Obama's victory, hope triumphs over experience


America elected its first ever coloured President, Barack Obama, proving thereby that it is a land of opportunity for all and a nation that knows how to change. He won, on the hopes of millions of Americans, by a margin of over 2:1 in electoral votes, over the more experienced McCain. Obama inherits a complete mess left to him by George Bush. America's fiscal position is hugely deficit (in fact investor Jim Rogers thinks the nation is bankrupt its foreign relations are at a dismal low and its financial system is in the worst ever crisis ever experienced. Obama would need all the qualities of the inspirational leader he is (witnesss his phenomenal victory speech, Yes We Can) to tide over the difficult times ahead.

The global financial crisis is a triumph of greed over prudence. It is unadulterated greed together with criminally lax supervision that has brought down venerable institutions such as Washington Mutual (the largest bank failure), Freddie and Fannie (the largest mortgage lenders to be rescued), Wachovia, Lehman Brothers (the largest brokerage to file for bankruptcy) and AIG (the largest insurance company to be bailed out).

This columnist was, at the commencement of his career, a loan appraising officer at ICICI and is aghast at the change in attitude towards money. Three decades ago, an officer was able to appraise at most 3 projects a month, giving time for scrutiny, and the loans remained on the books of the lender for the next 10 years. Today financial intermediation is more about investing than about lending; decisions are made at a rate of perhaps 3 a day (or faster?) and loans are taken off the books of the lender through securitisation. In effect, financial institutions have become creators of increasingly fancy derivative products and marketers of them, relinquishing their fiduciary responsibilities to their investors.

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In order to lend or invest at that rate, the appraisal of risk is outsourced to a rating agency (which have given AAA ratings to tranches of NINJA, subprime mortgages, for Chrissake!) and the collection is also 'derisked' by taking the loans off the books. The risk of such tainted assets has been spread globally, leading to the huge crisis of confidence that is preventing lending now.

The reason for this foolishness was pure greed, to drive up business (hence bottom line without factoring in the risk that was to hit later), leading to larger bonuses for Wall Street people. The average Wall Street salary and bonus was $ 379,000, more than six times the average of all private sector jobs in NY state! A fall in this will hit the State budget!

Obama must get a team to fix the overexuberance of shareholder capitalism that caused such financial destruction; one could say the financial meltdown is going to be worse in its destructive force than 9/11. Some of the things that need a re-think are

  1. Focus on quarterly performance as a driver for stockmarkets as also for bonuses of top management, inducing in them a short term growth fever unmindful of long term risk

  2. The structure of stock options, which, too, induces short termism and needs to be altered to be exercisable only after, say 5 years.

  3. Short term outlook of mutual/pension/hedge funds, which now control far larger financial assets than the banking industry and whose managers' compensation is also linked to short term performance. This is exacerbated by the NAV linked open ended schemes popularised by mutual funds, creating an investor psychology of 'if its Tuesday it must be Fidelity' whilst in effect leading to infedility.

  4. The unregulated growth of increasingly fancy derivative products which are meant to reduce risk but, because of the complexity and the comfort given by a rating agency, have actually enhanced to an unbelievable extent the systemic risk.

There is a coordinated effort by Central bankers and Governments throughout the world to prevent the credit crisis spilling over into the real world. Last week, Bank of England reduced interest rates 1.5%, whilst ECU and Swiss National Bank cut them 0.5%. Our own PSU banks, under advice from the Finance Minister, cut prime lending rates 0.75%.

But the financial contagion has already spread. Growth in India's six core industries during the first half of the year has fallen to 3.9%, from 6.9% in H1 last year. Automobile manufacturers are cutting production, due to falling demand after interest rates were raised earlier; Ashok Leyland and Tata Motors Jamshedpur are working 3 days a week; Bajaj Auto and M&M have scaled back. Money, when available, is expensive; Hindalco took a 5 year loan of $ 982m. to repay part of its bridge loan for acquiring Novelis, at LIBOR plus 3.15%. Had it made an IPO at the time of the acquisition instead, to part finance it, the debt servicing burden would have been manageable. The interest cost for 1742 companies in Q2 has doubled to Rs 16,386 crores. IMF has cut its growth forecast for 2009 for India to 6.3% made just a month ago, down from 6.9% and of China to 8.5% from 9.3% made last month. This is how fast the situation is changing.

Noted economist Nouriel Roubini sees even darker days ahead. The two growth engines of the global economy were the US and China. The US is already in recession, and China is likely to have a hard landing

Nine out of 11sub indices of the purchase managers index (PMI) show a decline. China needs to grow at 9-10% in order to absorb 24 million new job entrants every year and the 12-14m farmers who migrate to cities. If growth were to fall to 5.5-6%, as he thinks likely, it would be a hard landing for China. Since exports constitute 40% of China's GDP, and with its main buyer, US, in recession, China's GDP growth could fall to this level, creating enormous problems for its Government.

For investors this means a very tough year ahead. Stock prices, compared to peaks, may seem like tempting bargains, but these bargains would remain, or improve, during 2009. Warren Buffet said 'It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price.' Use this time to study the fundamentals of companies and the quality of their management. Global market conditions would ensure a fair price during 2009.

Last week the BSE-Sensex gained 176 points to end at 9964 and the NSE-Nifty added 87 to end at 2973. Sell on liquidity induced rallies. Obama is a leader the doctor ordered but he would require expert plumbers to clean up the smelly mess created by the Bush administration.

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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