in 1929 and much deeper, linked to the basics of the world economic system. Merely trying to reflate the economies without any basic change will not work.
In India, the NEP launched in 1991 depended on the proper functioning of the global financial system but because this is now collapsing, the success of NEP is in doubt. While the marginalized sections were suffering and continue to suffer, now the beneficiaries of the NEP are being grievously hurt. In the changed global scenario, NEP need a rethink.
Many companies are close to bankruptcy if not bankrupt, public does not trust the present financial system so it has ground to a halt and due to extreme uncertainty, everyone wishes to remain liquid rather than invest. The crisis has been building from 2006 without our recognizing it and we are still groping for solutions because these have to be out of box and this will take time. If the social and political situation deteriorates with rising unemployment and destitution, then even big economic interventions will not succeed and governments will become helpless. While 2008 is closing on a difficult note, 2009 appears to be heading for deeper trouble.
Eventful Year 2008: Descending into the Precipice
Eventful Year 2008: Descending into the Precipice
Arun Kumar
CESP/SSS, JNU, New Delhi 110067.
Published on January 5, 2009 on Taxindiaonline.
http://www.taxindiaonline.com/RC2/inside2.php3?filename=bnews_detail.php3&newsid=8395
Year 2008 began with all round predictions of reduced but positive growth for the world economy. The US economy was expected to continue to grow even if anemically. Mr. Paulson, the US Treasury secretary and Prof. Bernanke, the Fed chief prognosticated that the problems faced by the US economy were tractable and certainly not systemic – something they admitted only on September 19, 2008.
2008 is ending with rapidly rising unemployment and houselessness due to foreclosures and a deepening recession in the USA. The trend is no different in the other major world economies. Some have suggested that this is just the start of a major downturn in the world economy. Fears of deflation in the world economy are real with prices softening and this could head the world towards a depression and a recovery many years away.
The US financial system is no more what it was even six months back. Major entities like, the housing mortgage giants, Freddie Mac and Fannie Mae, the insurance giant, AIG, the largest US bank, Citibank, the giant investment banks, Goldman Sachs, Merrill Lynch, Lehman Brothers and Bear Sterns, have faced collapse. They have had to be bailed out by the government or gone bankrupt. Given the inter linkages the effect on the real economy has been sharp. The rest of the world has been hit hard by these events.
GOVERNMENT INTERVENTIONS: TOO LITTLE, TOO LATE.
USA, Euro zone, UK and Japan are all in recession while China and India are slowing down rapidly, in spite of the massive interventions by all governments which according to one estimate exceeds $10 trillion - about one sixth the size of the global GDP. The slide in the world economy is continuing even though under normal circumstances this would have led to hyper inflation – times are clearly abnormal.
Each time the US government felt that it had licked the problem - tax cut in February, bail out of Bear Sterns in March, take over of Freddie and Fannie, bail out of AIG and then of Citibank - fresh problems erupted soon thereafter. Finally, when the unprecedented bail out package of $700 billion was announced on September 19, it was felt that the collapse would halt. But fresh packages have had to be announced and now it is suggested that the U.S. President elect, Mr. Obama, is planning another package of $800 billion. The gravity of the situation maybe gauged from the announcement by the Fed that it will print as many notes as would be required to stem the collapse.
Each time, government intervention has been `too little too late’ so that the crisis has continued to deepen. The stock markets have responded temporarily till the next bad news. Most policy makers and analysts have been in a state of denial so that rather than anticipating events they have been surprised by them. This could partly be because they wished to avoid panic but the effect has only been a worsening of the situation due to lack of timely actions.
One of the key reasons for the spread of the contagion is the interlocked nature of the balance sheets of the various economic entities. Today, almost any seemingly healthy company can soon head towards trouble because it is not able to recover money from some other entity to which it has extended credit and which is failing. Hence trust has evaporated and credit has frozen almost all over the world and made central bank interventions ineffective. The delay in a decisive response from the US since it has a lame duck President is likely to prove expensive since toxicity in the financial system would have spread further by January 20, 2009 so that even more drastic intervention would be required then.
FINANCIAL FRAUD
The recent discovery of the audacious Ponzi scheme run by Mr. Madoff of the USA, resulting in losses of possibly $50 billion to various entities is going to aggravate failures and fresh problems will appear. Losses have been incurred by charities, universities, individuals, asset management funds, etc. Not only will pensioners and university students be affected, the viability of some of the companies involved will be dented and some of the smaller entities may head towards bankruptcy.
The Madoff fiasco shows that those who were supposed to be alert on behalf of the public - auditors, SEC, etc. - were possibly taken in by the swindle (a charitable view) or were a party to it. It highlights the all pervading desire to make a quick buck with little regard for risks. Since others were making money it was a good enough excuse to take unacceptable risks and make money.
While Mr. Madoff committed fraud and more such frauds maybe discovered in the coming months since there were many clever people who were hoodwinking others and making a killing for themselves, the crisis is deeper than fraud. The problem lies in the way the financial system was functioning.
DO WE REALLY KNOW WHAT TO DO?
Some have argued that because the world faced the depression of 1929, we know what to do. Namely, go in for massive fiscal intervention through the creation of fiscal deficits to boost demand. However, even this may not work since the nature of the crisis is different from the earlier one. There was lack of demand and the lesson learnt was to intervene counter cyclically to reinflate the economy.
This time while the deficiency of demand initiated the problem in the financial system that was only a trigger for the collapse of the current financial system. The collapse itself is not due to the deficiency of demand but linked to the structure of the unregulated financial system which has a built in instability which is now playing itself out. The financial bubble inflates gradually but deflates suddenly. This leads to loss of trust and collapse of confidence which then pulls the rug from under the feet of the financial system. The financial markets then freeze so that even Central Bank’s and government’s interventions fail to revive the economy.
The world economy can still produce the output it produced in June 2008 – the factories, offices, fields, etc., are still there – but the system of production which is based on finance to lubricate the flows of goods and services has been disrupted and hence the real economy has been dented. The real and the financial sectors are interlinked and the latter is taking the former along with it. Since the government announced interventions are too little too late and unable to prevent the collapse of the financial sector, the real economy is also not responding to the steps announced till now.
The problem stems from the fact that while each financial transaction is separately reversible, the totality of transactions is irreversible due to the complexity involved. Further in a situation of a freeze in credit markets, governments do not have the resources to cover the losses of all the entities or even most of the losses of some of the major entities.
IN FOR A LONG HAUL?
With spare capacity emerging everywhere and as slow down accelerates, many factories are shutting down or working fewer hours. In this situation, investment plans are bound to be frozen, as reports suggest and demand falls further. This suggests that any chance of a turn around any time soon is bleak. Unless demand begins to turn around and unutilized capacity worked out of the system, investment levels will not recover.
