Teflon coated elites - Straight from the Hip by J Mulraj
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Investing in India - Straight from the Hip by J Mulraj
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22 FEBRUARY 2014

This column has spoken about the advent of shareholder capitalism, promoted by the US, as a counter to the then successful alternative economic model of stakeholder capitalism. Japan and Germany pursued the latter form, very successfully, in the '80s, and were challenging the US in economic hegemony. Under stakeholder capitalism, the various stakeholders, viz. employees, shareholders/financiers, suppliers, and customers, are all given roughly equal importance. Following this, Japanese banks and companies were at the forefront. Four of the top ten global banks, in terms of assets, were Japanese, NTT Docomo had the most expensive stock in the world, the Nikkei was at an all time high of 40,000 and the Japanese were buying prized US assets such as Universal Studios and Rockefeller Centre.

Shareholder capitalism puts the interests of owners of capital first, above that of other stakeholders. Over the past three decades, following shareholder capitalism, the US has retained its economic hegemony and is the largest economy in the world. However, the pendulum has swung too far the other way, and the pitfalls of an excessive focus on shareholder capitalism are becoming apparent.

It has resulted in too big to fail (TBTF) elites. Such TBTF entities are Teflon coated, and get away with abusing the system, and the rights of others. Consider the elites:

BANKS A must read article in Rolling Stones magazine by Matt Taibi is titled 'Too Big to Jail'. It starts of by mentioning that a TBTF bank, HSBC, was fined $ 1.9b. or five week's profits, for money laundering by drug dealers and by terrorists. And this happened in the US, which has far stricter monitoring and regulatory measures than India does. As per the article, HSBC ignored several MRA (matters requiring attention) sent by the regulatory agency, with impunity. Swiss TBTF bank, UBS, one of the world's largest, got off lightly after having been discovered to have manipulated the setting of the LIBOR rate.

Also a must read is another of Matt Taibi's articles, 'The Vampire Squid Strikes Again: The Mega Banks' Most Devious Scam Yet'. Not many people know about it, but an amendment has been passed by US lawmakers, creating a loophole for TBTF banks to exploit. It allows them to undertake a complimentary financial activity to their business. The intention was, e.g. to permit banks who have a credit card (such as Amex) to start a magazine which will help promote the use of the card. It has, however, been used by TBTF banks to acquire hard assets. "Today, banks like Morgan Stanley, JPMorgan Chase and Goldman Sachs own oil tankers, run airports and control huge quantities of coal, natural gas, heating oil, electric power and precious metals. They likewise can now be found exerting direct control over the supply of a whole galaxy of raw materials crucial to world industry and to society in general, including everything from food products to metals like zinc, copper, tin, nickel and, most infamously thanks to a recent high-profile scandal, aluminum."

One recalls how Enron Corporation, which had taken a large position in the derivative market betting that power costs would go up, ensured that they did, by bribing a power generator to cut off supply for a few hours, never mind the angst this caused. Imagine the havoc that such TBTF banks could create if they held both physical assets in the value chain, as well as domain knowledge and positions in financial markets!

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Today four of the top ten global banks are Chinese. Over the past five years, Chinese banks have grown far more than US banks (adding $ 15.4 trillion in assets versus $2.1 by US banks), thanks to monetary easing in China at a faster pace. See chart below:

Data Source: zerohedge.com

The Chinese banks are being asked to bail out Trust products in China's shadow banking sector. This is a bubble just waiting to burst, for the banks cannot continue bailing out these products. It is a matter of a few months when China faces a financial crisis that will have global implications, perhaps worse than the domino collapse initiated by Lehman Brothers.

POLITICIANS Politicians, globally, are considering themselves an elite, impervious to accountability. Last week saw several depressing events in Indian politics, culminating in the abhorrent attempt by Tamil Nadu Chief Minister, J Jayalalita, to seek to free the assassins of an Indian Prime Minister. This was to get political mileage, ahead of the general elections. But surely there is a line which even politicians cannot cross? Why do we need a Supreme Court to remind us where that line is, each time? Prior to this, we had sordid episodes such as the use of pepper spray during a Parliamentary debate; the shedding of clothes by MLAs in the UP Assembly, the attempt to snatch papers from the hands of the Rajya Sabha secretary general and of the mike from the speaker. Are MPs not accountable for their behaviour?

