Saturday, March 31, 2018

Markets in bail bonds - the limitations of market solutions

The Times carries a very good story on bail bond agents in the US. The $2 bn industry has its business to deliver their clients to court, by charging them with non-refundable fees for the service of guaranteeing their bond and securing bail. The Times writes, 
The bond agent takes a fee in exchange for guaranteeing the amount of the bail on the defendant’s behalf. But the fee — or premium — usually about 10 percent, is too high for many defendants, the vast majority of whom are poor. So they arrange a payment plan. The debt, paid over weeks or months of installments, can outlast the criminal case. The arrangement can include steep late fees or require signing over collateral worth many times what is owed. And while defendants, or the family members and friends who often shoulder the costs, typically pay no interest as long as their payments are on time, if they go into default they can trigger annual interest rates as high as 30 percent...
The system has worked well for the industry, even attracting private equity investors. Mom-and-pop bail companies are backed by large surety companies, which guarantee the full amount of the bond in exchange for a portion of the premium. Together, the surety companies and the bail bond agents collect about $2 billion a year in revenue...
As commercial bail has grown, bond agents have become the payday lenders of the criminal justice world, offering quick relief to desperate customers at high prices. When clients... cannot afford to pay the bond company’s fee to get them out, bond agents simply loan them the money, allowing them to go on a payment plan. But bondsmen have extraordinary powers that most lenders do not. They are supposed to return their clients to jail if they skip court or do something illegal. But some states give them broad latitude to arrest their clients for any reason — or none at all. A credit card company cannot jail someone for missing a payment. A bondsman, in many instances, can. Using that leverage, bond agents can charge steep fees, some of which are illegal, with impunity, according to interviews and a review of court records and complaint data. They can also go far beyond the demands of other creditors by requiring their clients to check in regularly, keep a curfew, allow searches of their car or home at any time, and open their medical, Social Security and phone records to inspection. They keep a close eye on their clients, but in many places, no one is keeping a close eye on them.
Such services typically operate in regulatory vacuums,
Bond companies fall into a sort of regulatory gulf between criminal courts and state insurance departments, which are supposed to regulate them but seldom impose sanctions. With rare exception, defense lawyers and prosecutors are too busy with their caseloads to keep bond companies in line. Further complicating things, it is often unclear whether consumer protection laws apply, and insurance departments say they lack the resources to investigate complaints.
And even where the law is clear, enforcement failures is typical of markets which service predominantly the poor, 
Though California law appears to be quite clear about what bond agents can charge, a review of more than 100 bail contracts and legal documents by the criminal justice reform clinic at the University of California, Los Angeles, School of Law found that such protections were routinely ignored. The contracts included all manner of additional costs, including late fees, interest on delinquent balances and “renewal premiums” that required the defendant to pay again to stay out of jail if the case was not resolved within a year.
In the final analysis, the logic of market efficiency is elusive,
The entire premise on which the commercial bail system is built — that when defendants skip bail, someone must either find them or pay, is somewhat illusory.
The problem with any private sector based solution to what are essentially public services (bail bond enforcement) is that market failures invariably develop and concentrate around fleecing consumers, skimping on expenditure, creating social costs, stretching the boundaries of the law, and in general cutting corners wherever possible. All these get amplified if the services serve predominantly the poor.  

Supporters would argue that the problem is with poor regulation and once it is sorted out, then everything would be fine. This situation is something like saying free-trade is great as long as there is a mechanism to sufficiently compensate the losers. When we know that some assumptions are impractical, it is just as well to acknowledge the failing of the original idea itself!  

The point I wish to highlight when I post such examples, as I often do, is not a blanket assertion that markets are bad or ineffective and governments are good. Far from it. 

Instead, my point is that the problems that governments typically deal with are complex ones - some people call them wicked problems. It is facetious to then carry the generalised perception that the private sector and markets can solve them more effectively. At best, we can say that market solutions are more likely to be effective in certain limited and specific contexts (or when certain conditions are available) or to address certain parts of the problem. But for the major part these problems are better managed by governments and the focus should be on trying to make public systems manage them more effectively.

Wednesday, March 28, 2018

Shareholder capitalism - JP Morgan Edition?

Consider this story of a large financial institution located in the country considered the flag-bearer for rule of law and free-market capitalism. The firm is charged with misleading clients, selling dodgy securities, deceiving and mis-selling to customers, rigging bids and interest rates, foreclosure abuses and mortgage misrepresentations, market manipulation, predatory sales, fraud cover-ups, and so on. In sum, the full spectrum of white collar crimes, many with outright criminal liabilities. And those at the receiving end included both retail customers, regular investors and high-net worth ones, and institutional investors, including public pension funds.