Government interventions have largely helped the financial sector because policy makers are mostly financial experts. But this will neither help raise basic demand in the real economy nor shore up trust and confidence in the shattered financial system because what the government can provide is a fraction of the total losses being incurred. Consequently, the recession can only deepen.
As recession deepens, commodity prices will weaken. Petro goods prices are a case in point. In spite of the slow down having just started, crude oil prices have fallen by a massive 70% from their peak. Many other commodity prices would also fall substantially since their prices had also climbed sharply till 2008 middle. There is an underlying worry of a deflation and if that happens a depression would be inevitable.
INDIA AND CHINA AND ABSENCE OF DECOUPLING.
The Chinese economy has slowed down rapidly due to its dependence on exports. Indian economy which is less dependent on exports has also slowed down. Confidence of investors has been dented by the sharp decline in the stock markets triggered by the withdrawal of funds by FIIs and reduction in the flows of FDI. With gaping holes in the balance sheets, companies need funds to shore up their accounts so they are willing to sell assets even at a loss. Further, since these markets had gone on a speculative boom and were overly priced, it pays to leave early rather than late setting up a herd mentality.
The exporters of primary produce - the developing world, petroleum exporters, etc. - will be hit hard by this decline in commodity prices. In India, Bellary iron ore mines have seen activity drop from a reported 15,000 trucks per day to just a few hundred trucks per day – a drop of more than 95%. Many plants have announced planned monthly closures or reduced the number of shifts. The over heated real estate markets and construction industry have taken a severe drubbing and along with that the cement and the steel industry. Tourism, hotels, transport, finance, trade, consumer durables, etc., are declining.
If the rate of growth of the major economies of the world falls by one per cent, then China and India can compensate for that only if their rate of growth goes up by at least 10 per cent. Given that they were already growing at possibly their peak rates, this possibility never existed so a decline was inevitable. Further since the two depend on exports to the advanced countries, their growth was bound to slow down and worsen the situation.
INEFFECTIVENESS OF POLICY INTERVENTIONS
The collapse of the British Pound, the decline in the Euro and the rise in the dollar has been the response of the crisis ridden financial sector. In spite of the weakness of the US economy, the dollar seems safer than other currencies. Investors feel that the other economies will sink more than the US since the big loses the least. Further, the confusion in the Euro zone due to competing national interests has reduced the chances of a coordinated response so that Europe could suffer badly. In contrast, the US does not face this problem.
In times of crisis, theory suggests that economic entities facing uncertainty go liquid and that is what we are witnessing all over the world. Hence interest rate cuts do not stimulate the economy. Release of liquidity by Central Banks is simply being held and not circulated – money multiplier and the velocity of circulation have collapsed leading to a freezing of the financial markets.
Central banks and governments are liberally promising money to companies without any risk assessment. They have become the lender of first resort to the financial sector and are no more the lenders of last resort as required by banking theory. Are they equipped to assess the risks involved, etc.? In any case, it takes a while to decipher the balance sheets made by clever accountants and lawyers who have devised myriad ways of hiding holes in the accounts. AIG has absorbed $150 billion in the months since September, 2008 but hardly anyone understands where the money has gone and how much more may go.
NEED FOR GLOBAL COORDINATION
The stimulus package of one country may fail due to inaction by others so that there is need for global coordination. Action by one may benefit another due to the global nature of the economy and the former may be left with deeper problems. This is likely since different views of what needs to be done prevail. Mr Obama’s non participation in the G 20 summit in November is an indication that he did not see eye to eye with Mr. Bush. Germany has been critical of Britain. China has hinted at moving away from the dollar since it has suffered big losses. Iceland froze British assets and the latter declared the former a terrorist state. The US rapidly losing jobs could go in for protecting jobs by making retention of jobs in the USA a condition for bailing out companies. All this is pointing in the direction of protectionism.
While global coordination is essential it is necessary but not sufficient for recovery. The problem is, policy makers do not quite know how to resolve the crisis. Understanding of the past is useful but inadequate given that the core problem is not what it was. Policy makers have to get out of their state of denial and the hope that somehow the crisis will blow away – we are not in the world of inevitable happy endings.
CONCLUSION
The world cannot do without the financial system that is essential for investments and trade to occur efficiently. This basic function of the financial system was eroded by the various imaginative innovations in the financial system and led to collapse. These were supposed to lower risk but now it is clear they ended up enhancing it.
There is need to restructure the global financial system completely. The present system has completely lost credibility with the citizens and investors. Trust is not likely to return any time soon given the kind of losses that have been suffered all around – running into trillions of dollars. Experts are no more going to be acceptable to the public since they have proved to be too clever by halves and caused enormous losses to their clients.
The complex financial system was treated by the vast majority of the investors as a black box and faith laid on it because the experts said so. This opacity did not matter as long as money was being made but now the public would demand transparency.
In fact, as is now clear, most policy makers themselves did not fully understand what was going on. Alan Greenspan has admitted this. Demand for proper regulation of the complex financial system is likely to grow so that the powers of the Central Banks are likely to be enhanced and more policy intervention maybe acceptable. The fragility of the financial system would no more be acceptable. A long term view would have to be taken since it is now clear that short term profits with eventual collapse is worse than a steady return. All in all, we are in for a long haul and in 2009 we are entering a world substantially different from the one we started with in 2008.
Arun Kumar
CESP/SSS, JNU, New Delhi 110067.
Published on January 5, 2009 on Taxindiaonline.
http://www.taxindiaonline.com/RC2/inside2.php3?filename=bnews_detail.php3&newsid=8395
Year 2008 began with all round predictions of reduced but positive growth for the world economy. The US economy was expected to continue to grow even if anemically. Mr. Paulson, the US Treasury secretary and Prof. Bernanke, the Fed chief prognosticated that the problems faced by the US economy were tractable and certainly not systemic – something they admitted only on September 19, 2008.
2008 is ending with rapidly rising unemployment and houselessness due to foreclosures and a deepening recession in the USA. The trend is no different in the other major world economies. Some have suggested that this is just the start of a major downturn in the world economy. Fears of deflation in the world economy are real with prices softening and this could head the world towards a depression and a recovery many years away.
The US financial system is no more what it was even six months back. Major entities like, the housing mortgage giants, Freddie Mac and Fannie Mae, the insurance giant, AIG, the largest US bank, Citibank, the giant investment banks, Goldman Sachs, Merrill Lynch, Lehman Brothers and Bear Sterns, have faced collapse. They have had to be bailed out by the government or gone bankrupt. Given the inter linkages the effect on the real economy has been sharp. The rest of the world has been hit hard by these events.
