RBI releases guidelines for off-balance sheet exposures

RBI has released the guidelines on prudential norms for off-balance sheet exposures of Banks. The press release says:

It may be recalled that Paragraph 165 of the Annual Policy Statement of the Reserve Bank of India for 2008-09 proposed to review current stipulations regarding conversion factors, risk weights and provisioning requirements for specific off-balance sheet exposures of banks and prescribe prudential requirements as appropriate, in view of the recent developments in the global financial markets. Accordingly, the requirements were reviewed and it is proposed to bring about certain modifications, as outlined in the draft guidelines, to the existing prudential norms applicable to the off-balance sheet exposures of the banks.

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CDO mess continues

The mess in CDO markets continue (see the earlier post on settlement problems). This alphaville blog post says:

Standard & Poor’s have just downgraded 153 CDO tranches – all of them European and all of them synthetic; which means they’re based on credit default swaps.

Here’s the release:

LONDON (Standard & Poor’s) May 29, 2008-Standard & Poor’s Ratings Services said today that it has taken credit rating actions on 153 European synthetic collateralized debt obligation (CDO) tranches (see list below).

Specifically, the ratings on:

– 122 tranches were removed from CreditWatch with negative implications and lowered;
– One tranche was lowered;
– One tranche was lowered and placed on CreditWatch negative;
– 28 tranches were lowered and remain on CreditWatch negative;
– One tranche was raised.

The interesting part, though, is that while 39 of the tranches downgraded reference US RMBS, 113 are linked to corporates. Downgrades on corporate CDOs have been rare before now. Moody’s reported in March than just 10tranches of synthetic corporate CDOs were downgraded in 2007, compared to 1,572 structured finance – MBS and ABS – CDOs.

S&P’s action, then, is pretty significant, and reflective of a serious uptick in default risk in the market – perceived and actual.

The rating agency lists some of the key culprits – corporates which have seen severe downgrades and thus impacted CDS referencing them. For now, the list is dominated by subprime casualties – monolines FGIC and ACA, Countrywide Home Loans, ResCap, GMAC. But there are also – in perhaps a taster of things to come – a couple of leveraged buyout names: Alliance Boots, TXU.

Highly leveraged companies are going to see significant rating actions against them if debt market funding conditions don’t improve. And with that, there will be further downgrades, and with them, as above, more trouble for synthetic corporate CDOs.

So, we are seeing concerns in corporate CDOs as well. This is the concern I raised in my CDS report as well.

India’s GDP for FY 2007-08- much higher than forecasts

This is another surprise. Whenever you try and develop a view over economy, the numbers come and surprise you. So there was an emerging view that growth in Indian economy is moderating. Moreover, people felt we are having some stagflationary conditionswith rising inflation and falling growth. Though, I still do not know how can we really define stagflation. It needs some serious research. If we have stagflation, policymaking is really tough. I have a paper on the same here 

The recent CSO press releasesays we are still growing at 9% ! So, atleast now the situation is clearer of high inflation because of high growth rates. There isn’t any stagflation. Industrial growth rates have fallen but stellar performance by agriculture and continued robustness in Services, the overall growth rates are still quite good.

Future of India is in jobs

Somebody asked me which of these papers is closest to you? After some thinking, I said the one on employment issues in India. Though, it hasn’t got me any comments (like the one on financial inclusion, impossible trinity etc) but this issue to me is one of the most important issue in India.

This issue nearly sums up what ails India as of now and the challenging path ahead for India. If the employment statistics are right then the trend of falling quality of employment is worrisome. Earlier the problem was of “growth without employment”. Now it is “growth without any quality employment”. Both ways, it implies, much of growth is shared by lesser number of people.

Similar thoughts were expressed by Dr Rangarajan in his paper. I also came across this paper in Fed’s International Finance Discussion Paper Series by Geoffrey N. Keim and Beth Anne Wilson which echoes very similar thoughts as well:

Projections of sustained strong growth in India depend importantly on the utilization of the huge increase in India’s working-age population projected over the next two decades. To date, however, India’s economic growth has been concentrated in high-skill and capital-intensive sectors, and has not generated strong employment growth. In this paper, we highlight the tension between India’s performance in output and employment, describe the characteristics of India’s demographic dividend, and discuss impediments to India’s shift away from agriculture.

