Archive for June 13th, 2009

How Merril Lynched Bank of America?

June 13, 2009

Committee on Govt Oversight and Reform held a hearing to discuss precisely the title of the post. Ken Lewis, CEO of BoA was asked to testify and one should really read his testimony and opening statements of the members.

The opening statement says:

On September 15, 2008, when the financial crisis was at its height, Bank of America announced that it was purchasing Merrill Lynch, creating one of the nation’s largest financial institutions. At the time, Bank of America’s CEO, Ken Lewis, called the merger “a great opportunity for [Bank of America] shareholders.”

When it was announced on September 15 th, this merger was a marriage negotiated between two willing parties. It was designed for the exclusive benefit of private shareholders, and it was to be paid for exclusively with private money.

Four months later, on January 16, 2009, after the merger was consummated and the quarterly earnings were announced, the world woke up to a different kind of marriage.

The American people discovered that Merrill Lynch had experienced a $15 billion fourth quarter loss. Most importantly, we found out that the merger had taken place only after the Federal government had committed to give Bank of America billions in taxpayer money.

What happened in the interim?

Lewis begins by defending the deal as an immense value creator and making BoAML a supermarket of financial services. He then shows how the alliance has led to them becoming a leader in so many financial services. He also adds how ML is now contributing bulk of the revenues as commercial banking has declined because of the recession.

Towards the end he reflects on the actual issue being discussed and says he had  expressed concern over ML losses and wanted to delay the deal. But was asked by US Treasury and Fed to continue it as it would pose huge concenrs to the system as a whole!

The closing statement of Chairman of the hearing sums up the entire thing best:

As we come to the conclusion of this hearing it’s important to remember that we have heard only one side of the story today. The Committee needs to hear from Mr. Paulson and Mr. Bernanke before we draw any hard and fast conclusions.

However, I do think it is fair to observe that a flawed financial regulatory process was at work in this case. We see closed door meetings, coded messages, motives questioned and private e-mails. Basically the regulators and the financial institutions seemed to be making up the rules as they went along.

As Congress considers financial regulatory reform, one of the lessons from this case is that we need much more transparency and accountability in our financial regulatory and oversight process. The American taxpayers and corporate shareholders deserve no less.

All you can do is  🙂 and shudder at state of affairs.

Developing Country’s Strategies post-crisis

June 13, 2009

Dani Rodrik has written a thoughtful paperproviding growth strategies for developing econs after this crisis.

First a bit of growth econ history. His basic presumption is that countries that have grown in the past 50 years have done so from specialising in industrial tradable products:

What is common about Japan, South Korea, and China is that they based their growth strategies on developing industrial capabilities, rather than on specializing according to their (static) comparative advantages. They each became manufacturing superpowers in short order— and much more rapidly than one would have expected based on their resource endowments. China’s export bundle was built up using strategic industrial policies that forced foreign companies to transfer technology, and as a result resembles one for a country that is three or four times as rich (Rodrik 2006). South Korea started out with very little manufacturing capability and quickly moved from simple manufactures (in the 1960s) to more complex products (in the 1970s). Japan, unlike the other two countries, had developed an industrial base (prior to the Second World War), but this base was totally destroyed in the war and was restored thanks to trade and industrial policies that protected domestic producers.

The general lesson to be drawn from the experience of these post-war growth champions is this: High-growth countries are those that are able to undertake rapid structural transformation from low-productivity (“traditional”) to high-productivity (“modern”) activities. These modern activities are largely tradable products, and within tradables, they are mostly industrial ones (although tradable services are clearly becoming important as well). In other words, poor countries become rich by producing what rich countries produce.

Hmm. And what were the policies?

First, it is clear that sound “fundamentals” have played a role, as long as we interpret the term quite broadly and not associate it with any specific laundry list of policies 

Second, all successful countries have followed what one might call “productivist” policies. These are activist policies aimed at enhancing the profitability of modern industrial activities and accelerating the movement of resources towards modern industrial activities. They go considerably beyond the conventional recommendation to reduce red tape, corruption, and the cost of doing business. They entail in addition (or sometimes instead): 

  • explicit industrial policies in support of new economic activities (trade protection, subsidies, tax and credit incentives, special government attention);
  • undervalued currencies to promote tradables; and 
  • a certain degree of repression of finance , to enable subsidized credit, development  banking, and currency undervaluation.

This is pretty much the advice Rodrik (along with others at KSG School) has given across the years. He then looks at the criticism of each of the above three growth strategies.

He then says this crisis has led to 3 things which are of concern to developing econs:

The indirect effects operate through the channels of international trade and finance. Three likely developments here are of potential concern: (i) reduced appetite for cross-border lending; (ii) slower growth in world trade; and (iii) less tolerance for large external trade imbalances.

As per Rodrik, each of the three are not a concern for developing economies. Instead by focusing on industrial policies to produce tradables and focusing on domestic demand, the developing econs can still grow.

Read the rest of the paper for more details. As usual Rodrik does not disappoint and has some great insights for developing economies and its policymakers.

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