GOVERNMENT INTERVENTIONS: TOO LITTLE, TOO LATE.
USA, Euro zone, UK and Japan are all in recession while China and India are slowing down rapidly, in spite of the massive interventions by all governments which according to one estimate exceeds $10 trillion - about one sixth the size of the global GDP. The slide in the world economy is continuing even though under normal circumstances this would have led to hyper inflation – times are clearly abnormal.
Each time the US government felt that it had licked the problem - tax cut in February, bail out of Bear Sterns in March, take over of Freddie and Fannie, bail out of AIG and then of Citibank - fresh problems erupted soon thereafter. Finally, when the unprecedented bail out package of $700 billion was announced on September 19, it was felt that the collapse would halt. But fresh packages have had to be announced and now it is suggested that the U.S. President elect, Mr. Obama, is planning another package of $800 billion. The gravity of the situation maybe gauged from the announcement by the Fed that it will print as many notes as would be required to stem the collapse.
Each time, government intervention has been `too little too late’ so that the crisis has continued to deepen. The stock markets have responded temporarily till the next bad news. Most policy makers and analysts have been in a state of denial so that rather than anticipating events they have been surprised by them. This could partly be because they wished to avoid panic but the effect has only been a worsening of the situation due to lack of timely actions.
One of the key reasons for the spread of the contagion is the interlocked nature of the balance sheets of the various economic entities. Today, almost any seemingly healthy company can soon head towards trouble because it is not able to recover money from some other entity to which it has extended credit and which is failing. Hence trust has evaporated and credit has frozen almost all over the world and made central bank interventions ineffective. The delay in a decisive response from the US since it has a lame duck President is likely to prove expensive since toxicity in the financial system would have spread further by January 20, 2009 so that even more drastic intervention would be required then.
FINANCIAL FRAUD
The recent discovery of the audacious Ponzi scheme run by Mr. Madoff of the USA, resulting in losses of possibly $50 billion to various entities is going to aggravate failures and fresh problems will appear. Losses have been incurred by charities, universities, individuals, asset management funds, etc. Not only will pensioners and university students be affected, the viability of some of the companies involved will be dented and some of the smaller entities may head towards bankruptcy.
The Madoff fiasco shows that those who were supposed to be alert on behalf of the public - auditors, SEC, etc. - were possibly taken in by the swindle (a charitable view) or were a party to it. It highlights the all pervading desire to make a quick buck with little regard for risks. Since others were making money it was a good enough excuse to take unacceptable risks and make money.
While Mr. Madoff committed fraud and more such frauds maybe discovered in the coming months since there were many clever people who were hoodwinking others and making a killing for themselves, the crisis is deeper than fraud. The problem lies in the way the financial system was functioning.
DO WE REALLY KNOW WHAT TO DO?
Some have argued that because the world faced the depression of 1929, we know what to do. Namely, go in for massive fiscal intervention through the creation of fiscal deficits to boost demand. However, even this may not work since the nature of the crisis is different from the earlier one. There was lack of demand and the lesson learnt was to intervene counter cyclically to reinflate the economy.
This time while the deficiency of demand initiated the problem in the financial system that was only a trigger for the collapse of the current financial system. The collapse itself is not due to the deficiency of demand but linked to the structure of the unregulated financial system which has a built in instability which is now playing itself out. The financial bubble inflates gradually but deflates suddenly. This leads to loss of trust and collapse of confidence which then pulls the rug from under the feet of the financial system. The financial markets then freeze so that even Central Bank’s and government’s interventions fail to revive the economy.
The world economy can still produce the output it produced in June 2008 – the factories, offices, fields, etc., are still there – but the system of production which is based on finance to lubricate the flows of goods and services has been disrupted and hence the real economy has been dented. The real and the financial sectors are interlinked and the latter is taking the former along with it. Since the government announced interventions are too little too late and unable to prevent the collapse of the financial sector, the real economy is also not responding to the steps announced till now.
The problem stems from the fact that while each financial transaction is separately reversible, the totality of transactions is irreversible due to the complexity involved. Further in a situation of a freeze in credit markets, governments do not have the resources to cover the losses of all the entities or even most of the losses of some of the major entities.
IN FOR A LONG HAUL?
With spare capacity emerging everywhere and as slow down accelerates, many factories are shutting down or working fewer hours. In this situation, investment plans are bound to be frozen, as reports suggest and demand falls further. This suggests that any chance of a turn around any time soon is bleak. Unless demand begins to turn around and unutilized capacity worked out of the system, investment levels will not recover.
Government interventions have largely helped the financial sector because policy makers are mostly financial experts. But this will neither help raise basic demand in the real economy nor shore up trust and confidence in the shattered financial system because what the government can provide is a fraction of the total losses being incurred. Consequently, the recession can only deepen.
As recession deepens, commodity prices will weaken. Petro goods prices are a case in point. In spite of the slow down having just started, crude oil prices have fallen by a massive 70% from their peak. Many other commodity prices would also fall substantially since their prices had also climbed sharply till 2008 middle. There is an underlying worry of a deflation and if that happens a depression would be inevitable.
INDIA AND CHINA AND ABSENCE OF DECOUPLING.
The Chinese economy has slowed down rapidly due to its dependence on exports. Indian economy which is less dependent on exports has also slowed down. Confidence of investors has been dented by the sharp decline in the stock markets triggered by the withdrawal of funds by FIIs and reduction in the flows of FDI. With gaping holes in the balance sheets, companies need funds to shore up their accounts so they are willing to sell assets even at a loss. Further, since these markets had gone on a speculative boom and were overly priced, it pays to leave early rather than late setting up a herd mentality.
The exporters of primary produce - the developing world, petroleum exporters, etc. - will be hit hard by this decline in commodity prices. In India, Bellary iron ore mines have seen activity drop from a reported 15,000 trucks per day to just a few hundred trucks per day – a drop of more than 95%. Many plants have announced planned monthly closures or reduced the number of shifts. The over heated real estate markets and construction industry have taken a severe drubbing and along with that the cement and the steel industry. Tourism, hotels, transport, finance, trade, consumer durables, etc., are declining.
If the rate of growth of the major economies of the world falls by one per cent, then China and India can compensate for that only if their rate of growth goes up by at least 10 per cent. Given that they were already growing at possibly their peak rates, this possibility never existed so a decline was inevitable. Further since the two depend on exports to the advanced countries, their growth was bound to slow down and worsen the situation.
