The danger of TBTF - Straight from the Hip by J Mulraj
Investing in India - Straight from the Hip by J Mulraj
The danger of TBTF A  A  A

14 DECEMBER 2013

Of the four factors of production, viz. Money, Machines, Materials and Men, the first has gained the largest weightage, because it is the only one that can be digitized. The other factors of production, including men, become subservient to it. This has bad portends.

The largest wealth management firm in the world is Blackrock, which has $ 4.1 trillion in assets under management. This is twice India's GDP. So, if the head of such a firm were to meet corrupt Indian, or other, policy makers, they would be willing to bend whichever way they were directed, unafraid of consequences of the recently declared validity of article 377. Together with other asset management firms which share its 'Aladdin' platform, Blackrock holds sway over $ 17 trillion of global financial assets.

This represents 7% of the $ 225 trillion invested, globally, in financial assets. That one firm should be in control over such an amount is both an achievement as well as a danger.

Chart 2 in the above article in the Economist shows what % of equity of the world's largest corporations is held by Blackrock. Such holdings help it to influence managerial decision making. Given the structure of compensation of fund managers, the influence is often exerted to make such decisions short term, in order to improve quarterly results.

TBTF (too big to fail) financial firms are those whose collapse poses a systemic risk. The US Government stepped in, with a TARP rescue package, after the 2008 global financial crisis, and the US, together with other countries such as China and Japan and EU, have been following easy money policies to prevent the failure of a TBTF firm.

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In 1985 there were 18,000 banks in the US; now there are 6,891. The top six, viz. JP Morgan, BOAML, Citicorp, Wells Fargo, Goldman and Morgan Stanley, have a 2/3rds share in banking assets of $14.4 trillion. Besides "Four U.S. banks now lug total derivatives exposure well north of $40 trillion, or more than the combined value of U.S. gross domestic product and the national debt."

The easy money printed by the central banks have been deployed less in lending to businesses and to consumers and more in purchase of assets, including stocks, commodities, real estate and derivatives. JP Morgan has just settled, for extraordinarily large amounts of $ 13b. plus another $ 6 b., liabilities arising from its London whale episode.

The US has just passed a Volcker rule, in order to prevent proprietary trading by such TBTF firms, which can pose systemic risks. There are, however, a lot of devils in the details and one is unsure how it will all pan out.

In India the public sector banks control 70% of all banking assets. Being majority owned by Government, there are often cases of directed lending to well connected people, which then end up as non performing assets (NPAs), because the lending was done on direction rather than on appraisal.

When this happens on a large enough scale, the price has to be paid by someone. One section of such suckers are the depositors. Cyprus imposed an initial 40% haircut, overnight, on its bank depositors (which went to 60%).

Another section is employees, especially youth. When banks lend prudently, they help create assets which add economic value and which create jobs. When banks get easy money and use it to play the derivative market (like JP Morgan) or to buy assets, or when they lend to the wrong set of people without an appraisal, being directed to do so, jobs are not created. This leads to social consequences, and justifiable protests. See this chart about youth unemployment of people below 25 years of age in different countries. In Greece and Spain youth unemployement is just under 60%, untenably high.

Youth unemployment

A third section of affected persons is pensioners. The Spanish Government has withdrawn 5 billion Euro from the Social Security fund in order to keep its fiscal deficit under control, as per the conditions of the EU.

Similary, in India the Government raids various pools of money. One such pool is an oil cess, ostensibly levied to allow the Government to collect resources to be used to search for energy resources. A very laudable objective, to be sure. What is not laudable is its misuse. The Government has raided this pool of money; a whopping Rs 118,500 crores, and has spent barely 1% in searching for energy resources.

So Governments appear free to dip their grubby hands into various pools of money seemingly with impunity. One wonders when the CAG, whose job it is to monitor the use of funds collected through such cesses, will get down to doing it.

Since we do not allocate resources for finding energy resources, we naturally do not find them. Nor is the private sector incentivised enough to look for energy resources because, as mentioned in a previous column, the ownership of natural resources vests with the Government and not with the owner of the land on which these are discovered. Other countries, with no such hang ups, succeed in finding such resources. A small company in Australia has found huge reserves of unconventional oil in a God forsaken town of Coober Pedy

The reserves are estimated at 233 billion barrels, nearly equal to Saudi Arabia's reserves.

But our Government has not used the Rs 108,500 crores to look for such energy reserves; because the money has probably been directed to meet its bloating overheads and its well intentioned but very leaky welfare schemes.

Now, had this money been successfully spent on discovering new energy assets, India would have not had a problem with a rising current account deficit. To curtail CAD, the Finance Minister clamped down hard on gold imports, making these prohibitively expensive by hiking import duties. Unmindful of the fact that gold jewellery is one of the highest employment generators in the country.

The medicine seems to be, on a superfluous inspection, working. The CAD has come down. But smuggling has increased and there has been a spurt in gold imports by neighbouring countries where import duties are lower than in India with India as the ultimate destination of such smuggled gold.

This poses huge dangers. Once a network has been profitably established to smuggle gold from countries such as Pakistan and Bangladesh and Nepal, these routes can then be used to smuggle in terrorists, armaments, drugs and other stuff. Corruption increases for border crossings and poses huge security risks.

But, of course, the CAD shows a falling trend, and everyone applauds the achievement.

