Continued Rise of Evils identified as Culprits of the 2008 Crash

1. In 2008, in the wake of the financial crisis, assets under management in so-called "retail alternative funds" in the US [a.k.a. alternative investments, and defined to include absolute return, commodities, currency trading, dedicated short bias, equity energy, leveraged strategies (both long and inverse), managed futures, market neutral, multi-strategy alternatives, natural resources, options arbitrage, precious metals, real estate and volatility strategies; but to exclude distressed debt] crashed in the US from $368Bn to $275Bn. However, as a percentage of "all long term retail fund AUM" [defined to include mutual funds, closed-end funds, ETFs and UCITs (Undertakings for Collective Investments in Securities) structures, and excludes limited partnerships and separately managed accounts], it never fell - indeed, the figure of $275Bn in 2008 was 5% of LT Retail Fund AUM in 2008 whereas the bigger figure of $368Bn was 4% of the same figure in 2007. 
2. From 2009, the share of alternative investments as a percentage of the all long term retail fund AUM started rising once again, boht, in the US, and globally excluding the USand they have been growing @21% CAGR in absolute terms in the US, and at 11% globally excluding the US;  till 2011.
3. At the same time, several other disturbing parameters have been heading in the "wrong" direction. See the table below, which shows these statistics as they stood  at three different times I have tracked them in my blog. 
4. Reading this table closely shows that the average American is on the right path (reduced personal debt per citizen; higher GDP per citizen) but the US Government has continued its profligacy with a vengeance (rise in National Debt as % of GDP; Total Debt per Citizen; and US Debt held by Foreign Countries). Just look at the US Total Liabilities and US Interest Burden per citizen from April, 2010 to September, 2011 to see what havoc the US fiscal and monetary policies are wreaking.   
5. What is worse, the investment bankers are back with a vengeance: as paras 1. and 2. above indicate, and as the figure of Currency and Credit Derivatives in the Table below confirm, what Warren Buffett famously termed as Weapons of Financial Mass Destruction are growing in value at an uncomfortable pace.  Derivative exposures have risen by as much as $91 Trillion (or 6.37 times the US GDP in just 30 months), when they should have been falling! 
6. It is time that the US Investment bankers are stopped from selling "innovative" risk-masking derivative products - for the sake of the financial health of the entire world.

Table 1

Parameter	8 Apr 10	26 Jul 11	11 Sep 12
US National Debt as % of US GDP	89%	98%	104%
US National Debt per citizen ($):	41,381	46,619	50,959
US GDP per citizen ($):	46,381	47,488	48,805
US Total Debt per citizen ($):	1,80,484	1,76,113	1,81,307
US Personal Debt per citizen ($):	53,787	51,441	50,132
US Interest Burden per citizen ($):	1,493	11,664	12,343
US Total Assets per citizen ($):	2,34,181	2,43,086	2,96,124
US Total Liabilities per citizen ($):	3,50,054	10,26,974	10,54,522
US Gross Domestic Product ($):	14.333 Tr	14.809 Tr	15.342 Tr
US Debt held by Foreign Countries ($):	3.875 Tr	4.584 Tr	5.376 Tr
Currency and Credit Derivatives ($):	648.975 Tr	611.499 Tr	740.277 Tr

Sources of data: 

Para 1 and 2 above: from "The Mainstreaming of Alternative Investments - Fueling the Next Wave of Growth in Asset Management", a Report by the Financial Services Practice of McKinsey & Co, Sep 2012.

Para 3 : extracted on 11 Sep, 2012 from www.usdebtclock.org,

Table 1 above: extracted on dates mentioned in cols 2-4 of table 1 from www.usdebtclock.org,  

Dexia Bank Collapse: What it means for Europe, Belgium and the World

Dexia Bank is among the Top 50 financial institutions in the world. It is not just some small, unknown bank. It is different from other banks because it, and with it, Belgium, are caught in an uncomfortable spot. How? Let me attempt an explanation.