INEFFECTIVENESS OF POLICY INTERVENTIONS
The collapse of the British Pound, the decline in the Euro and the rise in the dollar has been the response of the crisis ridden financial sector. In spite of the weakness of the US economy, the dollar seems safer than other currencies. Investors feel that the other economies will sink more than the US since the big loses the least. Further, the confusion in the Euro zone due to competing national interests has reduced the chances of a coordinated response so that Europe could suffer badly. In contrast, the US does not face this problem.
In times of crisis, theory suggests that economic entities facing uncertainty go liquid and that is what we are witnessing all over the world. Hence interest rate cuts do not stimulate the economy. Release of liquidity by Central Banks is simply being held and not circulated – money multiplier and the velocity of circulation have collapsed leading to a freezing of the financial markets.
Central banks and governments are liberally promising money to companies without any risk assessment. They have become the lender of first resort to the financial sector and are no more the lenders of last resort as required by banking theory. Are they equipped to assess the risks involved, etc.? In any case, it takes a while to decipher the balance sheets made by clever accountants and lawyers who have devised myriad ways of hiding holes in the accounts. AIG has absorbed $150 billion in the months since September, 2008 but hardly anyone understands where the money has gone and how much more may go.
NEED FOR GLOBAL COORDINATION
The stimulus package of one country may fail due to inaction by others so that there is need for global coordination. Action by one may benefit another due to the global nature of the economy and the former may be left with deeper problems. This is likely since different views of what needs to be done prevail. Mr Obama’s non participation in the G 20 summit in November is an indication that he did not see eye to eye with Mr. Bush. Germany has been critical of Britain. China has hinted at moving away from the dollar since it has suffered big losses. Iceland froze British assets and the latter declared the former a terrorist state. The US rapidly losing jobs could go in for protecting jobs by making retention of jobs in the USA a condition for bailing out companies. All this is pointing in the direction of protectionism.
While global coordination is essential it is necessary but not sufficient for recovery. The problem is, policy makers do not quite know how to resolve the crisis. Understanding of the past is useful but inadequate given that the core problem is not what it was. Policy makers have to get out of their state of denial and the hope that somehow the crisis will blow away – we are not in the world of inevitable happy endings.
CONCLUSION
The world cannot do without the financial system that is essential for investments and trade to occur efficiently. This basic function of the financial system was eroded by the various imaginative innovations in the financial system and led to collapse. These were supposed to lower risk but now it is clear they ended up enhancing it.
There is need to restructure the global financial system completely. The present system has completely lost credibility with the citizens and investors. Trust is not likely to return any time soon given the kind of losses that have been suffered all around – running into trillions of dollars. Experts are no more going to be acceptable to the public since they have proved to be too clever by halves and caused enormous losses to their clients.
The complex financial system was treated by the vast majority of the investors as a black box and faith laid on it because the experts said so. This opacity did not matter as long as money was being made but now the public would demand transparency.
In fact, as is now clear, most policy makers themselves did not fully understand what was going on. Alan Greenspan has admitted this. Demand for proper regulation of the complex financial system is likely to grow so that the powers of the Central Banks are likely to be enhanced and more policy intervention maybe acceptable. The fragility of the financial system would no more be acceptable. A long term view would have to be taken since it is now clear that short term profits with eventual collapse is worse than a steady return. All in all, we are in for a long haul and in 2009 we are entering a world substantially different from the one we started with in 2008.
Saturday, December 13, 2008
Sign of Systemic Crisis: US Companies too big to fail but failing
Sign of Systemic Crisis: US Companies too big to fail but failing
by Arun Kumar
The Tribune, December 13, 2008.
TILL early 2008 it was believed that certain economic entities are too big to fail, hence safe. Companies like, Fannie Mae and Freddie Mac, AIG, Merrill Lynch and Citibank each with assets running into hundreds of billions or trillions of dollars were supposed to be in this category. Their turnover was larger than the GDP of most countries in the world. Each one of them has failed since August 2008 and has been bailed out by the US government or bought over by other companies. General Motors, another giant, has been pleading for help.
Earlier, even if such companies faced financial problems they could stay afloat for years before going under. Now these companies have collapsed in a matter of months. Citibank with reported assets of $ 2 trillion and operations in 100 countries was considered to be healthy and was to take over Watchovia bank in early October but in the third week of November, it has had to be bailed out by the government. Fannie and Freddie were supposed to be healthy in May 2008 but had collapsed by September.
Governments the world over are pumping in trillions of dollars to shore up their economies. The mega package on offer from the US government amounts to $ 7.8 trillion. $ 1.7 trillion is being offered as loans to companies whose hard to sell securities are being accepted as collateral. Since there is substantial chance of failure in this, it could amount to a dole to these companies. Investment worth $ 3 trillion is being poured into buying stocks, corporate debt and mortgages. $ 3.1 trillion is the amount of guarantees on offer to corporate bonds, money market funds and money in specified deposit accounts.
Britain, China, Germany, Japan, etc. have also offered their own packages, each running into hundreds of billions of dollars. The Indian government has pushed liquidity and additional budgetary provisions of $ 100 billion. Thus, the total amount committed world over has swelled to above $ 10 trillion (eleven times India’s national income). For a world economy of $ 65 trillion, this is a staggering amount of money and most of it is committed since September. Yet, things seem out of control even though the pace of the collapse maybe slower compared to two months back.
Rates of economic growth have plummeted. In August 2007, the US economy was slated to grow by a healthy rate, by mid 2008 marginally and now a recession has been declared since 2007 (anticipated by this author in these columns on Feb 6, 2007). An even sharper decline is expected in the next quarter. European zone, Japan, Taiwan, etc., have been declared to be in recession whereas they were supposed to have positive growth till early 2008. Chinese economy has slowed down considerably since mid 2008 and so has the Indian economy (whatever be the government’s claims of healthy growth).
Demand is plummeting everywhere and companies are laying off people many of whom were anyway losing their houses in the US due to foreclosures. There are reports of people living in their cars in parking lots and also of worried banks requesting some people not to vacate their houses till they find a buyer. Temporary employees are losing jobs and the permanent workers are working fewer hours because of plant closures. Failure of banks and companies is rising in the USA. This could spread to other countries too.
Nationalisation and government intervention have suddenly become acceptable. Minimum government is no more the desirable state of affairs. The kind of liquidity being released into the markets in a short space of time would have resulted in massive increase in demand and possibly hyperinflation if the situation was normal. Yet, in the present scenario, these steps are neither able to stem the decline of the financial institutions nor demand in the economy.
Can the governments go in for even larger packages of intervention? The US Fed has said that it will print whatever notes would be required, to prevent a collapse of the US economy and that seems to be the stance of most of the Central banks in the world.