Words of praise for Mostlyeconomics

This blog gets comments from many people and I would like to thank them. Recently, Finance Clippings Blog, written by Prof Richard Warr of North Carolina State University blogged:

Mostly Economics Blog

Just a quick mention of the Mostly Economics Blog. Plenty of good stuff over there on current market and economic conditions..
https://mostlyeconomics.wordpress.com/

 

Assorted Links

1. Jeff Frankel says odds of recession in US are above 50%

2. WSJ Blog points to Fedspeak- Kohn and Fisher. It points traders are betting that Fed might raise rates in October to 2.25%

3. WSJ pointsto a Dalas Fed research which says it is difficult to sustain oil prices at USD 100 levels. the summary is

The future of oil prices “will be determined by the same four factors that have shaped the market in recent years — global demand, expectations about future market tightness, the value of the dollar and fear of supply interruptions.” The paper argues “if these factors stay on their present course, prices are likely to be pushed higher.” But, “if one or more factors change, markets could see some easing of price pressures.”

4. Nudges points to a paper that says choices confude and exhaust people. I agree

5. Mankiw points Yen is a negative beta asset

6. Rodrik says Easterly is saved of some earful at a conference on development. Chris Blattman comments on the conference and Easterly

7. Fin Prof points to last day of Bear Stearns on Earth

8. EPSA Blog points to a paper on whether investment in agricultural technology will help in abetting food crisis in future

9. DB Blog points to reform of ports in France

10. TTR reviews growth commission report

11. MR points to tranformation of Chinese higehr education

ICRIER report on retail

The much-discussed (awaited) report is here. It is a very long report (250 pages) and would require a lot of reading to do.

Which government says this?

I had pointed sometime back that politicians/policymakers make similar statements/actions and geography doesn’t really matter. Whenever there is some crisis the response is very similar. But there are many commentators/experts in India who believe ours are the only ones. Read this for instance (thanks to Eurointelligence for pointing the same):

—- government blames high profit margins for rising consumer prices

—- is to counteract rising consumer prices by reinforcing stricter transparency requirements for retailers and their suppliers, reports —-. The reform package is a ten measures catalogue. Companies with high or deemed “excessive” profits will be listed in public. It will also oblige multinationals to reveal their wholesale and retail prices in other countries. There had been reports that companies move products from country to country with bogus sales between subsidiaries and sell those more expensively in —-.

To see who said it, see this.  

IMF’s next Chief Economist – Oliver Blanchard

Eurointelligence pointed that next IMF’s Chief Economist is going to be Oliver Blanchard, economist at MIT.  Eurointelligence points to this based on Reuter’s article:

The International Monetary Fund’s (IMF) next chief economist has said he is upbeat about the global economy, partly because of emergency measures taken by the U.S. Federal Reserve which have prevented the credit crunch causing excessive damage.

Olivier Blanchard, who will become chief economist of the IMF on Sept 1, said the Fed’s aggressive interest rate cuts and massive injections of liquidity since the autumn mean the threat to the U.S. from the credit crunch ‘is not enormous’.

On a global scale, Blanchard said authorities ‘understand fairly well’ the problems presented by the credit crunch, which include the bursting of the U.S. property bubble, the crisis in financial markets and soaring commodity prices.

This level of understanding makes him ‘relatively optimistic’ on the outlook for the global economy, Blanchard said.

The future IMF economist described the U.S. property crash as ‘one of the most standard crises you could have’, and played down the impact of the spike in crude oil prices, saying the world is not facing a repeat of the 1970s oil crisis.

He is pretty optimistic indeed!!

Assorted Links

1. WSJ Blog looks at Mishkin’s resignation

2. Mankiw points to Amartya Sen’s article on food prices. Chris Blattman comments on the article

3. TTR points China’s turn to lecture the West

Settlement problems surface in CDO markets

Those who believe wotse is over, there is some bad news. I think we are just seeing the tip of the iceberg. FT Alphaville pointed to this article which says trouble is back in Monoline insurance companies. What is Monoline? See this Wikipedia primer.

The blog post is based on this NY post article which says:

At issue is a type of protection that banks have obtained against defaults that is now preventing them from purging portions of their holdings of arcane mortgage securities known as collateralized debt obligations.

Under the terms of this protection, the banks need approval from the monolines in order to unwind these securities – and obtaining that OK is proving difficult in some cases

For the past several months as the credit crunch has pummeled mortgages and other forms of debt, a lot of collateral used to form CDOs has triggered defaults due to rating agency downgrades. As a result, if the banks begin dumping these problem securities, financial guarantors would be forced to pay default claims almost immediately – a tall order for companies whose financial future is already murky.

Typically, monolines pay out claims on losses over a period of 20 or 30 years, but the types of sales that the banks are looking to score would accelerate those payments and further hammer companies already hurting.

So, as I said in my CDS report, settlement is a problem with these complex instruments. In times of low volatility all these firms have taken up huge exposures to instruments expecting it to be this way all the time (20-30 years as per Monolines!!) . And now we see this mess and no one knowing how to settle the claims.

