Two Questions for business leaders

Masaaki Shirakawa, Governor, Bank of Japan in his recent speech asks 2 very timely questions:

I would like to first pose two questions to the top executives that are here with us today.

First, in the years heading up to the crisis, especially the five year period between 2003 and 2007, did you recognize that risks were building up in your institution and/or in the financial system?

Second — this is a question about the now famous quote regarding dancing with the music — if we were in the future to experience a similar benign economic period of high growth, low inflation, low interest rates and low market volatility, would you choose a different business strategy? If you were to choose a different strategy, what would be your expectations on the path that senior executives of your rival institutions would choose?

The answer to the first question is all to obvious now- No we did not. Though some may say they saw risks but didn’t really do anything to mitigate it. The best account os risk management in firms is given by Andrew Haldane of BoE. It was complacenecy and awareness of moral hazard all through. Ignorance of economic history was another very important factor.

It is the second question which interests me more. Ok we can say people have made mistakes and we need to give them a chance to learn from it. Quite a few people have not experienced a crisis, so deserve another chance.

Alas all this is anything but true. The way equity market, oil markets are rallying makes me wonder whether this is really that big a crisis as it is made out to be?? The same experts who said we have learnt lessons and will be cautious next time a rally happens, are all reversing their words as if nothing has happened. And of the 4 factors which Shirakawa cites – benign economic period of high growth, low inflation, low interest rates and low market volatility- none are really there. There is low inflation but it is because of depressed economic activity which is negative and not because of positive factors like increased productivity etc. There are low interest rates as central bank policy rates are at their lowest but lending rates are still high.

Once again low interest rates are leading to excessive liquidity searching for yield. The liquidity seems to have been waiting for some green signals to emerge. The moment Bernanke said he is seeing some green shoots suddenly all barren fields became high yielding green ones. All the caution has been thrown to the winds. The utter pessimism has become utter optimism in one flash.

Coming back to Shirakawa’s question- most business executives are hardly doing  anything differently. They are back to the same track with each one showing huge positives ahead.

Let me focus on India because I watch things more closely here. The Indian growth rate is now being revised upwards (9% seems to be a cakewalk), the new targets are coming for equity markets (BSE Sensex initial high 21k is a given, the target most asked is 30k), the company prospects are suddenly looking bright etc etc. The markets have ignored the huge fiscal risks we are facing (it is just 11% fiscal deficit) and most sectors are asking for more fiscal stimulus.

Again reflecting on Shirakawa’s question – the Indian business executives are back to their old track. You can see same statements being made on various media channels which they said when times were good. We have again started making the same assumptions which have gone so horribly wrong just a few months back! All kinds of fancy stories are being built.

An analyst friend was telling me it is pretty difficult for anyone to miss this rally. So even if some people r’ber their lessons, the business decision usually is to follow the herd. 

UTI MF Chairman in a recent interview said:

Has the mutual fund industry learnt its lessons from the meltdown (in the money market segment ) of October 2008?

I wish the lessons had been learnt. But I don’t think so that has been the case. The support provided by the government and RBI in October (2008) was in the context of the larger financial system, and not to bail out any particular scheme or any particular mutual fund. The lessons that mutual funds should have learnt from this turmoil is: not to grow assets (under management) at any cost and not to invest in low quality paper. Till around December, the industry was cautious. After that the old practices have begun. Fund managers are again buying assets (under management) — they are paying distributors and corporates to buy assets — there are stories of how structured deals are happening once again.

I am not saying things are still as bad. Gulzar in his superb blog shows green shoots are being seen in Indian economy. However, what was needed was some caution from the executives which is missing. You cannot forget history so quickly.

A final word on India’s GDP. What I gather is people feel 9% GDP growth rate in India is a given.  Once this crisis gets over, India will again come back to 9% growth. As a result all this rise in asset markets is justified.  

However, we must not forget that 9% growth rates were also because of the very favorable external business environment as well. It wasn’t as if 9% growth rates were mainly because of Indian conditions. If it was the case we shouldn’t have been affected by the global crisis at all.

Now, to create similar sort of external environment would take quite a bit of effort and good luck.  And we now know such an environment could easily lead to a huge disaster later on. So we must do everything to not rush into things. However, what we are seeing is exactly the opposite. Why forget history so soon?

4 Responses to “Two Questions for business leaders”

  1. Interest Rates » Two Questions for business leaders « Mostly Economics Says:

    […] Read the rest of this great post here […]

  2. Buiter on Fed-Treasury Games « Mostly Economics Says:

    […] is even more puzzling is the way our financial markets and market participants are behaving. Just because it is on our interest to move markets up, it does not mean we should ignore a risk as […]

  3. bill greene Says:

    I believe the questions were aimed at the wrong people. Most business leaders were operating their companies well and prudently. They had little say about the mortgage–housing–financial shenanigans going on between the federal agencies, Congress, and mortgage lenders. The panic occurred primarily because those institutions accumulated a lot of over-valued debt instruments. With the government guaranteeing bad loans what else could have happened? The federal agencies, insurance companies and banks were suddenly faced with their need for reserves that equalled or exceeded their net worths.

    Most manufacturing and service companies were and still are in good shape, suffering just the dislocations caused by the finacial sector. Many such companies are maintaining or increasing their earnings and dividends.

    Thus the question should be addressed to the members of Congress, especially the House Bsanking Committee, the Treasury and HUD Secretaries, the heads of the major banks and insurance companies, the people at the SEC, and all the academic economists who follow the finance and mortgage statistics. Those are the people that should have seen it coming.

    In cases like that, where something should have been obvious to certain individuals, the answer is often that they either had to be incompetent or corrupt. No other excuse is available. In this case, both answers applied, more or less, to the various perps. Unfortunately, that makes a lot of such people and organizations to blame, and they represent the political and economic elites of the country–which shows just how bad our leadership has become. The morass of legislation complicated matters, and the reversal of prior successful regulatory requirements, combined to so confuse the markets that it became a fools’ parade.

    Revoking Glass-Steagal, adding the “mark to market” by Sarbanes, loosening at the SEC, HUD promotion of bad loans, and Fannie Mae and Freddie Mac excesses were the work of government elites. And it all followed very similar melt-downs with, first, 3rd world debt, then S&L debt, then Mexican debt, and now mortgage debt- These occurred every decade for the past forty years with the same pattern of government encouragement, government guarantees, followed, after the crash by government bail-outs. With this pattern of rewarding bad behavior, where can anyone go to protect themselves? The question for the future-for all Americans–is whether there is any place safe from governmental policies for investors to go?

  4. Worst is behind us…really? « Mostly Economics Says:

    […] this time, no hype, no baseless forecasts etc etc. However, I just see the opposite.  I had raised this point earlier but requires a […]

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