Investment is falling everywhere since companies are not only facing a collapse in consumer demand but also are not sure of their own financial situation and would like to strengthen that before going in for fresh commitments. This is aggravated by drying up of credit since everyone is suspect in the eyes of others.
Exports have collapsed as demand has fallen and nations are buying less from others. Thus, all the major components of demand — consumption, investment and exports — have declined drastically. Only the government is left. This is the reason that the various economies are headed into deep recession and possibly a depression. So much spare capacity is emerging in each industry that it will take a while for this to be depreciated and for new investment to become worthwhile. It is only then that growth can pick up.
The nature of the crisis being faced today is different from the ones in the last 75 years. Hence analysts are groping for answers and specially those in policy making who led the world into this crisis. Governments can try to keep demand going by spending more on infrastructure (both physical and social). However, that may have limited effect unless it is on a massive scale, something that the present policy makers seem to be uncomfortable with.
The US financial system as it existed till the beginning of 2008 has now failed and a new one is needed to replace it. The moot point is since it was such an integral part of the US economy does it not need revamping instead of just the financial sector. The nationalisation/government takeover of major institutions and the introduction of regulation in the hitherto unregulated parts of the financial structures is itself changing the economy in fundamental ways but even this maybe mere tinkering and more basic change maybe required.
The failing mega institutions located in the US commanded huge amounts of the world’s resources and not just those of the US. This is what capital does; it enables control of institutions and resources in a few hands. So, failures on this scale will lead to a collapse of major economic structures in the world and will affect production world wide (as is already happening).
When those entities that were thought of as “too big to fail” actually fail, it signifies the failure of the system of which they are a part. It is not that the world suddenly cannot produce what it was producing till say July 2008. It is the organisation of that production (with control by finance) that is failing and hence the decline in the world economy. The marginalised who hardly benefited from the boom are hit by the bust. Remedy requires that controls over resources be reworked, monopolies need to be split up and their control over resources and political power and the resulting increase in disparities all need overhaul.
arunkumar1000@hotmail.com
by Arun Kumar
The Tribune, December 13, 2008.
TILL early 2008 it was believed that certain economic entities are too big to fail, hence safe. Companies like, Fannie Mae and Freddie Mac, AIG, Merrill Lynch and Citibank each with assets running into hundreds of billions or trillions of dollars were supposed to be in this category. Their turnover was larger than the GDP of most countries in the world. Each one of them has failed since August 2008 and has been bailed out by the US government or bought over by other companies. General Motors, another giant, has been pleading for help.
Earlier, even if such companies faced financial problems they could stay afloat for years before going under. Now these companies have collapsed in a matter of months. Citibank with reported assets of $ 2 trillion and operations in 100 countries was considered to be healthy and was to take over Watchovia bank in early October but in the third week of November, it has had to be bailed out by the government. Fannie and Freddie were supposed to be healthy in May 2008 but had collapsed by September.
Governments the world over are pumping in trillions of dollars to shore up their economies. The mega package on offer from the US government amounts to $ 7.8 trillion. $ 1.7 trillion is being offered as loans to companies whose hard to sell securities are being accepted as collateral. Since there is substantial chance of failure in this, it could amount to a dole to these companies. Investment worth $ 3 trillion is being poured into buying stocks, corporate debt and mortgages. $ 3.1 trillion is the amount of guarantees on offer to corporate bonds, money market funds and money in specified deposit accounts.
Britain, China, Germany, Japan, etc. have also offered their own packages, each running into hundreds of billions of dollars. The Indian government has pushed liquidity and additional budgetary provisions of $ 100 billion. Thus, the total amount committed world over has swelled to above $ 10 trillion (eleven times India’s national income). For a world economy of $ 65 trillion, this is a staggering amount of money and most of it is committed since September. Yet, things seem out of control even though the pace of the collapse maybe slower compared to two months back.
Rates of economic growth have plummeted. In August 2007, the US economy was slated to grow by a healthy rate, by mid 2008 marginally and now a recession has been declared since 2007 (anticipated by this author in these columns on Feb 6, 2007). An even sharper decline is expected in the next quarter. European zone, Japan, Taiwan, etc., have been declared to be in recession whereas they were supposed to have positive growth till early 2008. Chinese economy has slowed down considerably since mid 2008 and so has the Indian economy (whatever be the government’s claims of healthy growth).
Demand is plummeting everywhere and companies are laying off people many of whom were anyway losing their houses in the US due to foreclosures. There are reports of people living in their cars in parking lots and also of worried banks requesting some people not to vacate their houses till they find a buyer. Temporary employees are losing jobs and the permanent workers are working fewer hours because of plant closures. Failure of banks and companies is rising in the USA. This could spread to other countries too.
Nationalisation and government intervention have suddenly become acceptable. Minimum government is no more the desirable state of affairs. The kind of liquidity being released into the markets in a short space of time would have resulted in massive increase in demand and possibly hyperinflation if the situation was normal. Yet, in the present scenario, these steps are neither able to stem the decline of the financial institutions nor demand in the economy.
Can the governments go in for even larger packages of intervention? The US Fed has said that it will print whatever notes would be required, to prevent a collapse of the US economy and that seems to be the stance of most of the Central banks in the world.
Investment is falling everywhere since companies are not only facing a collapse in consumer demand but also are not sure of their own financial situation and would like to strengthen that before going in for fresh commitments. This is aggravated by drying up of credit since everyone is suspect in the eyes of others.
Exports have collapsed as demand has fallen and nations are buying less from others. Thus, all the major components of demand — consumption, investment and exports — have declined drastically. Only the government is left. This is the reason that the various economies are headed into deep recession and possibly a depression. So much spare capacity is emerging in each industry that it will take a while for this to be depreciated and for new investment to become worthwhile. It is only then that growth can pick up.
The nature of the crisis being faced today is different from the ones in the last 75 years. Hence analysts are groping for answers and specially those in policy making who led the world into this crisis. Governments can try to keep demand going by spending more on infrastructure (both physical and social). However, that may have limited effect unless it is on a massive scale, something that the present policy makers seem to be uncomfortable with.
The US financial system as it existed till the beginning of 2008 has now failed and a new one is needed to replace it. The moot point is since it was such an integral part of the US economy does it not need revamping instead of just the financial sector. The nationalisation/government takeover of major institutions and the introduction of regulation in the hitherto unregulated parts of the financial structures is itself changing the economy in fundamental ways but even this maybe mere tinkering and more basic change maybe required.
The failing mega institutions located in the US commanded huge amounts of the world’s resources and not just those of the US. This is what capital does; it enables control of institutions and resources in a few hands. So, failures on this scale will lead to a collapse of major economic structures in the world and will affect production world wide (as is already happening).