Enough one would have thought for the knives to be out - dismissal of the CEO, replacement of the Board, imprisonment of several employees including maybe even the CEO, radical restructuring of the firm, and so on. And also the country being the paragon of strong institutions and free-press, one would have thought of vociferous outrage if the regulators back-pedalled on any of these. 

So some questions. What happened to the CEO and the Board? What happened to those found responsible for these individual charges? What happened to the firm? 

Answer. None of the expected scenarios. In fact, exactly the opposite. The Chairman became the most influential and admired Bank CEO in the world. The firm became one the largest and most powerful banks in the world. Not one employee at any serious enough levels, leave aside executives, went to jail. The executives got promoted and were paid out fat bonuses. What's more, the CEO became the highest paid Bank CEO in the world, making the median employee's salary in just one day! 

For the record, this is no banana republic and any ordinary small financial institution. This is the United States, home to the Wall Street, corporate governance standards, beacon on shareholder capitalism and so on. These crimes belong to the long list of achievements of JP Morgan under Jaime Dimon that Zero Hedge has listed out. 

In the aftermath of the global financial crisis and spooked by some high-profile bank failures, the remaining few large banks like JP Morgan benefited from state support that helped them through the crisis not just unscathed but bigger and with a larger share of the market. As to Dimon himself, he enriched himself with $28 m in salary for 2017. He is feted everywhere as the face of the new Wall Street. He even sits on the New York Federal Reserve, influencing sabotaging any financial market reform proposal that seriously hurts Wall Street's interests, and advises the President of the United States on national economic policies by sitting on the President's Business Advisory Council. 

JP Morgan settled all these cases with a host of US regulatory agencies - SEC, DOJ, CFPB, FHFA, OCC, and even the FERC - and paid a small amount of over $35 bn in just over 3 years. And these fines came not from the salaries and bonuses of Jaime Dimon and other executives, but from the profits accruable to its shareholders. Not one person at the leadership level has been held accountable for the $35 bn in fines, leave aside all the frauds and crimes. It is almost as if those fines and long list of charges were respectively the cost and legitimate actions to boost the firm's share price and profits. 

In simple terms, Dimon and Co bet the Bank and lost, brought the entire financial markets to the brink and the economy to its knees, and came out rewarded with more adulation and much higher salaries!

Monday, March 26, 2018

The challenge of marrying experiential and evidentiary knowledge

Manu Joseph has this very nice article which distinguishes between the arrival of an idea and its justification, their relative merits and importance, and the way in which society perceives each,
An idea comes to some minds as an intuition, to many in the form of faith or imitation, or a convenient corroboration of a bias. An idea always arrives as a realization, spreads as a belief. The arrival of an idea is a religious moment. But its legitimacy is proved in public and private through the fabrication of rational substantiation. An argument then is reverse engineering of a religious moment. Here I am not referring to collegiate people who can debate either way, or are paid to debate for a cause in television studios. I am only referring to people who have ideas, or at least convictions. Even when they practise it, is debate as intellectually robust and pure as we are trained to assume? Isn’t it true that all debates emerge from the scripture of personal faith? Is the pre-eminence of debate then overrated? In the hierarchy of intellectual activities, why is this method of transmission of an idea more respected than the very force that creates ideas—intuition? An intuition is not a supernatural force—it emerges from dormant or subterranean knowledge. Even so, science celebrates intuition only after it has been proven to be right. Can it be that across the ages, superior thinkers have been subdued by lesser minds who were and are merely good debaters? Is the transmission of truth now entirely in the hands of the articulate, who are better at transmission than truth?...
When we debate, argue, or even write a column, we build a case, we substantiate our argument and consider opposing views. There is one thing we do not say at all—how we actually got the idea. Usually, an idea does not come to us after an argument with ourselves, or after a deep investigation into the facts. This is not how ideas usually arrive, or form. The argument does not create the idea, the idea creates the argument.... But the imitation of scientific debate in politics, economics, culture, even literature and other aspects of the subjective arts, is outrageous. In television studios and around dinner tables, people are forced to dress up their intuition or beliefs through the masquerade of logic and evidence. That is a wasteful decorum of modern intellectual life.
This has resonance with the ongoing obsession with argument in the form of evidence generation among development cosmopolitans (not practitioners) residing outside the development context. I have a plausible explanation for this in the case of international development. 