Now, instead of utilising the cess to discover energy resources, we are pursuing an insane policy of wanting nuclear power. Has the Government bothered to understand the risks to humanity from nuclear power? The Fukushima unit number 4 is leaking radiation which, at some places is 25 Sieverts, enough to kill a person in 20 minutes!

The ground levels are sinking, posing a danger to the 1500 fuel rods, which, for some inexplicable reason, are situated at a height of 50 feet above ground. The PM should read what has been said "During a recent interview, Mitsuhei Murata, the former Japanese Ambassador to both Switzerland and Senegal, explained that the ground beneath the plant's Unit 4 is gradually sinking, and that the entire structure is very likely on the verge of complete collapse.

This is highly concerning, as Unit 4 currently holds more than 1,500 spent nuclear fuel rods, and a collective 37 million curies of deadly radiation that, if released, could make much of the world completely uninhabitable.

Then there is the financial cost. Japan will spend nearly $ 1 b. for storing the spent fuel rods from unit 4, for 40 years.

In India, the Government has, for reasons unknown, not taken any action in the case of scandals such as NSEL. Despite a preponderance of evidence, Jignesh Shah and his cohorts have yet to be declared persons unfit and improper to run exchanges. The reason is obvious from this article in India today, which says that investigators found that the exchange has paid bribes of Rs 11 crores to tax officials, the money coming from a defaulting borrower company. Perhaps other Government departments are also beneficiaries of such largesse. Why else is the recovery of the money at a tardy pace, with only one agency, the Economic Offences Wing (EOW) of the Mumbai police, doing commendable work. The FMC and the Finance Ministry have a lot of explaining to do for their callous treatment.

But the Congress has a history of callous treatment towards individual investors.

One cannot forget how individual investors, the mainstay of US 64, were short changed, when, overnight, they were compelled to take a big loss. Other than a miniscule amount they were forced to sell their units to SUUTI at a loss. SUUTI, which got stocks of companies like Axis Bank, ITC and L&T, has seen their value treble, in about 11 years. This appreciation should be used to compensate the erstwhile unit holders, if the Government has honest intentions. That it is not being so used reveals the honesty of its intentions. Similarly, it has not displayed honest intentions towards investors in NSEL who have been defrauded.

The people who are short changed voice their protest during elections. With a general election coming up shortly, it would be prudent for the Finance Ministry and the regulator, FMC, to rethink their priorities.

Last week, the BSE-Sensex gained 329 points on the opening day, buoyed by FII (foreign institutional investor) buying of Rs 3,375 crores, after results of 5 states were declared on Sunday, showing a rout to Congress and a gain for the BJP plus an impressive debut by the AAP. Thereafter the sensex dropped in the next four days, closing the week with a drop of 280 points at 20,715. The NSE-Nifty dropped 91 points to close at 6,168.

It takes more effort to raise the index and less to make it fall. On Monday, FIIs were net buyers of Rs 3,375 crores, which raised the sensex by 329 points. But on Friday, a mere Rs 432 crores of net selling by FIIs caused it to drop 210 points.

In summation, the Indian market has been propped up by foreign institutional investors who have excess funds thanks to QE and who are banking on an improvement in public governance after the general elections, on the back of a Narendra Modi success. But if QE starts to taper, or if political developments lead to a setback for Modi, aided by the dirty tricks department, then the FIIs may turn net sellers. We have seen how a little selling has a magnified effect on the sensex.

On the global scene, the QE programmes have not really resulted in economic growth or in job growth. Youth unemployment is untenably high and has social consequences. The thirst for power has created a situation like Fukushima, which poses a danger to humanity.

The Dow Jones chart in the current bull run is eerily similar to the one in 1929, before the crash.

Dow Jones chart
The DJIA is not in the list of institutions TBTF. That is a sobering thought.

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.

The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.
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8 Responses to "The danger of TBTF"
J Mulraj
Dec 18, 2013
thank you, readers, for your comments.
I am glad, Vijay, that some readers do see the hyperlinks. Not everything can be put into a column, else it becomes too long and boring, so the hyperlinks direct interested readers to the various points of view.
I have, in fact, written for print media earlier. 15 years in TOI (1990-2005) and a year each therafter in DNA and HT.
vijay srivastava
Dec 15, 2013
Makes so much sense. The hyperlinks provided to elaborate the issue added value and insight.
Thanks a lot for sharing.
Lakshmi Krishnan
Dec 15, 2013
Have you thought of writing your ruminations in our country's national dailies. That way the general public will become more financially literate and understand the consequences of our governments shenanigans. Like 
Gopi Venugopal
Dec 14, 2013
Glad to know that the author does not support spending on building nuclear power plants. Like (1)
Dec 14, 2013
Very interesting column as always. The strange part of poor governance in all governments is the lack of control over the central government by the parliament or the Congress in the U.S. The legislative branch is either incompetent or in agreement with the wrong headed decisions being made by the center. I think we need to fire them all! Like (1)
anupam garg
Dec 14, 2013
impressive writing, as usual...but what a scary chart of DJIA Like (1)
chaitanya kirtane
Dec 14, 2013
i agree with you that there is a likely crash in world market once dow reaches 17000. india will also go down by 25% as there is no chance for bjp to get power as aam admi party will get 50 seats in lok sabha elections. Like (1)
Dec 14, 2013
A very realistic article. However, our politicians are blind eyed. Like (1)
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