1. Belgium has external debt to GDP ratio of close to 100% already. The Government thus does not have room for manouevre to fund losses of Dexia. That's already been done once - in 2008, the Belgian Government took control of Dexia. Various arms of Belgian and French Government now hold over 50% in Dexia. This closes off one source of succour. Worse, there is a political standoff in Belgium because of which there is no functioning Government at all at present in Belgium! Worst time for such problems to hit.
2. Dexia's leverage at present is estimated to be almost 60:1 – double that of Lehman Brothers when its collapse was triggered. So Dexia is not in pretty shape at all. Worse, of its over €500Bn of assets, €20Bn are debts of Portugal, Italy and Greece, all of whom are in need of bailouts.
3. After the 2008 takeover by the Government, instead of getting better, things got worse, because Dexia was a source of funds for the various parts of Belgium's Government. When they took it over, instead of stopping loans to Government which were the major part of its NPAs, they stepped up lending to Government, which enabled the Government to reduce its fiscal deficit somewhat. Now, if the Government were to bear even a small part of the losses of Dexia, its external debt to GDP ratio will shoot up to almost the level that Italy is at currently (which is 134%). So PIIGS will no longer be a sufficiently comprehensive acronym of European states in deep fiscal trouble. We have to find some way of adding a “B” to it. Just for comparison, US, Australia and India are at 99%, 94% and 22% respectively. France, one of the co-owners of Dexia, is at 208%.
4. The only time-tested solution for banks or financial institutions in such a mess as Dexia finds itself in is to break up the institution into a “good bank” and a “bad bank” - like India did for Unit Trust of India a decade or so ago. Usually, the bad bank sells the 'bad” assets for anything they can get for it – which could be single digit percentages of the book value. In Dexia's case, this is apparently not feasible because (a) Belgium's Government does not have the money and the political will (there is no functioning government now!) to bail out Dexia because it would mean choking its own source of funding; and (b) “Good bank” assets have not takers almost anywhere in the world today. So the good bank-bad bank solution will not work very well for Dexia. But that is the only solution – so you can expect sell-offs of any saleable assets.
   
   
   Already, Reuters reports Qatar as being interesting in buying out Dexia's Luxembourg business. So the dismembering of the Bank has officially begun. The vultures are circling, but then, there aren't too many vultures, this time. Trading has been suspended in Dexia's shares, and S&P has downgraded Dexia's group companies steeply. In its downgrade press release, it notes that there is negative revaluation reserve in respect of available-for-sale securities of almost €6.9 Bn. Moody's has followed S&P in steeply downgrading (by 3 levels) the sovereign rating of Italy, and also some Italian banks in the last 2 days. Besides, 12 UK banks and 9 Portuguese banks have also been downgraded. Sovereign ratings of Spain, Ireland, Greece, Portugal and Cyprus have been cut as well. From the US, Ben Bernanke has said that the US economy is close to faltering. Deutsche Bank has warned that it will miss its profit target.
   
   
   One must remember that failing banks are not just like manufacturing or services companies that fail. Banks, as they fail, tear asunder the transaction enablement capability of its citizens. Thus, slitting the banking system's throat is akin to slitting the underbelly of a crocodile – however strong the economy may otherwise be, the banking system is its weakest link. This, all the above news in just a few days is bad news indeed, for the entire world. When banks collapse, other businesses will follow, and depositors will panic, causing a financial logjam in not just those countries, but in all countries where businesses have business ties with enterprises in countries whose banking systems are collapsing.
   In India, our very own SBI has suffered a downgrade because of its low Tier-I capital level that would require it to raise money and/or ask for Government help/ support. So where is the good news? If at all, it is in India where the Government has both, the wherewithal (with some difficulty) and the will and inclination, to support its banks.
   PostScript: This is the text of an email I received. Makes for interesting reading.
   Uncertainty has now hit Japan. In the last seven days, Origami bank has folded, Sumo Bank has gone belly up and Bonsai Bank has announced plans to cut some of its branches. Yesterday, it was also announced that Karaoke Bank will go up for sale and will likely go for a song, while shares in Kamikaze Bank were suspended today after they nose-dived. While Samurai Bank is soldiering on after sharp cutbacks, 500 staff at Karate Bank got the chop and analysts report that there is something fishy going on at Sushi Bank, where it is feared that staff may get a raw deal.

Re-visiting Modern Accounting Standards

Should acquisition cost of an asset depend on how it is financed?

To my mind, and to most non-accountants, the simple answer seems to be No. But that is not how modern accountants see it. Costs incurred (including interest) till the time an asset is ready for use is treated as part of the cost of the asset. Whatever compulsions may have been behind adoption of such a treatment as standard, it tends to militate against simplicity, and creates needless (in my view) complexity.

Can a company have Net Profit After Tax equal to double its turnover for a quarter?