This is another sordid example of the Teflon coated elites misbehaving with impunity unmindful of the cost of their shenanigans to the rest of society. This can't last.

Fund Management Industry Elites After the US encouraged shareholder capitalism, its mutual fund industry took off. The assets under management of the fund industry now exceed that of the banking industry. Funds (equity, hedge, pension etc) now own over 70% of corporate equity and corporate management need to bend over to please them. It was earlier felt that this concentration of holding in fund managers' hands would help improve corporate governance; sadly it has not. There are few activist shareholders, like Chris Hohn, of The Children's Investment Fund, who take up cudgels for minority shareholders. Most other funds prefer to vote with their feet, exiting the stock of any company that does something unethical, rather than try to induce management to change its ways, or to change the management if it does not.

The focus of the fund management industry is short term. The fund managers are remunerated on the basis of short term performance of the funds they manage. They get a bonus if they beat an underlying benchmark (e.g. the Nifty 50), even though, sometimes, the performance is negative. This reminds me of the joke about two guys who come across a wild bear in the woods. One starts wearing his jogging shoes and the other tells him that the shoes would not help him outrun the bear. Which brings forth the sally that he had to outrun the other guy, not the bear!

This focus on short term performance in turn pressures corporate managers to take short term decisions. Lucent Technologies (earlier Bell Labs, the font of innovation at AT&T) was nearly driven to bankruptcy due to such pressures and focus on the short term. Several companies expand faster than they need to, on the back of debt, and end up in financial stress, due to such pressures.

Corporate Elites A handful of large corporate groups have huge outstanding bank debt, taken for the purposes of acquisition and expansion. If the economic growth sustains its momentum, the borrowings can be repaid and shareholders get handsomely rewarded by the debt leverage. If the economy slows down, the elites approach the lenders for a CDR (corporate debt recovery) programme, and manage to roll the debts over, on easier terms, but without any penalty to themselves. They are the Teflon coated corporate elites.

There have been many instances of corporate misdeeds which have gone unpunished, the most recent of them being the NSEL scam in which despite reams of evidence (a forensic audit of MCX has revealed flaws no action is being taken against the fraudsters. It suggests that the corrupt Government at the Centre may be involved, else why are they pussyfooting? The Sahara group continues to cock a snook at the efforts by both Supreme Court and SEBI to enforce the return of money illegally raised by two group companies and the chief, Subrata Roy, has been asked to present himself to the Supreme Court.

The Government continues to use its large companies as milch cows, from which it can draw money to fund its extravagant ways. Oil and Natural Gas Corporation Ltd. (ONGC), e.g. in which the Government has majority control, is being sucked dry by being compelled to subsidise petro products, relieving the fiscal strain on the Budget, and allowing P Chidambaram to (falsely) gloat that the deficit has been contained. It has little money left for exploration, which will affect its future. Look no further than Venezuelan company PDVSA, which was similarly milked by Hugo Chavez for his various welfare schemes. Its oil production has actually fallen, because of lack of funds. This despite Venezuala having the world's largest reserves of crude oil. Its production has actually fallen from 2.7 billion barrels per day in 1994 to 2.4 b. in 2013. ONGC will meet the same fate, because of Government dipping its grubby hands into its coffers.

And there are no large institutional shareholders, or mutual funds, willing to take the Government to court over this! They vote with their feet!

So we have a situation where, largely because of pressures on short term performance, banks and companies are sacking employees, in order to maintain operating profit margins, even as the top management gets large bonuses. RBS is to sack a quarter of its 120,000 employees! This is Teflon elitism.

So what are the consequences?

The OECD warns that the world will face slow economic growth and high unemployment. There are larger productivity gains to be made by hiring machines. No overtime, no coffee breaks and no maternity leave for them. So we will see the growth of things like 3D manufacturing, driverless cars, robots and drones delivering pizzas!