One should also read the various documents in these hyperlinks- you dont understand– the often stated claims of monoline insurers.

 

SEBI proposes a seperate equity exchange for SMEs

I have been reading about this in press for a long time that SEBI is proposing to launch a equity exchange for SMEs. Finally, SEBI has put a discussion paper and has invited comments.

It is a decent paper and covers the issues in a very comprehensive manner. It covers the need for the exchange and also points to the risks. Like these companies are more risky than those on the larger exchanges and thus might not be prudent for small retail investors. So it says some limits have to be put and only  those retail investors who can buy Rs 5 lakhs of securities in one time (primary and secondary) might be allowed. (Manas Chakravarty and Mobis Philipose of Mint  criticise this move).

But still, I hope the lessons from OTCEIare well learnt. Just because we need an exchange for SME alone will not suffice. There has to be a lot of push to get it going.  

I had done some research with colleagues on the topic (the paper is here, a more refined version by one of my colleagues Ayan Banerjee is here) and was amazed to see how this exchange has been ignored all along. It was launched with a big fanfare and had very similar backers as NSE. It was based on a state of the art technology with VSATs, etc. After few months, liquidity wasn’t there in many scrips and  continued to worsen. It was simply allowed to die and is a big puzzle why it didn’t take off.

Overall, I hope equity funding in SME picks up. One of my colleagues keeps lamenting that most PE/VC funds in India are not interested in SME sector. The size of the companies they invest in is much larger than the size of the average Indian SME. Plus there is heavy bias for IT/Software industry and other sectors are not adequately covered.

Have economists moved from Homo Economicus to Homosapiens

I was just reading this paper from Richard Thaler where he makes 6 (bold) predictions. The basic theme of the paper is that work in economics should shift from assuming rational agents (Homo Economicus) to normal human beings (homo sapiens) who is biased, overconfident etc. It is a fantastic paper full of wit and humor. Must read

The paper was written in 2000 and his predictions are for next couple of decades. So, have we shifted?

Yes we have but still it is pretty limited. There are many economists working on behavioral economics (see a profile of leading BE economists here) and Boston Fed has even set up a centre on research in the field (see this).

Still, we have a long way to go. Most economics work/papers is still based on Rational agents assumption and mathematical models. This paper by Oswald and Ralsmark looks at Future of Economics and has three findings: One of them is:

…contrary to numerous gloomy assessments of the state of academic economics –including some in the 1991 The Future of Economics centenary issue of the Economic Journal, compiled as a set of essays in Hey (1992)) — the great majority of these young economists are doing empirical work. Many people who criticise economists as bsessively mathematical have a view of economics that is out-of-date: our data paint a clear and more modern picture. The future of economics in the elite American universities seems likely to be heavily applied, not abstractly theoretical. Of our 112 researcherrs, few appear to be doing deductive theory for its own sake.

This paper is based on studying the resumes of the all Assistant Professors in Economics of the top 10 universities. The paper shows the popular research areas amidst the Professors and out of 112, only 5 are interested in Behavioral Economics. Now, many might shift to behavaioral economics in future, but most stick to their core areas. The authors have a nice Friedman quote at the end which is worth restating:

‘Again and again, I have read articles written primarily in mathematics, in which the central conclusions and reasoning could readily have been restated in English, and the mathematics relegated to an appendix…’

Assorted Links

1. WSJ Blog points US inflation could touch 5%. It also pointsto Fedspeak -Yellen on state of US economy. Meanwhile, the houseprices continue to fall.

2. MR points to a note on international capital

3. Mankiw points to a Jagdish Bhagwati (et al) article

4. DB Blog points to Nigeria easing its custom clearances

5. TTR points to dynastic politics. He also points to new UBS acronym- Used to be Smart.

6. IDB pointsto a microfinance firm seeking private equity investment

Credit derivatives in Microfinance

I came across this press release from IFC (thanks to IDB for the pointer) which says:

IFC will invest $45 million in credit-linked notes to be issued by MILAA (Microfinance Institutional Loans for Asia and Africa), a special purpose vehicle set up by Standard Chartered to facilitate microfinance lending. The notes will be linked to a portfolio of loans that the bank has made to microfinance institutions in Sub-Saharan Africa and South Asia. They will also enable the bank to extend additional credit to microfinance institutions that will in turn reach more unbanked people.

So, now we have Credit Default Swap in microfinance as well. For a primer on  Credit Linked Note see RBI’s draft guidelines (pdf).

I am not really sure of this development. With wide scares expected in CDS market, we have some developments in microfinance. It is not as if I am opposed to CDS in general, but we are still so unsure if how this is priced, ghow will they be settled etc. It is unregulated and no one knows how will it fare in case of a crisis.