Common sense tells us that this is impossible. How can profits exceed turnover, that too profits after tax? However, modern accounting is not all common sense. Or maybe, it is such highly developed common sense that it takes truly uncommon levels of sense to understand why this can happen. As it happens, there are several reasons why this can happen. Deferred Taxation Accounting (DTA) is one of the reasons. DTA is one more area where accounting has been made dreadfully complex. So much so that it creates situations occasionally as the one described in the question above, where quarterly Net Profits After Tax of some companies exceed even quarterly revenues! How can accountants explain to laymen this paradox – where, say, the quarterly turnover of a manufacturing company is Rs.50 crores and its NPAT is Rs.90+ crores? Most accountants trying to explain this situation will end up tying themselves and their listeners in knots. This happens in the relatively rare instance when a company has just turned the corner after several years of losses. One argument in favour of the currently favoured treatment of deferred taxes is that it makes clear the differences in expected tax provision on reported profits, and the actual tax provision. However, we lose sight of the fact that the net result of the income statement becomes almost impossible to understand, even to reasonably financially literate individuals. Surely, this could not have been the intent of introducing such accounting treatment!

Is it a bad thing to allow retired employees medical treatment for life in hospitals run by the company?

Certainly, one cannot fault managers in Tata Steel if they begin to think like this. Accounting for Employee Benefits is another area where accounting complexity has reached ridiculous levels (in my view). Tata Steel used to routinely allow their retired employees and their families to be treated in the wonderful hospital they have built in Jamshedpur; and absorb and meet the net losses or cash shortfalls of that hospital quite routinely, as part of its employee-friendly initiatives. Let us say their costs were Rs.30 crores per annum, give or take a few crores. When AS 15 was made mandatory, suddenly they realized that because they allowed their retired employees and their families to enjoy these facilities for life, they suddenly had to recognize the present value of all the costs they expected to incur over the next several years, as a cost in a single year. This resulted in a hit to their Income Statement to the tune of hundreds of crores in the year in which the new Standard was made mandatory (if I remember it right, it was over Rs.250 crores). Why? Could not well enough be left alone? Now, it has accountants and managers thinking closely about the impact of such facilities to its past employees on its current profits, way beyond the actual cash expenses of offering such facilities. Simplicity flies out of the door, to be replaced by dreadful complexity. What I wonder is, what purpose is served by such complexity?

Why did Warren Buffett call derivatives "weapons of financial mass destruction'?

Buffett should have included "securitised, structured products" which are a class of "innovative" derivatives, by the same appellation. We know now that derivatives and securitisation have made financial life, and accounting for the new-fangled "innovations" they spawned infinitely more complex. Banks in the developed world are still facing the consequences of the complex accounting legacy of the millions of securitised structured note transactions it entered into almost without thinking in better times. They are now realising the impact of all that complex accounting – it only passed the parcel of risk onto others. It did not eliminate risk. Ultimately, every bank in the developed world was left holding such risk parcels to varying degrees. But they did not simply pass on risk to others. Some structured products passed on risks to a distant tomorrow.

We have yet to see the complete impact of such contracts that, in addition to passing the risk around to different people, also passed the risk to a future date. There are several apparently innocuous deals and assets sitting on the books of several companies (not just banks) which represent accounting legerdemain of pushing losses off to a point of time in the distant future, so that the current management came out smelling like roses though their results should have had the faecal matter hitting the overhead rotating cooling device. They are the financial equivalent of mines in modern warfare. They will go off and claim the lives of innocents at any time in future, without warning. This is because several best-selling "structured products" designed by mathematical geniueses sitting at investment banks the world over, were designed to hide losses from shareholders, future management and regulators alike. We have yet to see the full impact of such deals. Liabilities under such contracts will crawl out of nowhere, as it were, and trouble future managers and bankers alike. This is the long-term legacy of allowing untramelled financial innovation. AS 30, 31 and 32 (collectively dealing with accounting and reporting of derivatives) is something that almost 90% of practising Chartered Accountants – those charged with implementing them and checking their implementation incompanies, will privately admit to not being comfortable with. I think these Accounting Standards is a gigantic case of GroupThink – the management phenomenon where even a unanimous decision taken by a Group is completely at variance with what almost all of those participating in taking the decision privately think and opine. We need the small boy who points out shrilly that the Empe3ror is not really wearing clothes!

Why should we bother about all these complexities?

Almost all the modern accounting standards that have contributed their bit to making accounting more complex and less understandable have behind them the objective of making a company's Balance Sheet more "realistic". What they have actually succeeded in doing is to make the Income Statement almost impossible to understand or predict. Why should one prefer Balance Sheet accuracy to Income Statement accuracy? I think that the Balance Sheet showing assets at unrealistic low values based on historical cost is a form of desirable conservatism in accounting. We have succeeded in making the Income Statement, which is a good indicator of how well a company is being run, almost too volatile to be of any use – whether to compare results with past years, or to compare results with those of peers. Therefore, what I make above is a case for a complete re-thinking of the basis of modern, fair-value based accounting, and slowly going back to the traditional historical cost based accounting.