The continuous quest for growth, however, runs up against the wall of nature's ability to supply endless human wants. We will face a shortage of water and of food. The state of California is expected to have a drought for the next 200 years. It supplies a lot of vegetables for USA and the world.

Over the past week, the BSE-Sensex gained 333 points to close at 20,700 and the NSE-Nifty added 107 to end at 6,155.

In interesting corporate developments, Vodafone and the Government called off their talks at resolving a tax dispute through conciliation. Vodafone has gone in for international arbitration.

The Finance Minister presented an interim budget, using accounting jugglery to show containment of fiscal deficit at 4.6% of GDP. He has done so by postponing expenditure. So, whilst the IT Department of the Government insists that tax payers use a consistent system of accounting, in which incomes and expenditure arise when accrued, the Government itself is free to fiddle around with its accounting practises. This bequeaths the problem to a future Government.

Chidambaram has also, quite foolishly, granted a sharp excise cut for SUVs (sports utility vehicles) which are gas guzzlers. This is insane! The largest import item is crude oil and it ought to be the mission of the Government to restrict its use and import. Instead we follow a crazy policy of subsidising petro products, thereby encouraging overuse instead of conservation, we fail to mandate fuel efficiency norms for vehicles and we encourage sale of gas guzzling SUVs by making them cheaper!

This is Teflon coated elitism.

However, Chidambaram thinks it prudent policy to tax the 2nd largest item of imports, viz. gold, by hiking its import duties and mandating that banks not lend against gold. The current account deficit has thus come down on paper, because official gold imports are down. But smuggling is on the rise, and a smuggling network once established, spills over into arms and terrorists. Gold demand continues to be high.

The fact that the market continues to remain buoyant despite several looming issues suggests that investors have faith in the future of India. This can come about if we have a strong Government, one that is dedicated to the welfare of the nation and not of self. The elections are slated for mid April-mid May and hopefully, by the end of May, a cool breeze of good governance will blow across India. The one blowing now is not conducive to economic health.

J Mulraj is a stock market columnist and observer of long standing. His weekly column on stock markets has run for over 27 years. An MBA from IIM Calcutta, he has been a member of the BSE. He is Conference Head - India, for Euromoney. A keen observer of events and trends, he writes in a lucid yet readable style and takes up issues on behalf of the individual investor. Nothing pleases him more than a reader who confesses having no interest in stock markets yet being a reader of his columns. His other interests include reading, both fiction and non-fiction, bridge, snooker and chess.

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5 Responses to "Teflon coated elites"
murugan
Feb 23, 2014
CDR is Corporate Debt Restructuring and not Corporate Debt Recovery programme as mentioned in the article.

The article is very informative. Stakeholder capitalism is better than shareholder capitalism any day. Lenders as an important stakeholder should have a say in what a company does (or does not do) Employees too since their personal fortunes are linked to that of the company. Auditors, regulators, and consumers too should have their say.
Like 
Dinesh Lal
Feb 23, 2014
There is a factual error in this otherwise commendable article. The oil production of Venezuela is 2.4 MILLION barrels per day, and not 2.4 Like 
Tikam Patni
Feb 23, 2014
Teflon Coated Elites are products of Crony Socialism, Crony Capitalism, Crony Politics, Crony Democracy that is now wide spread and for allowing all these to flurish : the Crony Constitution. Our Constitution has outlived it's purpose and after over 100 amendments, it requires redrafting into a new piece of document ... Like 
Mithun
Feb 23, 2014
The finance mandarins of UPA led by the likes of MM Singh,MS Ahluwalia and PC have all studied and worked in the west and imbibed sufficient toxins from the IMF and World bank.So,they want us to have faith in paper currency the value of which disappears over time like melting ice due to their prolific currency printing.Hence,they don't want us to buy gold which is real money and has been the storehouse of value for thousands of years.
No journalist has the courage to ask PC why his wife holds jewellery worth crores(as he himself has declared to the EC)and not sell it away and hold paper currency as advocated by him?
Another case of "don't do what I do but do what I say".

Like (3)
Niraj
Feb 22, 2014
Mulraj, look forward to your mail every week. Keep writing. Like (3)
  
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