Archive for April 8th, 2008

Similarities between 2007 subprime crisis and 1987 crash

April 8, 2008

I had written earlier about the superb Reinhart and Rogoff paper where they compare the previous crisis to the subprime crisis and see no difference. This paper has been discussed on many forums/blogs.

I came across this paper by Mark Carlson (of Fed) discussing the 1987 crash. What struck me was the similarity between 1987 and recent crisis. The Fed intervened even then providing liquidity and confidence to the frozen markets. Though, the current crisis is broader/worser but the way equity markets behaved then is very similar to the way they are behaving now.

And this again takes me back to the point- Can we call this modern finance? It keeps coming back in nearly similar ways. That is why we need a fresh thinking to understand developments in financial sector. By being stubborn and calling it capitalism (Fed/government bailouts isn’t capitalism), we are not going to move anywhere forward.

PS: The Rogoff -Reinhart duo have also done a more detailed analysis of the various financial crises spread over eight centuries. The paper is here. The shorter version of the paper is here.

 

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Raghuram Rajan Committee on Financial Sector reforms

April 8, 2008

I have got a few queries regarding which website can one download the Raghuram Rajan chaired Committee on Financial Sector Reforms (CFSR) ?

The report is placed on the Planning Commission website and can be downloaded from here. I am just going through the report and so far the recommendations have been usual well-known ones. I will add my comments if I find something interesting.

Also there have been questions over the location of MIFC report. It can be downloaded from here. My comments here.

Addendum:

My comments

1. I just wanted to raise this issue which is not related to the report but on the poor research capabilities at India’s leading institutes. I did a random check on the references mentioned at the end of the chapters. I usually check the references to pick papers which I have not read or am unaware of but is important to read. Most of my papers I point out on this blog are a resultof this exercise.

As it is a draft report, references are mentioned in just three chapters:

  • Chapter 2 The Macro-Economic Framework and Financial Sector Development
  • Chapter 3 Broadening Access to Finance
  • Chapter 4 Leveling the Playing Field

In all three, I didn’t find a single paper from India’s elite business schools. I had earlier raised this point that these institutes don’t point to their research. You hardly come across any of their papers mentioned as a reference in any paper/any topic on economics.

But on checking India specific reports and that too this one on finance (which is a speciality in most of these places) and not finding any reference is disappointing. Raghu Rajan himself is from one of the elite institutes and surely wouldn’t give their research a miss. I hope I get to see some papers in the other chapters’ reference list (if it is added that is).

Though, the institute I had mentioned about has a few papers in Chpater 3, which is their forte anyways.  Someone needs to fix this. It is not amusing anymore.

2. I have added some comments on the inflation targeting mandate suggested by the report.

3.  Chapter two has a discussion on macroeconomic issues in India. Unlike most reports on financial sector in India, this one understands that macroeconomics is as important. The chapter focuses on two main issues- capital account convertibility/controls and whether RBI should focus alone on inflation targeting.

The committee proposes both CAC and IT. I have written on IT issue earlier as well. As far as capital flows are concerned, despite the mixed evidence on whether it works or not, the  committee says India should adopt it. If benefits are more, so are the costs.

I am disappointed as there is hardly any empirical evidence. Why can’t the committee add empirical evidence on the Indian experience. (I have some basic idea on capital flows based on Rodrik’s paper here).

I am not against capital flows or IT but we need to make case for it. You simply can’t review literature and suggest ideas that belong to the developed economies. And we should expect some empirical evidence from such an eminent panel. We all want to become developed but the path isn’t as straight forward as it is made out to be. Most countries that have moved forward have charted their own path of growth.

Let me read the other chapters as well.

(15/7/2008) I think all the proponents of an IT frameowrk in India should read the paper by Otmar Issing

4. Chapter 3- Broadening Access to Finance : This chapter is on Financial inclusion. It is quite a good one detailing what has worked and what hasn’t in financial inclusion in India.

It is actually quite balanced as it says though the policies for financial inclusion have been well intended, they have not delivered as per expectations. (Usually, we find research pretty biased against India’s financial inclusion policies. Though, I came across this paper which says the policies led to lower poverty.)