BofA reacts to an article that says things remarkably similar to what I wrote 13 days back!

On August 10, I wrote about Bank of America, and headlined my blog entry with the words, The Death Spiral beckons ... . I then wrote a follow-through piece, on  August 16, highlighting the gathering storm clouds around BofA. Then, I attempted to put what I wrote about BofA into perspective for Indian readers of my blog, by explaining how serious the situation of BoA was, really, for itself and for the US economy, and indeed, for the rest of the world. 

On August 23, Henry Blodget, a former Wall Street analyst and currently CEO of Business Insider, an online financial news and views publication wrote about Bank of America. Blodget has cited many more figures - and exaggerated at least two, according to Bank of America's official Press Release. But Blodget exulted, 'Oh My Goodness: Now Bank of America is blaming its Collapsing Stock on Me!' He admitted that BofA was right about one of the two points of rebuttal, and updated the article to reflect the correct figure.

Why do I write about Blodget and BofA? I think I may have just influenced what Blodget wrote. Of course, it is entirely likely (and probably true) that Blodget arrived at the same conclusions as I did on his own. But that cannot obfuscate the fact that the substance of what he wrote on August 23 is remarkably similar to what I wrote in the three pieces referred to above. He even uses the same phrase - the death spiral - in his piece. Now, that is a coincidence, indeed!

Imitation, it is said, is the sincerest form of flattery. I should feel flattered indeed, except that

(a) Writing about BofA pained me, but when elephants flail around, ants get trampled. So I thought a warning was in order, to point out something the bank was hiding behind accounting opacity. Now, I have no illusion about being so well-regarded that BofA or the US economy or Wall Street would take note. But then, through Henry Blodget, exactly that seems to have happened!

(b) When what (in my view) is almost inevitable happens, those who took evasive action to the extent they could (after understanding what I, or for that matter, Blodget, had to say) will have me to thank in a small measure. That is the only moral justification for predictions of financial doom (which have a disconcerting habit of being self-fulfilling these days) in writing. What makes me puke is that Blodget is enjoying the discomfiture he is causing BofA.

Of course, Blodget has not cared to acknowledge that he has read my blog and been influenced by what he wrote. But then, how will he know that my blog had more readers in the United States than in India in the week upto August 16? (you need to be logged into Facebook to see that link).

Blodget probably thought he was the only guy in the US who read it. But then, even after being in the online news business, I am sorry that he has not fathomed the power of the Internet.

Now to Bank of America again - their Press Release  reproduced here defends itself weakly by talking of its tangible book value per share as of June 30. This is a non-GAAP measure by BofA's own admission in its Balance Sheet (read the footnote to my death spiral writeup). GAAP means Generally Accepted Accounting Principles. Non-GAAP measure thus means, by definition, not a generally accepted accounting measure. If you read what BofA wrote about Goodwill, the only figure I concentrated on in the death spiral blog entry, you will realize that BofA knew it was on tricky ground there.

Putting the Bank of America situation in perspective

What would you think of the state of the Indian economy, if what I said of BofA and Citibank was said of State Bank of India and ICICI Bank in India by some economist of repute? 

The situation is that serious for the US and for many countries in Europe, where the nation's top banks have dug themselves into deep holes that not even the EU or their respective Governments can afford. All these economies have their underbellies exposed.

On both continents, banks are hiding behind accounting gobbledygook called Impairment and Fair Value Accounting. But the understanding is filtering through. Tonight (in India) brought news of a blood bath on bourses in the US and Europe. So tomorrow (19th August) will almost certainly see a bloodbath on Indian stock exchanges - as FII Fund Managers make a beeline to the nearest exit. Expect a fall of at least 400 points in the Sensex on 19th August, 2011 before short covering enables a partial recovery.

I believe that this is the beginning of the unravelling of several economies in Europe and of the US economy as well, with them slipping into R-2, needing QE-3 and possibly QE-4.

I shall write again tomorrow to report whether what I said about the bloodbath on Indian stock markets was accurate. I feel comfortable making these gloomy predictions because I currently am sitting on cash, having (fortunately) believed in my own predictions and taken my own advice!

BofA: The vultures are gathering ...

