15.10.2008

• The triumph of communism?
• Reports that USA has drastically altered its plans from merely buying sticky mortgage assets, for which there are no takers, to a direct infusion of $250 bn capital into thousands of banks' stocks makes me wonder whether it is the triumph of socialism. Even in UK the contours of the bail out plan that has been announced are becoming clearer by the day. They show that the government there too is buying preference shares in the banks to shore up their capital. It would be interesting to see what capitalism's theorists have to say now. What kind of laissez faire is this? The very things that the West has preached against over time to the emerging and developing economies, are now being indulged in by them.
  
• Treasury secretary Henry Paulson has reportedly urged the banks to use the funds to spur economic growth, rather than hoard it. The deal entails that these banks will have to cap executive pay and “golden parachute” payments made to CEOs.
• What is meant by 'golden parachute' payments in the above note?
• A golden parachute is a non-contractual agreement between a company and an employee (usually upper executive) specifying that the employee will receive certain significant benefits if employment is terminated. Sometimes, certain conditions, typically a change in company ownership, must be met, but often the cause of termination is unspecified. These benefits may include severance pay, cash bonuses, stock options, or other benefits. They are designed to reduce perverse incentives.
• Why is the bail out package announced by the US likely to fail in achieving its purpose?
• In an op-ed piece in today's ET H. Chander writes the following:
• The bail out fails to recognise the nature and the extent of the problem, its geographies and the number of entities affected by the crisis. By now, reams of newsprint have been used to write that the crisis is not confined to mortgages, rather it stems from the paying/buying capacities of the users of loans and may get extended to retail loans. It may even spur credit card defaults.
• Firstly, EESA authorises the Treasury Secretary to establish Troubled Asset Relief Program (TARP) to buy troubled assets from any financial institution. Troubled asset means residential or commercial mortgages and any securities, obligations, or other instruments that are based on or related to such mortgages, that in each case was originated or issued on or before March 14, 2008, the purchase of which the Secretary determines promotes financial market stability and any other financial instrument purchase of which would achieve the same purpose. The problem with this is that it’s called TARP, while it should have been Troubled Assets Stabilisation Program (TASP). The troubled financial institutions need capital and not relief which would not shore up their capital and the relief to the entire system comes from the stabilisation of the troubled assets and not from foreclosures.
  
• Secondly, the term financial institution means any institution, including, but not limited to, any bank, savings association, credit union, security broker or dealer, or insurance company, established and regulated under the laws of the US or any state.
  The implications of these two terms constitute the second reason for which the package might fail. The economists have already established that most of the troubled financial institutions are unlikely to get the much-needed capital from this package excepting those who had made aggressive provisions against the troubled assets. Further, due to the inclusive nature of the definition of the term financial institution , the amount might get distributed to hundreds or thousands institutions thus not benefiting the system.
  
• When or how did the Bretton Woods system got crippled?
• It came about when in the sixties, in the wake of Vietnam war, the US started running huge trade deficits. If it tried to correct the balance of payment situation, it would result in serious liquidity crisis at home. And if it allowed the deficit to continue, the international community would lose their confidence in the dollar as the reserve currency and clamour for converting their dollar reserves into gold. Under the huge post-war burden, as deficits continued to mount and the dollar continued to lose its sheen, the US reneged on the Bretton Woods agreement, by unilaterally dumping the convertibility of the dollar into gold, ending the exchange rate regime agreed to at Bretton Woods. In effect, the regulation of global financial order has been crippled ever since under the financial muscle of the US, making it the biggest beneficiary of this lack of global regulation.
• Deposit cover to be doubled
• With a view to infuse more confidence in the country's banking system, the Government is contemplating increasing the maximum limit for deposit insurance cover from Rs. 1 lk to Rs. 2 lk.
• What is deposit insurance? All those deposits of Rs. 1 lk (now proposed to be raised to Rs. 2 lk) and below now with the banks, are insured against a bank going bust. So even if the bank fails, the depositor will get his money because the deposit is insured with DICGC.
  
• Deposit Insurance and Credit Guarantee Corporation (DICGC) is the nodal body working under RBI to oversee deposit insurance activity in the country. Deposits with all scheduled commercial banks, co-operative banks and regional rural banks are insured. All banks have to pay a certain premium to the Council to get their deposits covered. The increase in cap to Rs 2 lakh is also likely to increase the outgo of the banks on account of higher premium allocation for deposit insurance.
  
• Deposit insurance was introduced in India in 1962, the second country in the world to introduce such a scheme after the United States, which had launched the scheme in 1933. The government had introduced deposit insurance to save the country’s banking system from crises-like situations. It was in 1960 that the failure of Laxmi Bank and the subsequent failure of the Palai Central Bank catalysed the introduction of deposit insurance in India.
• EC announces elections in five states
• CONTROL of five states is up for grabs with the Election Commission on Tuesday announcing the schedule of assembly elections. The election season, which stretches from November 14 to December 4 will see the electorate deciding on their choice to lead governments in Madhya Pradesh, Chhattisgarh, Rajasthan, Delhi and Mizoram.
• This graphic gives you enough details about these elections.
  
• How is it that the current financial crisis will not pose problems for the Indian IT sector? And what are the challenges that the Indian IT companies should be ready to face?
  
• When companies eventually emerge from the crisis they would start thinking of how to get their work done in a much more cost-efficient manner without compromising on quality. India still has all the ingredients to be the best offshore destination for IT services/BPO work requiring significant scale. As crisis situation starts wrapping up western organisations would look restructuring at a large scale. This will bring lot of opportunities and, given India’s reputation and credibility, there’s a big role to play for India’s IT sector. It is going to be a time of stock-taking and putting your house in order.
  
• The key challenges the Indian IT sector (and the Indian offshore service providers in particular) is facing are rising overall cost structure, paucity of skilled resources, over dependence on US geography and linearity in business model. It is high time the Indian IT sector put its house in order and took some concrete steps to effectively meet these challenges.
• The Hedge fund market
• There are reportedly about 3100 hedge funds worldwide managing about $1.9 trillion as of June 30, 2008.
  
• Many of the hedge funds are reportedly losing tonnes of money in the current financial meltdown. This year's investment losses may see almost a third of them closing in the next two years.
• Hedge funds are based on the premise of making money whether the markets rise or fall. But if recent performance of many of these funds is any indication, they won’t be able to collect performance fees, usually 20% of gains, while management fees, usually 2% of assets, will shrink.