A Clear Policy on future bailouts

Senator Ron Paul is keen to get the Fed audited and closed. I don't know how that will pan out but I would seek clarity in one aspect of Fed's functioning. The bailout criteria needs to be defined and communicated.

We need a decision tree to understand how Fed will hereafter decide who gets bailed out. The current "case-to-case basis" and "threat to financial system" arguments are too esoteric. We need clear principles and guides to understand how such decision will be made in the future. There are four critical element of "Guidelines of future bailouts" plan:

1. We need clear understand of who can seek a bailout. Is it banks? Are insurance companies allowed? Who is allowed? Who is not? Why?
2. The next part is within this set, who are eligible for bailout, how will you choose? What self-help measures the company has to go through first before coming to Fed for the bailout? What if someone exceeds Fed's / other regulators benchmarks for leverage? Or pays excessive bonus? Will those companies get bailed out too?
3. How will the bailout amount be decided? Will it come entirely out of Fed gurantees? How about untouched bonus pools? How about unwinding risky position in hard-to-sell paper?
4. What happens after companies are bailed out? How will they be restructured? How will Fed ensure that those funding the bailout (US citizens) get control over the company?

It is right time to initiate the plan. We have Ben Bernanke at the end of his term. We have some green shoots so markets are reasonably calm to absorb and accomodate the rules of the game. I believe this will reduce uncertainty in the markets. I think it is a moral duty to explain to tax-payers how future bailouts, if any, will be decided. Moreover, I believe tough times lie ahead. It is better to be prepared with a plan - at least for things that we know we might need.

Exchange Rate appreciation

The Reserve Bank of India (RBI) announced the monetary policy on tuesday 28th. In one of the innocuous statements RBI mentioned it will allow appreciation of Rupee if there is higher capital inflow than can be managed through intervention. Not many commentators weighed in on this at the time. But that represents the most important signal.

Felix Salmon explains the dilemma of the asian central bankers in more details. RBI has sensibly tackled the financial crisis as of now and this indicates RBI is one of the intelligent central banks around. China faces this dilemma more critically as it wants an undervalued Yuan. To top its list of worries the GDP is rising really fast. If there is one way to attract big money then this is it.

There is a good chance central bankers will soon resort to good old capital restriction. This will be the first blow in the test of globalisation. This threatens to raise the friction between countries. We are witnessing increase in friction over anti-dumpting duty imposed by EU on Chinese.

Such regulatory threats have the potential to create more cycles in markets. So this is definitely going to be painful - we will have to hold our nerves. Fortunately or otherwise, we cannot, will not be able to reverse the globalisation.

Why no one saw the crisis coming?- An explaination for Queen Elizabeth II

The question reminds me of King Charles II who invited members of the Royal Society to explain why a dead fish weighs more than same fish alive. After the Royal society provided various explanations it was brought to everyone’s notice that they actually weigh the same! It is the same with current economic crisis.

The group of eminent economists could not foresee the current crisis due to “failure of collective imagination of many bright people”. In my humble view, your highness, this is incorrect. Nobody actually bothered to make the real‑world observations. How could one not notice unemployed people buying multiple homes? Or, how could they not notice people with mortgage repayments more than their incomes?

Such ignorance on the part of trusted few will cost the world dearly. The developed world, including Great Britain, is on throes of worst economic decline spurred by international debt. We are facing a decline in standard of living that will undo decades of development. In such times of calamity, the elites are busy retrofitting explanations to history. The “group of eminent economists” has been deeply inbred and so have all other eminent groups who run the financial system. These are groups formed between likeminded fellows, those conforming to specified views. These groups have shown clan-like behaviour ridiculing alternate points of view. One only needs to look at ridicule heaped on likes of Peter Schiff, Nicholas Nassim Taleb, Nouriel Roubini and others. These groups lack diversity of opinion to understand multiple facets of financial, economic innovation.

