Monday, December 22, 2008

"Ceteris Paribus & in Hindsight, we were right!"

Mint has an article today about an American journalist's perspective on how Indian banks avoided the global economic crisis.

The basic premise of the article is the author's 'mea culpa' reaction which Americans, the US Feds and specifically Alan Greenspan should have. The 'No regulation in the banking sector stand' which the above mentioned "culprits" had maintained, in comparison to the "prudent and timely controls" by the State (read RBI's ex-governor YV Reddy) in India, is the main reason why Indian banks are safe, while American and Eurpoean ones aren't.

The author interviews India's top bankers who are partayed as being very 'perplexed' about how the Americans could have been so 'greedy'. They compete with one another in having a 'our garbage don't stink' smugness when they gesticulate about how Indian banks are more regulated and hence - 'safe from greed'. They all seem to accept that had they been shown the carrot of deregulation, they would most probably have gone ahead and 'sinned' just like the American banks. They all seem to agree, that while they opposed RBI's stringent measures at the time they were being introduced, in hindsight they thank RBI that they did not have the 'temptation to sin'. One of them even goes on to say that the RBI governor saved them!

There you have it folks - India's top bankers agree that they are children who need to be 'shown the right way' at every step, lest they should fall prey to the evil, greedy temptations that are by the wayside!

I find this attitude revolting - but who is to blame for our apparent lack of morals and self regulation in the absence of a grand regulator? Well, the answer is simple - the regulator.

While the article gives due credit to YV Reddy's foresight of 'applying brakes too early than too late', I find the complete lack of comparing the two situations in the right context, apalling! One needs to compare oranges with oranges, after all.

The crux of the problem in the US economy is the government sponsored push towards increased home ownership. This push by the US state to over-promote homeownership has been the 'prodigal push to the stack of dominoes' which eventually lead to Fannie and Freddie becoming over aggresive mortgage lenders, to the over exposure to subprime borrowers, development of CDOs and all those other weapons of financial mass destruction. The important fact one needs to observe here is that the crux of the issue starts with government interferring in the working of the market. By artificially trying to boost homeownership, the government essentially lets loose excessive corporate risk taking - this is essentially what happened.

Robert Shiller in the book "The Subprime Solution" analyses this very problem and rightly points out that -

"Overly aggressive mortgage lenders, compliant appraisers, and complacent borrowers proliferated to feed on the housing boom. Mortgage originators, who planned to sell off the mortgage to securitizers, stopped worrying about the repayment risk. They typically made only perfunctory efforts to assess borrower's ability to repay their loans - often failing to verify borrower's income with the Internal Revenue Service, even if they possessed signed authorization forms permitting them to do so."

The reader, here would kindly note that a regulatory enviroment existed. The borrowers were essentially required to authorize the lender rights - to verify the borrower's ability to repay the loan. But in an environment where checking if a borrower can repay, would have hindered the mortage lender's chances of 'closing a deal', a lot was let slip between cup and lip. Afterall, there was the Big Brother State standing behind mortgage lenders like Fannie and Freddie waiting to write-off bad assets, you see.

Does my arguement here then mean that in India there is no government sponsored boost for home ownership? The answer is, partly yes. As one CEO-designate of one of the largest banks in India tells the author -

"Indian banks are not levered like American banks. Capital ratios are 12 and 13%, instead of 7 or 8%. All those exotic structures like CDO and securtization are a very tiny part of our banking system. So a lot of the temptations didn't exist"

Luckily, it seems that the Indian State has not got behind the 'increasing home ownership' bandwagon. While HDFC has been a private player (majority stake) in the Indian mortgage market it has not come under pressure from the government to boost home ownership and therefore no apparent need to take excessive risks by creating money out of thin air using CDOs and other weapons of mass financial destruction.

The housing real estate market in India has to a large extent grown due to growth in Indian economy, not due to subsidies given by the government. Therefore it has not been a 'government generated boom'. As Murray Rothbard elucidates - the 'bust' in the business cycle is usually causally linked to the earlier government generated 'boom'. The market economy is self correcting and will quickly eliminate the earlier government generated errors in investment, unless the process of adjustment is interfered with by government policies. (Source)
Also, one needs to evaluate the relative sizes and trend of the two economies being compared. I am currently involved in an assignment which is trying to study how Indian consumers are responding to the global recession - and the main problem I face, is ascertaining whether Indian consumers are in fact, facing a pinch like their western counterparts. The growth in the Indian economy and the new affluence which many Indians have witnessed as a result, is making the Indian consumer somewhat of a contrarian.

Considering many such differernt nuances about the nature of the Indian and American economies, I think it would incorrect to heap all the praise on the strict regulatory environment of the Indian banking regulators as the main reason why Indian banks are safe vis-a-vis American banks. That would be assuming that Ceteris Paribus all other conditions are the same between the two economies. Unfortunately, with the case of central macro economic planning, the only way to prove something would be based on what has, by luck, turned out to be a better strategy, in hindsight.

God forbid, if the same Indian bankers were asked by the government to start lending money to people wanting to increase home ownership, the same incentives which drove the 'greedy' American banker might tempt our bankers too. Would not happen in India you say? Read this.

"The government, on its part, also infused Rs 4,000 crore into the housing sector through National Housing Bank (one of the reasons for LIC Housing Finance cutting its rates) and forced PSU banks to slash home loan rates for new loans of up to Rs 20 lakh.

The steps taken by the government and the RBI were also aimed at reviving the housing sector which is struggling because of the slowing economy"

So it begins...

Wednesday, December 10, 2008

Three articles that are worth reading.

Here are three articles I find very interesting.

1. 'Macroeconomics is Complete Bunkum' - by Bill Frezza: For a free market supporter and a strong follower of the Austrian School of Economics like me, this article rings as being very true. As the author mentions, it is only Hayek, Rothbard and other Austrian School economists like Menger who advocated the futility of the use macroeconomic statistics and its direct result - central planning. I say down with this macroeconomic, central planning nonsense! Viva Liberty!

(Hat Tip to Mr. Sadowski in the RCM comments)

2. 'Our Friends in Bombay' - by Christopher Hitchens: Staying true to my earlier call that people around the world need to be continually sensitized about the regular nature of terrorist attacks in India - the most by any standard, outside of a war zone - I find this article as a superb piece of straight talk by Mr. Hitchens.

3. 'Eye Spy' - by Priya Ganapati: Finally! Here is something I have always hoped would happen. A camera in the eye! As a photography enthusiast, one of my regular complaints is the fact that in the presence of a camera, people being photographed, stop being 'themselves' and pose. While I accept that it is a mark of a great photographer who can prevent his subject from doing this, I have hoped many times that the camera become invisible. Like an extension to ones' eye. Well, a camera in one's eye socket is the closest to this dream as can be!

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