All of the doing in international development is done by the practitioners from inside, especially the government officials, for-profit social enterprises, and non-profits working in the field. A lot of the thinking about and funding of international development is done by outsiders or foreigners. There is a vast difference between how the two parties process information. 

Both sides are equipped with the analytical framework and evidence, the latter much more so than the former, though sufficient for the former to make informed enough comparative and objective judgements. Let us call this the evidentiary knowledge. Then there is experiential knowledge, which comes from a deep understanding of the context and its nuances, informed by a rich and diverse set of experiences accumulated over a long period of living and working in those contexts. By the very nature of their respective nativities and careers, the former internalise this deeply, whereas the latter are sorely deficient. Whether we like it or not, that's the way the world is and we need to accept it. 

Accordingly, the former discounts their evidentiary knowledge base with their experiential knowledge base to make judgement calls. This IT App or innovative product (in any sector) with an RCT to back its efficacy looks logically great but the practical challenges are too many that it is unlikely to make a dent on the problem which is significant enough commensurate with its opportunity cost when compared to alternative efforts (a very relevant trade-off in capacity and resource constrained environments). In contrast, the latter, with an evidentiary knowledge base which is as rich as their experiential knowledge is poor, process information overweighting evidence and logic. So the same IT App or innovative product, with its logical neatness and rigorous enough evidence, looks very appealing.

None of this is to overlook the inevitable human behavioural failings associated with both sides. In the case of the former entrenched priors socialise out evidence and manifest as prejudices. In the latter, logic crowds out reality and manifest as algorithmic reasoning.   

In conclusion, we have the classic tension between inductive and deductive inferences. The former uses inductive inference that draws on a rich set of priors to exercise judgement. In contrast, the latter uses deductive inference to rationalise from a logically drawn and rigorously proven theory of change. 

The gulf is actually much bigger. While talking of experiential knowledge, we grossly underestimate its richness and value. One only needs to keep in mind Karl Polanyi's description of tacit knowledge, "We can know more than we can tell".

Saturday, March 24, 2018

Weekend reading links

1. The persistence of the belief in the use of Public Private Partnerships (PPPs) to address acute problems in health and education, despite overwhelming evidence to the contrary universally from across the world, is an example of why development is a faith-based activity. This is the latest attempt to use PPPs to solve deep structural deficiencies in health care. 

The problem with PPPs in Indian context, apart from the inherent challenges associated with contracting and contract management in these sectors, is that of supply-side constraints with the market itself. PPPs are not going to attract specialist doctors into small town district hospitals. There are unlikely to be more than just a few providers across the country with the attitude and expertise to deliver faithfully and effectively on such contracts. 

The belief that the likes of Apollos and Fortises will step forward to deliver healthcare while also keeping the social equity objectives in mind is misplaced. Forget doing PPPs, these corporate chains do not seem to have the resources and management capacity to even expand by much in their own urban terrains and are now having to fight off foreign takeover attempts. 

2. Livemint points to disturbing signs from India's labour-intensive industries. Since the introduction of GST, exports have been declining, imports rising, production falling, and rural wage growth slowing when compared to the capital intensive industries. 
3. A Livemint analysis of a sample from the Prowess database of over 27000 listed and unlisted firms from both industrial and services sectors provides empirical evidence that the heavy lifting with respect to job creation is done by the small firms. As the graphic shows, the smallest quartile of firms in terms of sales revenues have consistently created more jobs than those in the biggest quartile. 
Further, the largest firms were net job destroyers in recent years. This is in accordance with trends in the developed countries and elsewhere.

4. More labour market news, as Livemint reports of a steep increase in the share of contract labour in organised manufacturing. The graphic shows the share of contract labour from ASI data
To put this in perspective,
In the 17 years between 1997-98 and 2014-15, the compound annual growth rate (CAGR) of directly employed workers was a piffling 0.55%. In stark contrast, the CAGR of contract workers over the same period was 6.79%... In the manufacture of motor vehicles, for example, workers employed as contract labour are now 45.9% of total workers employed. In 1997-98, contract labour was 10.9% of total workers directly employed.
This trend is likely to accelerate as the government has just issued revised rules expanding fixed tenure of contract labour across all industries. 

5. Fascinating comparison of the fates of Martin Shkreli and Elizabeth Holmes, two people who rose to prominence as pharmaceutical entrepreneurs and who have been convicted/admitted of white collar crimes to defraud their investors.