Hence, there is a need for improvement. The chapter suggests setting up special small local banks, rethink on priority sector lending/subsidies ( I liked the idea of creating a market for Priority sector certificates) , use technology etc.

Though, the chapter is more on supply side issues (expansion of services) and contributes little in terms of addressing demand (why people don’t come forward) issues. I am not sure whether that should be the only way.

Financial products/services are different from the usual products because of information asymmetry and the poor is more conscious of the asymmetry because of volatile incomes. Hence, though finance may help to lower his income volatility, he is not sure of availing the service. The chapter does mention financial literacy, but is just a small para at the end.

CFSR should have looked more into findings of behavioral economics/ finance. They had the best brains behind the study and am sure we could have come with more India centric demand ideas than pure suppy approach. The pure supply approach is costly and takes a lot of time. Many a time using BF/BE we realize the solution could be more simpler. I had mentioned about this paper where some ideas have been mentioned.

Though, the chapter (Page 29) does use BF/BE mention that cash transfers should be automatically transferred to a bank account electronically (the default should be the bank account) so that a person has to come to the bank and get the award. But, that is the only example. CFSR could have expanded the findings. I frankly don’t know why Policy documents ignore BE/BF. It has so much to offer.

5. Chapter 4: Leveling the Playing Field: This chapter goes back to the first few lessons of microeconomics – competition is good. It says people should get good quality financial services and this should not depend on some special privilieges given to certain firms namely public sector.

The chapter’s main idea is that certain firms and financial products are favored than others as rules and regulations have been framed in a manner which puts them in a beneficial place. Instead of tweaking the regulations further, the authorities should level the playing field so that anyone can offer financial services as long as he can compete with the others.

6. I have not been able to post any further comments on the report. I did manage to read chapter 5 and 6. Chapter 5 is on improving efficiency in markets and Chapter 6 is on regulation.

Chapter 5 has a chapter called – Are financial markets casinos? Despite all the good reasons of having efficient financial markets, the common man (on whom the report is targeted) has some other ideas. The committee members need to visit small towns where equity culture is thriving (atleast was till the markets were rising). In all these towns it is much like a casino with people glued to screens monitoring the swings very closely. If you them what the compamny does, the large part will not have a clue. Look, this does not mean that financial markets are casinos. But, pointing to a reality.

Expert viewpoints

1. Rajan writes on the report – 100 small steps, Rajan interview in ET, interview in Businessworld. Rajan and Prasad on the importance of inflation objective. Rajan & Prasad on exchange rate policy

2. Shankar Acharya has some interesting comments on the report.

3. Economist’s comments

4. TCA Srinivas comments. He has more comments on the financial sector reforms

5. Andy Mukherjee says it is ill timed

6. Suman Bery comments

7. R Ravimohan’s views  (MD& Regional Head of Standard & Poor’s South Asia )

8. Rajeev Malik (Executive director at JPMorgan Chase Bank, Singapore)

9. Dr. Nirvikar Singh (Prof. University of California, Santa Cruz)

10. Dr. Subir Gokarn (Chief Economist, Standard & Poor’s Asia-Pacific)

11. Dr Sona Varma ( ICICI Bank Economist, she was part of the team that prepared Chapter 4 of the report on Financial Inclusion)   

12. Arvind Subramanian (of Peterson Institute) on whether India needs inflation targeting? (The article does not refer to CFSR but it does look at the issue raised by CFSR)

13. Businessworld Edit

14. Ramesh Ramanathan

15. Ajay Shah has also compiled various comments on CFSR

16. Planning Commission website has also compiled the comments so far

Assorted Links

April 8, 2008

1. Krugman compares food prices crisis to subprime crisis

2. Ajay Shah points to some comments on Raghu Rajan committee on financial sector reforms in India

3. ID Blog on farmer suicides.

4. DB Blog on how practices adopted in colonies still continue and detrimental to the system

5. Econbrowser points how growth forecasts are continuously being revised dowwards


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