When those entities that were thought of as “too big to fail” actually fail, it signifies the failure of the system of which they are a part. It is not that the world suddenly cannot produce what it was producing till say July 2008. It is the organisation of that production (with control by finance) that is failing and hence the decline in the world economy. The marginalised who hardly benefited from the boom are hit by the bust. Remedy requires that controls over resources be reworked, monopolies need to be split up and their control over resources and political power and the resulting increase in disparities all need overhaul.
arunkumar1000@hotmail.com
Thursday, December 4, 2008
Current Financial Turmoil - Lessons for the Future: Video Link
The following are the youtube video links of a talk by Prof. Arun Kumar on the current financial turmoil delivered at The Ahmedabad Management Association.
Part 1 http://in.youtube.com/watch?v=KaZIyrPDwSE
Part 2 http://in.youtube.com/watch?v=ghDklXgoJb4
Part 3 http://in.youtube.com/watch?v=8AJSxAyloJ4
Part 4 http://in.youtube.com/watch?v=7qbGT7lbx64
Part 5 http://in.youtube.com/watch?v=tox-I_FEdYg
Part 6 http://in.youtube.com/watch?v=2lwP1uV859U
Part 7 http://in.youtube.com/watch?v=3PZnjQf2INY
Part 8 http://in.youtube.com/watch?v=vFcfzibYsu4
Part 1 http://in.youtube.com/watch?v=KaZIyrPDwSE
Part 2 http://in.youtube.com/watch?v=ghDklXgoJb4
Part 3 http://in.youtube.com/watch?v=8AJSxAyloJ4
Part 4 http://in.youtube.com/watch?v=7qbGT7lbx64
Part 5 http://in.youtube.com/watch?v=tox-I_FEdYg
Part 6 http://in.youtube.com/watch?v=2lwP1uV859U
Part 7 http://in.youtube.com/watch?v=3PZnjQf2INY
Part 8 http://in.youtube.com/watch?v=vFcfzibYsu4
Thursday, November 20, 2008
Interests of the Unemployed: A Radical Agenda for Obama
Interests of the unemployed: A radical agenda for Obama
by Arun Kumar
The Tribune, November 20, 2008.
Against all odds, Mr Barack Obama has won the Presidency of the US only to be confronted with extraordinary odds — incomparably greater than those faced by any recently elected US President. Economically, socially and politically, the country and the world are in a state of deep crisis. The US as the leader of the world is both a cause of the problems and a possible source of solutions. Without the US being a part of any solution, it is unlikely that the world, as it is, will be able to resolve its problems. In this sense, it is said the whole world should have a vote in the US presidential elections.
The G-20 heads met under the leadership of a lame-duck US President, Mr Bush, in a largely futile talking exercise. Our own Prime Minister made noises about how he saw the crisis coming while till the other day he was saying that there is no crisis; does credibility matter. Mr Obama did not participate, perhaps due to his irreconcilable differences with Mr Bush who only talked of the free markets. Mr Obama’s presence may have given the wrong signals and made his own task more difficult when he takes over in two months. However, this delay could be very expensive.
Not only is the economic weight of the US so large that it determines world economic events but its financial and political clout sways other countries politically and socially as well. It draws the best in the world to its universities and think tanks and leads all others in research in almost all fields. Thus, it is able to set the agenda for the entire world in intellectual terms and also because it has lobbies pushing for its interest in almost all parts of the world. It dominates the multilateral agencies and that is another important source of its influence. From issues of poverty removal, research in health, agenda for the environment, nature of the financial architecture, fight against terrorism and money laundering, etc, the US moulds world events.
To be able to lead in such an extraordinarily complex world on such a broad front requires statespersonship of a high order among the leaders. This has been missing for decades. The US and, following its lead, most other governments in the world have been governed by narrowly defined short-term self-interest. One may say, what is new? But in a far more complex world, old ways will not do. Narrowness of approach is a recipe for disaster and pay-back time has now come. The world as we have known it can hardly survive.
All the above listed problems have a common source, a belief in a narrowly defined national and individual interest, based on greed and unlimited exploitation. Thus, respect for nature and other people has been at a discount. While this was tolerated earlier, today this has serious implications, especially at the economic plane and now we are confronted with a collapse for which no one has an answer.
The governments all over the world are scrambling with packages to salvage their financial institutions and their economies. Huge sums of money are on offer (capital injection, loans, etc.) — amounting to about $5 trillion. The financial bubble, which is in the process of collapse and is dragging down the real economy, was a result of deregulation of the financial markets and an undiluted pursuit of lucre and the resulting massive disparities in society.
The financial assets created (in hundreds of trillions of dollars) were a multiple of the size of the real world economy (around 60 trillion dollars) so that the latter does not have the resources to resolve the problems created by the former. Governments can neither replicate the markets nor their intervention is adequate to stop the financial bubble from collapsing.
The financial bubble consists of borrowings and lending by various economic entities. As the bubble deflates, while asset values decline, the liabilities remain. Hence institutions develop huge holes in their balance sheets. Since the various financial entities are interlinked through borrowing and lending, as one institution collapses and is unable to pay its lenders, the latter runs into problems and this ricochets to yet others leading to further collapse. A vicious cycle sets in and institutions lose trust in each other and stop lending to others and instead try to accumulate capital to cover their own declining asset base. The money given by the government goes to support their own asset base with little lent to anyone else.
While the build-up of the financial bubble is gradual and systematic, its collapse is sudden and chaotic and that is why it is beyond anyone’s control. Release of liquidity and cuts in interest rates do not spur investments and the economy enters a “liquidity trap”. In this scenario, it appears inevitable that the financial markets would collapse and nothing in the short run can save them.
Unfortunately, businesses are inter-linked, a large number of the firms dealing in real products and services also were involved in the financial markets to invest their funds or to cover their risk (say, in foreign exchange). These firms are also suffering losses. Further, they are confronted with a slow- down in demand and a tightening of the credit markets since borrowing and lending has frozen. Thus, the growth rate of the real output which had already started declining in 2007 is now in negative territory over large parts of the advanced world.
Consequently, unemployment is rising dramatically all over the globalised world. This is going to bring real pain to a vast majority of the people while the collapse of the financial world hits only a small percentage of the rich and the upper middle class populations. The collapse of the latter is inevitable but if the former collapses, it would be catastrophic. The choice before the governments is clear — should funds be thrown into the bottomless pit of the financial sector without any real benefits or should they be used to retrieve the real economy and keep it going?