The former gained notoriety for acquiring the rights to generic drugs for rare diseases before jacking up their prices, was convicted for fraud involving $10 million (though he did finally repay the investors, all of whom were wealthy people) for his activities at two hedge funds he ran. The latter becoming a darling of the VC world - appearing on the cover of Forbes, becoming a member of the Board of Fellows of Harvard Medical School, and receiving the Horatio Alger Prize - before being documented to have lied copiously to boost the valuation of her blood-testing start-up Theranos and thereby defraud investors, including public pension funds, to the tune of $700 million. While the former was convicted and jailed for 8 years, the latter settled with the SEC without admitting or denying them and with a fine of $500,000 and a ban on being an officer or director of any public company for ten years.

What explains the grossly disproportionate nature of punishments given the fraud perpetrated by Holmes being orders of magnitude higher?
John C. Coffee Jr., a professor at Columbia Law School who teaches classes on white-collar crime, said, “Typically you get more sympathy from the criminal justice system if you’re an attractive young woman than a brash, arrogant young male”... In comparison to Mr. Shkreli’s fraud, the Holmes allegations “are really a different order of magnitude,” Ms. Apps said.
Their respective reactions after being charged too appears to have played an important role. While Holmes kept a low profile, Shkreli constantly provoked the Court with his public comments about the case.
Mr. Shkreli repeatedly defied Mr. Ben Brafman’s (his defence lawyer) admonitions to keep quiet and avoid the limelight. He smirked through his trial, taunted prosecutors as the “junior varsity,” called the case a “witch hunt” and was suspended by Twitter after he threatened to have sex with a freelance journalist who covered him. His bail was revoked and he was imprisoned after he offered a $5,000 bounty in a Facebook post for a strand of Hillary Clinton’s hair — a “solicitation to assault,” Judge Matsumoto ruled. In theory, Mr. Shkreli’s well-publicized bizarre antics, both in and out of court, should have had no bearing on his guilt or sentence. As Mr. Brafman put it in his opening statement, Mr. Shkreli shouldn’t be found guilty for being “odd,” “weird,” or having a “dysfunctional personality.” But prosecutors cited his behavior to assert in closing arguments that he “had no respect for the law.” At his sentencing, Judge Matsumoto suggested his actions called into question whether his purported remorse was genuine. 
“I’ve never had a client who did more to hurt his own standing with the court than Martin Shkreli,” Mr. Brafman said. His behavior and comments “probably added several years to his sentence.”
While we all get caught up with the minutiae of legal stuff, ultimately we, including the judges, are all human beings. The cases highlight the critical importance of perceptions and prejudices in determining the fates of court cases.

6. Three very good articles by Anjan Basu, a former official of a public sector bank in India, that shines light on possible distortions that crept into the PSU banks over the years. The first is on the corporate culture of these banks. The second is about the progressive liberalisation of credit appraisal processes - elimination of the credit consortium approach of lending to large projects, which would require all the banks to approve the appraisal and terms negotiated by the lead bank, and its replacement with the multiple banking arrangement where the large company could independently negotiate separate terms with different banks so as to encourage swifter disbursals; removal of the minimum long-term margin requirement stipulations for borrowers; and relaxation in norms for identifying stressed assets whereby if a loan by one bank to a borrower had become NPA then all others too had to classify the same loan account as NPAs. The result was a competitive race to the bottom among PSU banks in lending to and retaining large clients.

The third article refers to business practice reforms for the worse driven by consultants - business process reengineering (BPR) which split loan processing functions into marketing, evaluation and assessment, and supervision and monitoring functions and scattered them across multiple layers within the bank, thereby losing critical synergies and accountability; and treatment of banks as a financial supermarket offering a bouquet of products and financial incentivisation of cross-selling by employees, which in turn enraged customers. The result was erosion of accountability mechanisms within banks and distorted incentives among employees.

This is one more example of the problem with deregulation in financial markets as well as the mindless acceptance of business practice fads that consultants peddle to make a living. 

7. A new IMF working paper explores the distribution of income gains from globalisation. Its summary,
In a panel of 147 countries during 1970-2014, we apply a new instrumental variable, exploiting globalization’s geographically diffusive character, and find differential gains from globalization both across and within countries: Income gains are substantial for countries at early and medium stages of the globalization process, but the marginal returns diminish as globalization rises, eventually becoming insignificant. Within countries, these gains are concentrated at the top of national income distributions, resulting in rising inequality. We find that domestic policies can mitigate the adverse distributional effects of globalization. 
The figure shows that in countries with low level of globalisation, increasing globalisation is associated with a greater income growth and the effect tapers off with increase in level of globalisation. 