Further Peter Sands, Standard Chartered Group Chief Executive remarked:

“This transaction will unlock more funding for microfinance. We believe improving access to finance is a key lever in reducing poverty and catalysing broader social and economic development. We hope other investors will be inspired by the IFC’s support of this transaction.”  

So, IFC-Stan C expect others to follow. I am sure they won’t be disappointed and we will see lot more deals in this sector. I just hope they do it carefully as they are dealing with a very sensitive sector- microfinance. And I liked the message on poverty. I would surely want to look at the spread on this deal!

Uniting Solow et al with Duflo et al

A new paper by Dani Rodrik is a must raed paper for those interested in Development Economics.

He calls it new development economics but it is actually trying to reunite the two distinctly emerging fields of development economics. His blogpost explains:

• Macro-development: focus on economic growth and tend to analyze economy-wide policies such as trade, fiscal, and currency policies.  Think Anne Krueger, Jeff Sachs, Bill Easterly, Paul Collier. 
• Micro-development: focus on individual-level outcomes and analyze microfinance, education, health and other social policies. Think Angus Deaton, Mark Rosenzweig, Michael Kremer, or Esther Duflo. (developed by MIT-PAL)
• The first group relies on cross-country econometrics or analytical country studies.  The second relies increasingly on randomized field experiments. 
• Both groups share the same objective: achieving sustainable improvement in standards of living of the poor. 
• But the way they go about it seems so different as to make them look like members of entirely different disciplines. 

What Rodrik says is the methods may be different but in reality both are thinking on similar lines- development policies shouldn’t follow the straightjacket mode and as each country is different , so should be the development policies.

Both approaches have their +ves and -ves and Rodrik says:

So my bottom line is that the practice of development economics is at the cusp of a significant opportunity. We have the prospect not only of a re-unification of the field, long divided between macro- and micro-development economists, but also of a progression from presumptive approaches with ready-made universal recipes to diagnostic, contextual approaches based on experimentation and policy innovation. If carried to fruition, this transformation would represent an important advance in how development policy is carried out.

Highly recommended

Assorted Links

1. WSJ Blog points to debate on oil prices 

2. IDBlog points Standard Chartered and IFC to partner in microfinance. Credit derivatives are being introduced in microfinance

3. Nudges points to useful Gmail default 

4. Rodrik points to a review of his book

5. Fin Prof points to a Bloomberg story on CDS

6. James Hamilton has a paper on what is leading to rise in oil prices. Should be good

How have quant equity funds fared?

I came across this CFA study from Fabozzi et al which is a survey of how equity Quants Funds have fared. Apart from the survey it is a nice primer on various topics like efficient markets, risk etc.

This website gives a nice summary:

Participants in the new Fabozzi-Intertek study commissioned by the Research Foundation of the CFA Institute attributed recent decay in performance at many quantitatively managed equity funds to rising correlation levels, style rotation and the fact that there are now more active quantitative managers using the same data and similar models. Specific to the problems many quantitative funds experienced in the summer of 2007, participants in the study attributed losses to the activity of hedge funds unwinding positions.
 
While alpha generation was identified by participants as the most important selling point for a quantitative fund, nearly three fourths of the study’s participants believe that it will become increasingly difficult for quantitative equity managers to find profit opportunities. The reason is that most models rely on similar predictive factors extracted from commercial data sets and academic models and therefore reach similar conclusions as regards investment opportunities.

An excellent survey!

Assorted Links

1. Ajay Shah points to papers on capital inflows

2. MR points to father of economics Blogosphere – Donald Lavoie

3. WSJ Blog points to Trichet interview

4. PIB asks motivating employees with cash or gifts?

5. DB Blog asks is Georgia the next Singapore?

Who is giving this speech?

Read this:

As everyone knows, the cost of food and energy is at record highs, creating economic distress for millions of working families in … and around the globe,” …. said. “At home, rising food and gasoline prices put a real and immediate strain on family budgets. And overseas, the consequences are even more dire. My own conclusion is that index speculators are responsible for a big part of the commodity price increases, and we …. ought to do the best we can to protect the public interest in an effort to bring food and energy prices down

I am sure most would say this is coming from some policymaker/politician in an emerging economy. But this comes from USA and these are words from Homeland Security and Governmental Affairs Committee Chairman – Joe Lieberman.

I read sometime back a post doing a similar kind of comparison. The words were from Zimbabwe’s Central bank but to the writer it appeared as if they were from India’s Central Bank! I mean you can’t compare India to Zimbabwe.

I keep reading the words of various experts on how ineffective India’s policies are and how good the west is. To me all looks pretty much the same. Policymaking is a tough job and usually comes with dilemmatic choices. It is not as easy as it is made out to be.