Bear Stearns: It's in the Name - Straight from the Hip by J Mulraj
Investing in India - Straight from the Hip by J Mulraj
Bear Stearns: It's in the Name A  A  A

24 MARCH 2008

The failure of Bear Stearns, the fifth largest securities firm in the US, caused tremors to run down the spines of investors all over the world, with the BSE sensex losing 951 points on Monday, when its sale was announced to JP Morgan. The latter bought Bear Stearns, (whose founders showed immense foresight in naming it) for $ 2 per share, or 90% below the value at which the market valued it a week earlier. The thing you see flying out of the window is the efficient market hypothesis.

The problems of Bear Stearns, as with several financial institutions is that of injudicious lending against poor assets, when there was a surfeit of liquidity, combined with the 'mark to market' principle of accounting. The latter is relevant because it works well when there is a well developed market for asset classes and not when there isn't. Things like sub prime mortgages, or collateralised debt obligations, which are derivative products, didn't have a well developed market. Both investments in them and accounting for them (until the **** hit the fan) was often on a normative basis. When, e.g. the Bear Stearns crisis hit, it is reported that Singapore Bank DBS asked its traders not to trade with Lehman Brothers, another marquee name in the US banking industry, on fears that it may have mark to market losses that could cause it damage. The US Fed sees this credit crisis, where banks are chary of lending to each other, as a danger, and the 75 basis point interest rate cut it announced, was an effort to avert such reductions in the velocity of money flow.

The problems of poor quality lending, including sub prime, by US banks, is having its impact on Indian markets, of course. Bear Stearns had to sell off holdings in firms such as Jaiprakash Associates, Madhucon Projects etc. to raise resources, impacting their stock prices. Rather like when your neighbour's pig dies, its stench can become your problem!

Inability to develop markets is also witnessed in India, where, after banning a well developed, easily understood, indigenously developed carry forward market called 'badla', and replacing it with the internationally accepted F&O (futures and options) market, the authorities made no attempt to see it develop well. So today, the options market, which is safer for retail investor, has quotes which don't make any sense; even if the assessment is right the investor makes no money unless in a very sharp move. The futures section is risky because of mark to market requirement, and is avoidable. The only reason for the large turnover in F&O is the foolish optimism, driven by greed, of punters.

The Government is now considering allowing short selling again, post April 21. Short selling was the baby thrown out with the badla bathwater, because short sellers were considered to be unpatriotic scum of the earth! The good news is that short selling as a desirable activity has been recognised. The bad news is that it is being introduced after a severe fall; had it been introduced earlier the sensex may perhaps have not reached 21,000 but also may not perhaps have dropped so fast either. Introducing it now is rather like trying to pop a pill in the eighth month of pregnancy! It won't work because of the same reason, nothing will be done to make sure that costs of borrowing stock to allow for short sale, would be reasonable. Lenders of stock will want the moon. SEBI will shrug its shoulders saying that it has introduced and allowed short selling and that developing the market is not its job.

In India the macro economic news has been bad. Inflation has gone up to 5.9%, the highest in 11 months. The performance of 6 core industries, viz. crude oil, petroleum refining, coal, electricity, cement and steel, during the 10 months to January, has been poor at 5.5%, in aggregate, compared to 8.9%. The Government has a large ownership of assets in, and a huge say in pricing of, crude oil, petroleum refined products, coal and electricity. This is sure to lead to a potential problem for consumers after the election.

Prices of petrol, diesel and LPG have not risen in line with prices of crude oil (which are not going to fall; the world is running out of easy to find fossil fuel). They have been capped and subsidised by the Government prior to elections. Any new Government that comes in will have to raise them, so we would then see a huge inflationary impact in 2009. This would dent industries like the auto industry; if petrol prices go to say Rs 70/liter, demand for cars would surely go down. By not raising them in line with crude prices the Government is abdicating its responsibility and is creating a monster for a subsequent one.

Falling asset prices are giving opportunities for bottom fishers. Reliance Power has bought fully an Indonesian coal mine, for Rs 1000 crores. It has a reserve of 2 b. tonnes of coal and a land area of 100,000 acres, larger than Mumbai! George Soros has bought a small stake in the real estate division of Indiabulls. Expect tech companies to announce acquisitions now that sellers' expectations of price have been deflated. HCL Techonologies, for example, is thinking of setting up a SPAC (special purpose acquisition corporation) to push an acquisition through, without loading its own balance sheet.

Amidst all this gloom, VISA International managed to successfully complete a $ 17.9b IPO, the largest ever in USA, and, whats more, it listed at a 35% premium! (No, I don't think they allowed applicants to use Visa card to buy shares). Hopefully issuers and the lead managers will learn that, while in the short run it may be beneficial to scalp the market with the highest possible price, in the long run, it pays to generate investor goodwill by leaving a little on the table.

The BSE-Sensex dropped 765 points last week to close at 14994. The major contributors were ICICI Bank (181), RIL (172) and HDFC (101). The market ought to bounce as bottom fishers come in; stock prices of ten leading groups have fallen 36% on average. After a bounce it should move in a sideways band until the economic and political scenario becomes clearer. The next pay commission report will shake the former and the recalcitrance of the Left parties opposing the nuclear deal will shake the latter.

Have you read the latest Honest Truth by Ajit Dayal?

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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