The US government is an establishment run by various vested interests, and the financial sector interests are deeply entrenched in it — they have been running the Treasury and the Fed for long. Their interest is seen as the main interest. That is why the poor are not getting help with their houses or General Motors is not getting $25 billion while AIG has got $150 billion. Mr Obama would have to overcome this bias in policy and put together a radically new plan. This would require him to change his set of advisers and those in the establishment, but that is easier said than done. Mr Obama’s win was like climbing Mount Everest, but can one do so everyday? Or, having climbed it once, can that become a habit? The world needs it to be so. Will Mr Obama, a left-leaning suspect in the eyes of the conservatives, be cautious and play safe? This would be tragic since there is no option but to carry forward a radical programme. His self-imposed limits will determine his achievements or failures and those of the world in the coming years. If he could take on the establishment in the economic sphere, there would be hope that he could also do so in other aspects of life.
by Arun Kumar
The Tribune, November 20, 2008.
Against all odds, Mr Barack Obama has won the Presidency of the US only to be confronted with extraordinary odds — incomparably greater than those faced by any recently elected US President. Economically, socially and politically, the country and the world are in a state of deep crisis. The US as the leader of the world is both a cause of the problems and a possible source of solutions. Without the US being a part of any solution, it is unlikely that the world, as it is, will be able to resolve its problems. In this sense, it is said the whole world should have a vote in the US presidential elections.
The G-20 heads met under the leadership of a lame-duck US President, Mr Bush, in a largely futile talking exercise. Our own Prime Minister made noises about how he saw the crisis coming while till the other day he was saying that there is no crisis; does credibility matter. Mr Obama did not participate, perhaps due to his irreconcilable differences with Mr Bush who only talked of the free markets. Mr Obama’s presence may have given the wrong signals and made his own task more difficult when he takes over in two months. However, this delay could be very expensive.
Not only is the economic weight of the US so large that it determines world economic events but its financial and political clout sways other countries politically and socially as well. It draws the best in the world to its universities and think tanks and leads all others in research in almost all fields. Thus, it is able to set the agenda for the entire world in intellectual terms and also because it has lobbies pushing for its interest in almost all parts of the world. It dominates the multilateral agencies and that is another important source of its influence. From issues of poverty removal, research in health, agenda for the environment, nature of the financial architecture, fight against terrorism and money laundering, etc, the US moulds world events.
To be able to lead in such an extraordinarily complex world on such a broad front requires statespersonship of a high order among the leaders. This has been missing for decades. The US and, following its lead, most other governments in the world have been governed by narrowly defined short-term self-interest. One may say, what is new? But in a far more complex world, old ways will not do. Narrowness of approach is a recipe for disaster and pay-back time has now come. The world as we have known it can hardly survive.
All the above listed problems have a common source, a belief in a narrowly defined national and individual interest, based on greed and unlimited exploitation. Thus, respect for nature and other people has been at a discount. While this was tolerated earlier, today this has serious implications, especially at the economic plane and now we are confronted with a collapse for which no one has an answer.
The governments all over the world are scrambling with packages to salvage their financial institutions and their economies. Huge sums of money are on offer (capital injection, loans, etc.) — amounting to about $5 trillion. The financial bubble, which is in the process of collapse and is dragging down the real economy, was a result of deregulation of the financial markets and an undiluted pursuit of lucre and the resulting massive disparities in society.
The financial assets created (in hundreds of trillions of dollars) were a multiple of the size of the real world economy (around 60 trillion dollars) so that the latter does not have the resources to resolve the problems created by the former. Governments can neither replicate the markets nor their intervention is adequate to stop the financial bubble from collapsing.
The financial bubble consists of borrowings and lending by various economic entities. As the bubble deflates, while asset values decline, the liabilities remain. Hence institutions develop huge holes in their balance sheets. Since the various financial entities are interlinked through borrowing and lending, as one institution collapses and is unable to pay its lenders, the latter runs into problems and this ricochets to yet others leading to further collapse. A vicious cycle sets in and institutions lose trust in each other and stop lending to others and instead try to accumulate capital to cover their own declining asset base. The money given by the government goes to support their own asset base with little lent to anyone else.
While the build-up of the financial bubble is gradual and systematic, its collapse is sudden and chaotic and that is why it is beyond anyone’s control. Release of liquidity and cuts in interest rates do not spur investments and the economy enters a “liquidity trap”. In this scenario, it appears inevitable that the financial markets would collapse and nothing in the short run can save them.
Unfortunately, businesses are inter-linked, a large number of the firms dealing in real products and services also were involved in the financial markets to invest their funds or to cover their risk (say, in foreign exchange). These firms are also suffering losses. Further, they are confronted with a slow- down in demand and a tightening of the credit markets since borrowing and lending has frozen. Thus, the growth rate of the real output which had already started declining in 2007 is now in negative territory over large parts of the advanced world.
Consequently, unemployment is rising dramatically all over the globalised world. This is going to bring real pain to a vast majority of the people while the collapse of the financial world hits only a small percentage of the rich and the upper middle class populations. The collapse of the latter is inevitable but if the former collapses, it would be catastrophic. The choice before the governments is clear — should funds be thrown into the bottomless pit of the financial sector without any real benefits or should they be used to retrieve the real economy and keep it going?
The US government is an establishment run by various vested interests, and the financial sector interests are deeply entrenched in it — they have been running the Treasury and the Fed for long. Their interest is seen as the main interest. That is why the poor are not getting help with their houses or General Motors is not getting $25 billion while AIG has got $150 billion. Mr Obama would have to overcome this bias in policy and put together a radically new plan. This would require him to change his set of advisers and those in the establishment, but that is easier said than done. Mr Obama’s win was like climbing Mount Everest, but can one do so everyday? Or, having climbed it once, can that become a habit? The world needs it to be so. Will Mr Obama, a left-leaning suspect in the eyes of the conservatives, be cautious and play safe? This would be tragic since there is no option but to carry forward a radical programme. His self-imposed limits will determine his achievements or failures and those of the world in the coming years. If he could take on the establishment in the economic sphere, there would be hope that he could also do so in other aspects of life.
Tuesday, November 11, 2008
Global Financial Crisis and Government Intervention: Surplus Generation, Gearing Ratio, Asymmetry of Financial Multipliers and Other Considerations
Global Financial Crisis and Government Intervention:
Surplus Generation, Gearing Ratio, Asymmetry of Financial Multipliers
and Other Considerations
Arun Kumar
CESP/SSS, JNU, N Delhi 110067.
arunkumar1000@hotmail.com.