Barely 3 days after I blogged on the death spiral Bank of America seems to be sliding into, the signs of death throes have become clearer. Already, its share price represents only 32% of its book value, showing that the market agrees with my assessment that its assets are massively overstated. I had pointed out only one asset, Goodwill, that called for significant impairment.  
Wall Street Journal now reports that Bank of America has entered into deals to sell the following:

• its Canadian Credit Card portfolio to TD Bank
• its Spanish Credit Card unit 
• its small-business cards in the UK to Barclays

WSJ also reports that BofA intends to sell other card units in Europe. It further speculates that BofA may also sell its stake in China Construction Bank Corp. Another report states that Bank of America has also sold off portions of its credit card business within the United States to Sovereign Bank and to Regions Financial Corporation. In April this year, BofA sold its stake in Black Rock Inc.. 
All these sales are obviously intended to shrink its way into a viable situation by raising money without a share issue, and also thus raising "tangible net worth per share" of Bank of America.
If you think BofA was the only bank in trouble, look at this list of 64 FDIC-insured banks that have failed and closed down in the first 7 months of 2011. This is in addition to 157 banks that failed in 2010, and 138 in 2009. It is obvious that things aren't getting better. But that they have company is cold comfort for BofA, around whom vultures are gathering. 

• In early 2011, it settled charges of mortgage-backed securities fraud charges with BlackRock, PIMCO, Freddie Mac, Fannie Mae, insurer Assured Guaranty and a few others, agreeing to pay $8.5 Bn. These settlements have run into some trouble, and are now facing opposition.
• Already, AIG has claimed $10 Bn damages for securities fraud in sale of mortgage-backed securities by BofA, Merrill and Countrywide. 
• In addition, over 90 similar suits have been filed demanding damages of $197Bn, says the above article, quoting LawyerLinks, a legal consulting firm.
• Now, it  is being reported that the National Credit Union Administration has declared that it is suing several banks for damages of up to $50Bn for misrepresenting safety of securities it sold to several credit unions that collapsed as a result of the investments. Among those likely to be sued is Merrill, now part of BofA. 
• Credit Default Swaps on BofA have risen to their highest level since May 2009, showing nervousness of investors.
• BofA has begun writing down principal on Californian "underwater" home loan mortgages of troubled borrowers. BofA is reported to be seeking immunity from prosecution in return for paying fines and writing down principal outstandings of underwater mortgages.
• Elsewhere, BofA is facing energetic protests from locals fed up of the number of foreclosed properties that are ill-maintained, sending property values in entire localities tumbling. 
• The richest Hedge Fund Manager in the world according to Forbes' 2011 List of Billionaires, John Paulson, and who is known for sticking to his bets for longer than most fund managers, has sold half his stake in BofA and Citigroup.

There is speculation that it could spin off Merrill Lynch Wealth Management and Investment Banking operations. There is also some speculation that BofA could put Countrywide, acquisition of which is by consensus considered as a big corporate blunder, into bankruptcy. However, moves taken to consolidate Countrywide and BofA have clouded BofA's ability to ringfence Countrywide-related liabilities. 
Watch this space! 

The Death Spiral beckons ...

Bloomberg reported that as of August 10, 2011, 186 US-based financial services companies traded for less than 60 percent of their book value, or common shareholder equity, including Bank of America, Citigroup Inc., Morgan Stanley, AIG and SunTrust Banks Inc. Together, they had a market capitalization of $300.5 billion, compared with $686.4 billion of book value. This means that a fall in their share prices to this extent (40%) is well nigh inevitable. 

How likely? These banks are very, very vulnerable. For example, earlier this week, AIG filed a suit accusing Bank of America of securities fraud; demanding damages of $10Bn. This sent the BofA stock down 20%, in addition to the bloodbath that the Dow Jones has experienced in the week after August 2, and the S&P downgrade. Its market cap stood reduced to $68.6Bn. Compare this with just one year-end intangible item on its 2010 Balance Sheet: Goodwill is shown at $73.8Bn (see p.130, Table XIII. See also Footnote 1 below)  – forget the rest of its balance sheet, BofA would have the world believe that this intangible item alone, built up from excess over book value paid for its past acquisitions, is worth more than the entire BofA is worth on Wall Street. How many will believe this, and for how long? There will always be the small boy who shouts, “The Emperor is not wearing any clothes!”. After reading Page 114-115 of its 2010 Annual Report, any accountant will understand that BofA will have to write down goodwill significantly (it wrote down $12.4Bn in 2010) - and to keep the shareholders' equity intact after this write-down, it would need to raise more equity. The dilution this would almost certainly drag the share price lower. Which will require them to raise more equity at even lower prices ... leading to a death spiral.

What about the demand for financial sector shares? All but non-existent. Retail interest was never very visible in the US in equities; now it has disappeared. Institutional investors are worried about what write-down of such intangibles would do to the Balance Sheet – and will stay away from any further issues in sufficient number as to make a public issue a very big gamble that could very easily fail. So the only solution – a government bailout wherein the financial institutions that still bear the TBTF tag (Too Big To Fail) are partly nationalized. Expect this to happen in the not too distant future, when the pressure of reporting numbers that have no relation to stock market prices forces them to look for ways of raising their net worth to blunt the edge of the writedowns that are inevitable already. 
What if the US Government finds it politically unpalatable or impossible to rescue these firms with a QE3? Refer to the title of this post! 




