Archive for May 28th, 2008

Settlement problems surface in CDO markets

May 28, 2008

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

May 28, 2008

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

May 28, 2008

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

May 28, 2008

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

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