Published: 'Accountancy Business and the Public Interest' Vol. 8, No. 1. February 3, 2009.
http://visar.csustan.edu/aaba/aabajourVol8-No1.html
I. INTRODUCTION: CRISIS NOT ANTICIPATED BY THE EXPERTS.
II. MONEY, RISKY FINANCIAL ASSETS AND UNREGULATED INVESTMENT BANKING
III. PROFITABILITY OF FINANCIAL INSTRUMENTS AND CONSEQUENCES.
III. a. Financial Assets and their profitability
III. b. Anatomy of the Financial Crisis
IV. BASE FOR FINANCIAL ASSETS CREATION: IMPACT OF LOW US SAVINGS PROPENSITY, WAR EFFORT AND TAX HAVENS
V. MONEY, MULTIPLIERS AND GOVERNMENT INTERVENTION IN A CRISIS
V. a. Non-Functionality of the Multipliers
V. b. Limits to Government Intervention in a Crisis: Asymmetric Multipliers
VI. CONCLUSION.
End Notes.
References.
Graphs
Completed: November 11, 2008
Abstract of the Paper:
The paper analyses the roots of the current global economic crisis and the reasons for the failure of the massive government interventions to control the crisis.
The paper tries to understand whether the crisis is a generalized crisis of capitalism or a specific crisis originating from the financial sector. If it is the latter, a reform of the financial system would have been enough to resolve the crisis but if it is the former then a more basic solution would be required.
The paper analyses the deregulated financial markets and the nature of their instability. The paper presents a simple model linking the returns on financial instruments to capital gains and the gearing ratio. As the gearing ratio rises, the instability increases. Further, the paper points to the inter locked balance sheets of the financial institutions so that as collapse sets in it spreads from one to the other. It points to the fact that when the asset values fall, liabilities do not decline in value to that the balance sheets have big holes in them and this is particularly the case due to the provision of mark to market.
It traces the trigger for the instability in the real economy to rising disparities, the growing challenge to the dollarization of the world economy, rising speculative activities, falling savings propensity of the US economy so that more and more of the assets of the US economy were being owned by foreigners and the surplus generated in the US economy was going out. This was being aggravated by the growing use of the tax havens and the rising war effort and the internal security expenditures. All this led both to the creation of the sub-prime assets in the US economy and their eventual collapse.
It is pointed out that in the current crisis, trust has disappeared amongst borrowers and lenders and credit has frozen. Entities wish to remain liquid. Consequently, the money multiplier is tending to one and the financial multiplier to zero. In the circumstances, the monetary authority’s steps to reflate the economy become ineffective even though under normal circumstances, they would have led to hyper inflation. The economy appears to be in a liquidity trap. Fiscal steps also do not yield the required results due to the downward adjustment of the private sector’s expectations about profits and investments.
The paper points out that an orderly reversal of the financial markets is not feasible because while there maybe micro reversibility there is macro irreversibility. It is like in a random walk where each step can be reversed but the probability of going back to the origin is low.
The paper discusses the need for global coordination of fiscal steps otherwise demand may leak out and leave the economy trying to inflate itself in deeper crisis. It points to the dangers of countries going in for protectionism and suggests that the architecture of the International financial institutions is likely to change because the US position has been severely dented. Further, it suggests that the free market paradigm is likely to undergo a rethink and there would be greater receptivity in the public to alternatives.
Surplus Generation, Gearing Ratio, Asymmetry of Financial Multipliers
and Other Considerations
Arun Kumar
CESP/SSS, JNU, N Delhi 110067.
arunkumar1000@hotmail.com.
Published: 'Accountancy Business and the Public Interest' Vol. 8, No. 1. February 3, 2009.
http://visar.csustan.edu/aaba/aabajourVol8-No1.html
I. INTRODUCTION: CRISIS NOT ANTICIPATED BY THE EXPERTS.
II. MONEY, RISKY FINANCIAL ASSETS AND UNREGULATED INVESTMENT BANKING
III. PROFITABILITY OF FINANCIAL INSTRUMENTS AND CONSEQUENCES.
III. a. Financial Assets and their profitability
III. b. Anatomy of the Financial Crisis
IV. BASE FOR FINANCIAL ASSETS CREATION: IMPACT OF LOW US SAVINGS PROPENSITY, WAR EFFORT AND TAX HAVENS
V. MONEY, MULTIPLIERS AND GOVERNMENT INTERVENTION IN A CRISIS
V. a. Non-Functionality of the Multipliers
V. b. Limits to Government Intervention in a Crisis: Asymmetric Multipliers
VI. CONCLUSION.
End Notes.
References.
Graphs
Completed: November 11, 2008
Abstract of the Paper:
The paper analyses the roots of the current global economic crisis and the reasons for the failure of the massive government interventions to control the crisis.
The paper tries to understand whether the crisis is a generalized crisis of capitalism or a specific crisis originating from the financial sector. If it is the latter, a reform of the financial system would have been enough to resolve the crisis but if it is the former then a more basic solution would be required.
The paper analyses the deregulated financial markets and the nature of their instability. The paper presents a simple model linking the returns on financial instruments to capital gains and the gearing ratio. As the gearing ratio rises, the instability increases. Further, the paper points to the inter locked balance sheets of the financial institutions so that as collapse sets in it spreads from one to the other. It points to the fact that when the asset values fall, liabilities do not decline in value to that the balance sheets have big holes in them and this is particularly the case due to the provision of mark to market.
It traces the trigger for the instability in the real economy to rising disparities, the growing challenge to the dollarization of the world economy, rising speculative activities, falling savings propensity of the US economy so that more and more of the assets of the US economy were being owned by foreigners and the surplus generated in the US economy was going out. This was being aggravated by the growing use of the tax havens and the rising war effort and the internal security expenditures. All this led both to the creation of the sub-prime assets in the US economy and their eventual collapse.
It is pointed out that in the current crisis, trust has disappeared amongst borrowers and lenders and credit has frozen. Entities wish to remain liquid. Consequently, the money multiplier is tending to one and the financial multiplier to zero. In the circumstances, the monetary authority’s steps to reflate the economy become ineffective even though under normal circumstances, they would have led to hyper inflation. The economy appears to be in a liquidity trap. Fiscal steps also do not yield the required results due to the downward adjustment of the private sector’s expectations about profits and investments.
The paper points out that an orderly reversal of the financial markets is not feasible because while there maybe micro reversibility there is macro irreversibility. It is like in a random walk where each step can be reversed but the probability of going back to the origin is low.
The paper discusses the need for global coordination of fiscal steps otherwise demand may leak out and leave the economy trying to inflate itself in deeper crisis. It points to the dangers of countries going in for protectionism and suggests that the architecture of the International financial institutions is likely to change because the US position has been severely dented. Further, it suggests that the free market paradigm is likely to undergo a rethink and there would be greater receptivity in the public to alternatives.
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