Footnote 1 referred to above: 
Table XIII on p.130, and Table XII and Table XIV before and after it, were the result of BofA's attempt to dress up their Income Statement and Balance Sheet, and the justifications for using these were on page 40. If they had followed GAAP alone, the Tables and the explanation on p.40 would be unnecessary. They used "non-GAAP measures" - euphemism for accounting legerdemain to make accounts smell sweeter, euphemism for which is "additional clarity". The footnote to Table XIII reads: Presents reconciliations of non-GAAP measures to GAAP financial measures. We believe the use of these non-GAAP measures provides additional clarity in assessing the results of the Corporation. Other companies may define or calculate non-GAAP measures differently.

Some scary statistics about the US - revisited

In April, 2010, I had blogged about some scary statistics about the US economy. I revisited these statistics, and here are the results. While everyone is absorbed about whether the Republicans will agree to increase the US debt ceiling, let us revisit some statistics that looked scary to me in April, 2010. Let us see what has happened since then.

• US National Debt has gone up from 89% of US GDP to 98% of GDP.
• Total US Public Debt stands at $14.293 Trillion; by August, it will touch $14.3 Trillion, which is the current ceiling.
• US GDP per citizen has actually gone up by a little over $1,100, in spite of increasing unemployment numbers.
• However, US National Debt per citizen has gone up by $5,200 in the same period.
• US Debt held by foreign countries has gone up from $3.875 Trillion to $4.584 Trillion.
• US external debt to GDP ratio has crossed 100%. The equivalent figure currently for India is 21%. For the UK and France, this ratio is at a staggering 388% and 208% respectively.
• Assets per citizen has gone up by $8,900 while Liabilities per citizen has gone up by a staggering $674,000. Similarly, Interest burden per citizen is up from $1,493 to $11,664.
• There has been winding down of about 5% of currency and credit derivative exposures, but a much longer road remains to be traversed.
• All-in-all, a dismal report card. For a Nobel Peace Prize-winning President who has got the US involved in a third senseless aggression in Libya, and so far failed to unwind its involvement in two other messy wars it has been engaged in for more than a decade. 

	8 Apr, 2010	26 Jul, 2011
US National Debt to GDP (%):	89.12	98.18
US National Debt per citizen ($):	41381	46619
US GDP per citizen ($):	46381	47488
US Total Debt per citizen ($):	180484	176113
US Personal Debt per citizen ($):	53787	51441
US Interest Burden per citizen ($):	1493	11664
US Total Assets per citizen ($):	234181	243086
US Total Liabilities per citizen ($):	350054	1026974
US Gross Domestic Product ($):	14.333 Trillion	14.809 Trillion
US Debt held by Foreign Countries ($):	3.875 Trillion	4.584 Trillion
US Government Bailout ($):	6.387 Trillion
Currency and Credit Derivatives ($):	648.975 Trillion	611.499 Trillion

• One point about India: Gold is a bulwark against uncertainty. Indian Government's holding of gold currently is higher than all countries save 9; if the private hoard of gold in Indian families is taken into account, India's gold holdings would be at least twice that of any other country on Earth. Gold prices are at their record high of $1,600 and John Paulson (the hedge fund manager who made a killing in 2008 by betting that the sub-prime crisis would result in CDO/CMO defaults) says it will touch $4,000 an ounce in the next 3-5 years.

Product Development is fun!

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My first attempt at product development resulted in a great software product (a copiously hyperlinked textual database of the tax laws) ahead of its time (before computers had CD-ROM Drives, and before people knew about the Internet (I had to explain what hypertext was!), but I failed miserably at marketing it. However, I had a clear idea of what the customers liked. And when I went out to sell, I sold successfully. But if I did that, continued product development suffered.  I just could not manage both. Even now, I think managing both is very, very difficult. But what I learnt was that you need not be a big moneybag with thousands of employees to bring out a great product.  That was between 1993 and 1995.


