The whole F______ system is manipulated - Straight from the Hip by J Mulraj
Investing in India - Straight from the Hip by J Mulraj
The whole F______ system is manipulated A  A  A

28 JULY 2012

If any reader of my columns thought that the F______ in the title stood for anything other than Financial, he really ought to re-evaluate his opinion of me, and of himself! For, as Eliza Doolittle would have said to Professor Higgins in 'My Fair Lady', 'I yam a good boy, I yam', and would be loath to put my editor in an ethical dilemma.

The manipulation probably began in 1999, when President Bill Clinton repealed the Glass-Steagall Act, one that segregated commercial banking and investment banking activities. As we have recently seen, banks like J P Morgan, both a commercial and an investment bank, ran up huge losses trading derivatives. Despite several rounds of quantitative easing (QE), these banks have used the money less for lending and more for playing in the derivative market.

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As a result, as per the above article, the notional value of outstanding derivative exposure of US banks is $ 227 trillion! This is higher than the exposure of $ 165 trillion at the end of 2007, just prior to the 2008 shock to the global financial system. Now hear this - 97% of that exposure is in just 5 banks!


Even if a small fraction of this goes wrong, it means billions of $ of losses, as faced by J P Morgan.

There are then demands for a bail out of banks, on the ground of 'too big to fail' and the losses it could cause to depositors, and the consequent panic.

It is thus that there are calls, including from Sandy Weill, ex Chairman of Citigroup, who was a strong proponent of the abolishment of the Glass-Steagall Act, for its reinstatement .

We have all heard about how setting of the LIBOR rate, to which trillions of $s of loan transactions are pegged, was manipulated. Barclays was fined for it, and its head, Bob Diamond, had to step down. A simple explanation of how the rate was manipulated is this. All banks were asked to quote rates at which they would borrow, to the Bank of England, who would then eliminate the lowest and the highest rate, to prevent manipulation, and average the others. Supposse four banks quoted 1%, 2%, 3% and 4%. After eliminating 1 and 4, the average would be 2.5%, which would be set as LIBOR. Now if a bank wanted a higher rate, as it had lent more money linked to LIBOR, all it had to do was quote, say 5%. Then, after eliminating 2 and 5, the average would be 3.5%. Voila! So simple! But millions of borrowers all over the world borrowed money at rates linked to LIBOR and they are likely to sue the manipulating banks. That would cause another upheaval in the global banking sector.

Not only was LIBOR manipulated, the credit default swap market was manipulated by Goldman . The author says "Furthermore, by controlling the variation margin on any position, Goldman could force its own clients to collapse on their positions, at massive losses, just so Goldman would make a profit, and Goldman's own traders could make another record bonus".

Now a major reason for banks not lending despite QE is becuase of demographics. The baby boomers in the US have peaked, in age and in spending, and are now spending much less. Since over 70% of the US economy is consumption driven, the decline in spending by post-retirement baby boomers could result in an economic meltdown

Interestingly, India is one of the few large economies in which demographics is working to our advantage. China, because of its one-child policy, is already aging. If only we had a Government that had the political will to bring in policies that would, as PM Manmohan Singh said 'release the animal spirits', we would have a flood of financial resources to sustain GDP growth at over 8% and rapidly bring down poverty. Sadly for India, the only animal spirit is that of a mouse, as all we hear from our political leaders is a squeak.

So, in a bid to spur consumption led growth, the developed world is likely to do more QE. The US Federal Reserve meets on Tuesday, the ECB and the Bank of England on Thursday. Last week global stockmarkets saw a brief flutter of excitement when Mario Draghi, head of ECB, said that he would protect the Euro to the extent possible within his mandate. The key words are 'within his mandate'.

That's similar to the PM saying he will do everything possible, within his control, to usher in speedy economic reforms.

This continued pumping in of money has led to a mountain of public debt. The chickens are now coming home to roost! "Nearly 50% of the total outstanding debt of the world's top 10 debtor nations needs to be rolled over by the end of 2015."