I further disagree with the economists’ gracious claim that everyone was doing their job to the best of their abilities. If guarding the door “to the best of our abilities” when thieves attack through the window, you are not much of a guard, are you? Sadly, even the press has abandoned its duties of fourth estate. Our journalists no longer reflect on social implications and problems but often report from their own ivory towers. We haven't seen any pointed intelligent debate between press and policy makers even as policy response aggravates the crisis further.

To ensure such crises never occur again, we need more respectful cross-disciplinary debates involving social understanding and moral values. We need philosophers and cross disciplinary thinkers more than ever. Usually, such is the responsibility of the House of Lords. Are there, if I may humbly ask, real knights amongst your ranks, your majesty?

Note: This is a response to Guardian Story about Economists explaining how the crisis happened to the Queen.

Future of Financial innovation

There has been a lot of talk about financial innovation being bad for general populace. Economist blogs about it Financial innovation in the rearview mirror quoting Tyler Cowen and Felix Salmon. This pulls up a paralled to pharma industry in my mind.

Just like we have drug testing labs for pharma companies, we need labs and regulation for finance innovations too. In a sense, sub-prime was a drug being directly tested on population. The result is predictably disastrous. The Consumer Financial Protection Agency (CFPA) could take up such a role. Then, if pharma is any indication, we will have lot more innovation in the near future.

Pharma industry also created higher cost structure to foster innovation. The regulatory burden along with pseudo-barriers in the name of intellectual property created unaffordable costs. The opportunity before the CFPA is to set the benchmark for simplied, easy to athere but difficult to cheat, low cost regulatory structure. CFPA, all eyes are on you!

Chris Anderson explains Free / Freenium

A lot of people get confused with Chris Anderson's book free. Particularly because his book is free. Here he explains the concept in details. A fantastic read about changes in business models.
Charlie Rose - A conversation with Chris Anderson of Wired Magazine

A re-polarization in Risk Structure of Investors

Tadas Viskanta notes how hedge funds have survived the current crisis in his post The curious incident of hedge funds during the financial crisis Abnormal Returns. This refreshes an old idea I had earlier about polarisation of investor companies based on risks.

Capital providing institutions were divided into two based on this. Banks (low risk) and Equity investors (higher risk). But now we have finer risk classifications. The resultant business models were, in a crude way, spread across the risk spectrum. The downside was the risk demarcation became a little (a lot?) fuzzy. Large banks too moved towards higher risk assets (CDO etc) and were burnt. Equity investors came with low-risk schemes that have mostly lost money. The money-making strategies in current market situations align better with clear risk demarcation. That's why possibly hedge fund survive.

The investment rules getting too tight is basically a risk reduction strategy. It will be wiser, possibly, to remove constraints on fund managers. Money managers who manage their own book may be better off with the flexibility (provided their reading of markets is correct of course).

China led recovery?

The largest consumers, US, EU and Japan are spent. US has domestic and corporate indebtedness. Japan still languishes from the lost decade. EU members sit across the spectrum between US style indebtedness to that of 1980s Japan. Only country who has the right cards is China. It is significantly big and fast enough to turn the course of the history. So then will China play its hand right?

Well, it is not inspiring any confidence to say the least. Micheal Pettis points to Notes on a real estate trip in China where we realize that Chinese policy of investment driven demand is banging against the wrong wall. China is looking for the final buyer that we discussed earlier.

Meanwhile, I notice market feedback, logic structures and arguments are regaining 2007 flavour. This definitely does not auger well for any of us. It is as if markets have noted Roubini near term possibilities but are still ignoring Taleb's long term solutions. (Taleb has attacked the root causes VAR, (ill-applied) probability theory, portfolio theory and algorithm trading framed on these.)

Where is the Greenspan Model?

I remember that there is a Greenspan model that Alan Greenspan used to determine if markets were fairly valued. It pointed to over-valuation in 1998 and again in 2004. Where is that model now and what is it indicating given the current earnings scenario?