Later, my second product was not really MY product. I was on the board of a co-operative bank as non-executive, honorary Director and during the three years there, my single big contribution was to make them believe that they could develop their own software. A small team of two staff and one consultant driven by me alone from the Board, developed a branch-level banking software (everything on liabilities side, and quite a few aids on the asset side) that had built-in linkages for centralization of data. This got implemented in 6 branches on a shoe-string budget. Then I left the Bank's Board to go on to other things.  Till this day, that Bank remains one of the few banks anywhere in India (or probably the world)  to run on its own software. Today, with RBI approval, they are selling the software and their implementation services to other Banks and this has become a profit-centre. Now, of course, the IT Dept has become as big as a small software company. This is something I had envisaged when this product was originally developed. I suspect that my Board colleagues okayed the project because, with the minimal resources I demanded, it was worth allowing me to fail - less than the cost of  software for one branch - they never expected me to succeed, and when I did, I learnt that success needs many fathers, else, the real father gets swept away in the first flush of success. (I know I am stretching the metaphor, but I think it conveys what I want to!) This was from 1995 to 1998.


Then, from 2000 to 2003, I joined a KPO (that acronym wasn't invented then) with responsibilities that covered the "D" in R&D. I developed processes that increased throughput, accuracy and allowed scaleability and replicability. I thoroughly enjoyed the daily technical challenges -- of designing services that allowed us to create more employment here in services acknowledged by our most demanding customers. 


Now, I am back on my own, and am developing a few exciting products. This time, again, I am on a shoe-string budget, but I am harnessing the sheer enthusiasm of young people by taking up projects that allow them to learn and that they are passionate about. And creating wonderful products that those working on surprise themselves. 

I also benefit from knowing up close a friend in Chennai who is successfully running multiple businesses and yet loves bringing out new products, services and technologies all the time.

What I read a few days back inspires me to improve the aesthetics of these products. It also encourages me because Jobs too has discovered that great products can be made by young people passionate about what they do. While not everyone can be a Jobs, anyone can benefit from his "methodology" and crazy attention to detail.


Watch this space for knowing what these products are!
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How Schools in Denver were cheated by Bankers

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Here is another sordid story of bankers' greed -- where they sold sophisticated structured products to a School Board who lacked the expertise to assess the risks of such a product realistically -- while the bankers laughed all the way back to their offices!!
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US Consumer Debt : Income 50 cents, expenditure 65 cents

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Since June 2008, the US household debt mountain has shown the seventh consecutive quarterly drop. This should be heartening. However it is not so for two reasons:

1.  The figure is down by a minuscule US$0.37 trillion, out of the US$ 13.9 trillion -- just 2.66% deleveraging in nearly two years. Not fast enough, when you consider that the bigger figure represents 131% of personal disposable incomes. Aamdani atthanni, kharcha 65 paise (Hindi proverb that translates into the second part of the headline of this blog entry) is the condition of the entire US population!
2. Most of this reduction has been achieved by banks writing off mortgage and credit card defaults. If one adds back to the debt figure the amount of write-offs, the bad news is that US household debt has actually gone up slightly, by only US$ 186 Billion! No sign of de-leveraging. The spendthrift habits of two generations are obviously refusing to die away.

 In the meanwhile, Government (Federal) debt has swollen from US$$5.16 trillion to US$ 8.16 trillion. So now, the Government has joined the excessive leveraging game. Not good either, for anyone. A healthy US economy is good for all, but today the US economy's condition is pink -- the pink of high fever, not the pink of good health.
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Some Scary Financial Statistics about the US

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Some scary statistics about the US Government’s financial condition:

US National Debt to GDP (%):                       89.12

US National Debt per citizen ($):                  41,381

US GDP per citizen ($):                               46,381

US Total Debt per citizen ($):                      180,484

US Personal Debt per citizen ($):                 53,787

US Interest Burden per citizen ($):               $1,493

US Total Assets per citizen ($):                    234,181

US Total Liabilities per citizen ($):               350,054

US Personal Savings per citizen ($):             1,558

US Median Income per family ($):                62,013

US Gross Domestic Product ($):                    14.333 Trillion

Currency in circulation within the US ($):      1.993 Trillion

US Debt held by Foreign Countries ($):         3.875 Trillion

US Government Bailout ($):                         6.387 Trillion

Currency and Credit Derivatives ($):       648.975 Trillion

When Lana Turner, famous filmstar of yesteryear was asked her age, she had diplomatically replied:

I really don’t know, because it keeps changing from second to second.

All these figures similarly keep changing from millisecond to millisecond. I had extracted these figures between 6:45 pm and 7 pm today, Indian Standard time, from here. Check out for yourself what these figures are at this very moment. 

Now, think like a banker would: If the US Government was a loan applicant, how much of additional loan would would you trust the man to service? 

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Is SBI's foray into general Insurance wise?

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A few days back, I criticised LIC's intention to get into banking.