This rollover would find increasingly fewer takers, and at higher cost. There is a crisis brewing in Spain, which is on the verge of a bankruptcy, after Spanish bond yields rose above 7%. This cause more consternation in Germany, because German banks are said to be holding around $1 trillion of Government debt of the weaker, peripheral nations. As a consequence, Moody's last week threatened to lower Germany's AAA rating.

That's why Germany's Chancellor Angela Merkel is taking no (pardon the pun) chances, and has allied with French President Hollande to go dutch (pardon, again) on defending the Euro. Because if Spain fails, then so, probably, will Portugal and Italy, and that would lead to German banks needing to be recapitalised.

All this has led to Dr. Nouriel Roubini, aka Doctor Doom, to predict a financial armageddon. Caution: listening to the video would not make good bed time listening.

So what is the Indian preparation for the coming global armageddon?

As mentioned several times, we have the chance of a lifetime. Demographic factors are working in our favour and Indian entrepreneurs have shown they can deliver. Despite all round gloominess, companies such as Hindustan Unilever, ITC, Cairn, Idea Cellular and others posted impressive increases in net profit figures. If left free to unleash entrepreneurial animal spirits, they would grow, providing employment and creating the virtuous cycle of spending, growth and jobs.

Yet what we see are hurdles. The IT industry, exempted from the provisions of an archaic labour law, is likely to see it come under it. This would mean management time spent on ensuring a printed notice is put at the entrance, instead of wooing global customers or thinking of the next vertical to enter.

Public sector banks are needing to make higher provisions for non performing assets, due largely to directed lending (such as to Air India) even as private sector banks are posting higher profits.

The Government is unwilling and unable to control its fiscal deficit. Increasing the price of diesel and cutting its subsidy burden is a decision that is a no brainer which makes political leaders eminently qualified to take it. Yet they cannot.

It is the judicial system that is doing what the legislature and the administration are too scared to. The Gujarat High Court has directed that all public transport must convert to gas, an eminently sensible decision. A similar decision taken in Delhi a few years ago saved the capital from becoming an environmental nightmare. The issue is that gas is being centrally allocated, and if, under Court guidance, the allocation policy would need to be recalibrated, then some other sector such as fertiliser or power would get less gas. That would mean fertiliser subsidy would go up. Other states are also bound to follow the Gujarat High Court.

That could also mean a reworking of the agreements signed with operators under NELP, the dispute over which has stalled the discovery of higher gas reserves. That could work to the advantage of the operators.

Last week the BSE-Sensex fell 321 points, to close at 16,837, and the NSE-Nifty declined 105 to end at 5,099.

The coming week is to see central bank policy reviews by US Fed on Tuesday and ECB and Bank of England on Thursday.

Perhaps the US Fed may announce another round of QE on Tuesday, which could lead to a rally. If not, investors may well say WTF.

Hey, come on, readers, you haven't re-evaluated your opinion of me yet? I meant Wednesday, Thursday, Friday, if no QE on Tuesday. Have a heart!

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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Equitymaster requests your view! Post a comment on "The whole F______ system is manipulated". Click here!
6 Responses to "The whole F______ system is manipulated"
Aug 8, 2012
It is true. and I agree. The whole Fxxxxxx IS manipulated.

Kingdoms of debt all over the western world.
Jul 30, 2012
columnist like to attract the reader concentration by their own thinking on F______. a knife will remind vegetable cutting for women, for butcher it may be different. Be simple and straight. Like 
Jul 29, 2012
dr ram babu
Jul 29, 2012
I usually like yr all comments on Indian state of affairs , including this whole f... - statement . Mouse spirit ! Like (1)
Jul 28, 2012
I do not agree with this " This would mean management time spent on ensuring a printed notice is put at the entrance, instead of wooing global customers or thinking of the next vertical to enter. ". IT industry is just working on increasing number of employees rather than building product skills and with increase in number of employees, better the management takes care of the employees also. Like (1)
Anupam Garg
Jul 28, 2012
even if Mr. Jawahar explicitly writes the 4 letter f word...i would read it as financial Like (1)
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