Now comes a report that, to top its foray into Life Insurance, SBI intends to enter General Insurance business before end of April, 2010. They have already been recruiting managers for this venture for the last 10 months, and are almost ready to launch.

The same logic and criticism applies to SBI's joint venture with Insurance Australia Group too. It is bad enough that they have ventured into Life Insurance. This makes it worse, in my view. Why?

Banking and Insurance are the two most risky businesses worldwide, and involve two completely different challenges. Insurance companies have to deal wisely with a surfeit of liquidity (usually) and banks have to constantly manage threat of liquidity shortfalls. Combining both reduces the strength of the combination to overcome threats and severe demands on liquidity that affect both industries. The recent global recession is an example of a threat to both industries simultaneously. Enough financial pundits (Nouriel Roubini, Nassim Taleb, et al) have predicted that this could happen again, and in our lifetimes.

We in India escaped the impact of the global crash because of three major factors: 

1. Our financial institutions were just not allowed to invest in derivative securities and there was consequently hardly any significant secondary market trading in debt securities;
2. Our banks had a very significant liquidity padding (SLR/CRR) that was nearly absent in the first world; and 
3. Our banks were not major players in any part of the banking business, and our insurance players were similarly almost absent in the banking sector.

Now the situation is set to change -- in the name of development and liberalisation. 

Banks are getting into insurance, and insurance companies are getting into banking. This in my view magnifies the riskiness of both businesses, and does not diminish it. I am not even talking of conflict of interest here, which can also rise considerably.

There is constant clamour for reduction in SLR/CRR, which, in my view is nothing but an operating profit cushion against the banking industry's inability to extract risk-adjusted returns on their lending and assurance intermediation (L/Cs, Bank Guarantees, etc) businesses, which the RBI has, in its wisdom, resolutely resisted, and I really hope they continue to do so..

In addition, our stock exchange margining system and transaction settlement system worked even better than in the US in containing huge negative exposures of individual players, mainly because algorithmic trading (which can very rapidly put through transactions involving mind-boggling amounts) was not permitted in India. Now algorithmic trading is permitted, and probably accounts for about 20% of all trades today. This percentage is set to zoom, giving traders with access to this technology a huge edge, and reducing retail investors to mere peripheral price takers. Given that our markets still do not have depth comparable to the first world exchanges, a runaway rogue trading program has the potential of putting almost the entire exchange settlement and margining system at risk, leading to a possible rapid stock market crash or boom. 

I hope I am wrong.  

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LIC to set up bank: Nothing more foolhardy!

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The recent news item to the effect that LIC wants to set up a bank flies in the face of basic financial prudence and wisdom that has been reinforced by recent events in the world.Let's briefly see why this is so.

A bank lends illiquid (its loans are invested in illiquid assets like property, stocks and receivables of its borrowers) and borrows liquid (its deposits have to be repaid anytime the depositor asks for it). Hence, the major raison d'etre of a bank is managing mismatched liquidity. This is impossible in times of financial uncertainty, and if the bank loses depositors' trust. At such time, the liquidity gap forces the bank into bankruptcy unless it is rescued by the central bank. 

An insurance company is very liquid in good times, indeed, awash in liquidity. When catastrophe strikes, this liquidity is drawn on suddenly. An insurance company manages this huge risk primarily by dissipating the risk over a large number of lives or properties as the case may be, in its areas of operation; and distributing the residual risk globally through reinsurance. Hence, the raison d'etre of an insurance company is to be liquid when nobody else is. 

We have seen that extreme financial risks do not conform to the normal distribution, and that the distribution they conform to have "fat tails". Hence, we now know that banks are more vulnerable to financial crises than believed before Bear Stearns' demise in 2007.  

We have also seen that natural catastrophes of all kinds have increased significantly (maybe because of climate change effect). For example, the two deadliest earthquakes in recorded history have happened in the last two years itself (Sumatra, Chile). If we go back 10 years, a blip on the cosmic clock, we find many more unusual natural disasters like flash floods in Oman (a desert!), raging forest fires in Indonesia, Australia and the US, and many others. Further, a major earthquake is overdue in California. Hence, we can say that there is a heightened expectation of exposure to catastrophes and claims for the insurance industry worldwide.

Today, banking and insurance are unarguably the riskiest businesses globally. We have seen the wisdom of RBI's not allowing banks to become exposed to toxic derivative securities.  We have also seen the foolhardiness (it seems in hindsight)  of AIG taking on unmeasured risks of the banking industry by insuring bonds. 

It simply is foolhardy to potentially commit the liquidity of India's most liquid entity in the riskiest industry by allowing it to diversify into an industry that has been shown to be almost as risky as the insurance business.
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