8. Staying with globalisation, it may be incorrect to blame Trump alone for the rise in protectionism. Trade as a share of world GDP, which doubled over the 1993-2008 period, has since plateaued off over the last decade and has even been declining since 2013 or so.
Cross-border financial flows too have undergone the same trend. They peaked at 22% of world GDP in 2007, but has since fallen to just 6% in 2016, the same as in 1996! See the graphic below from this MGI report.
Come to think of it, I am inclined to believe that this rise in protectionism is exactly what may be appropriate for China. It is already moving away from the lower end of exports and, given its own large enough domestic market, even dependency on trade itself. But for the American exporters, salivating at the growing and very large Chinese market, this is the wrong time for Trump to be pulling the plug. Now that protectionism has gone global, Beijing no longer needs any excuse to indulge in its version of protectionism! And the Chinese makers now have their market all for themselves.

9. Gaurab Aryal, Federico Ciliberto, and Benjamin Leyden find evidence of anti-competitive collusive behaviour by legacy airlines in the US. They parsed transcripts of quarterly earnings calls for 11 airlines for the 2002-16 period for mentions of "capacity discipline" (restricting the number of offered seats and flights to keep prices high enough). They write,
In recent years, airline executives have been discussing capacity discipline frequently, with the topic coming up in 54 percent of the quarterly earnings conference calls of legacy carriers since the end of 2002... we find evidence that legacy airlines used discussions of capacity discipline in their quarterly earnings calls to coordinate capacity reductions in competitive (non-monopoly) routes. In particular, we found that when all of the airlines serving a particular airport-to-airport market discussed capacity discipline in their most recent earnings call, they reduced the number of seats offered from 1.25 percent in large markets up to 4.21 percent in smaller markets, even after controlling for a rich set of factors that affect airlines’ capacity choices. In other words, legacy carriers used public communication (the discussion of capacity discipline) to collude with their competitors in order to reduce the number of seats that they as a group offered for sale.
An example of how too much information sharing can result in counter-productive outcomes. 

10. Finally, Times has a nice graphical feature on the latest empirical analysis by Raj Chetty, Nathaniel Hendren et al on social trends in the US. They track the anonymise data of virtually all Americans in their late thirties to find,
Black boys raised in America, even in the wealthiest families and living in some of the most well-to-do neighborhoods, still earn less in adulthood than white boys with similar backgrounds... White boys who grow up rich are likely to remain that way. Black boys raised at the top, however, are more likely to become poor than to stay wealthy in their own adult households. Even when children grow up next to each other with parents who earn similar incomes, black boys fare worse than white boys in 99 percent of America. And the gaps only worsen in the kind of neighborhoods that promise low poverty and good schools... Gaps persisted even when black and white boys grew up in families with the same income, similar family structures, similar education levels and even similar levels of accumulated wealth...


According to the study... income inequality between blacks and whites is driven entirely by what is happening among these boys and the men they become. Though black girls and women face deep inequality on many measures, black and white girls from families with comparable earnings attain similar individual incomes as adults.
The authors point to racist attitudes being faced by black males as explanation for this,
If this inequality can’t be explained by individual or household traits, much of what matters probably lies outside the home — in surrounding neighborhoods, in the economy and in a society that views black boys differently from white boys, and even from black girls... Other studies show that boys, across races, are more sensitive than girls to disadvantages like growing up in poverty or facing discrimination. While black women also face negative effects of racism, black men often experience racial discrimination differently. As early as preschool, they are more likely to be disciplined in school. They are pulled over or detained and searched by police officers more often. It’s not just being black but being male that has been hyper-stereotyped in this negative way, in which we’ve made black men scary, intimidating, with a propensity toward violence... this racist stereotype particularly hurts black men economically, now that service-sector jobs, requiring interaction with customers, have replaced the manufacturing jobs that previously employed men with less education.

Thursday, March 22, 2018

Public policy in the context of India's bankruptcy code

Public policy implementation is hard. Regulations have to trade-off between being too restrictive and too accommodative. The former stifles genuine activities whereas the latter opens up opportunities for subversion. Given the entrenched, and well-founded, concerns about Indian corporate governance standards, bureaucrats tend to err on the side of caution and choose to be more restrictive than they ought to be.  

The implementation of the Insolvency and Bankruptcy Code (IBC) is a good example. With good intent, the original regulations allowed considerable flexibility on who could participate in the bids for resolved assets. But in the very first case itself it became evident that promoters had exploited the flexibility to game the process and gain control over their firm with the added benefit of having knocked off the debt-holders at negligible cost. 

Stung by allegations of supporting crony capitalism, the government responded by amending the regulations to bar defaulting promoters, loan defaulters, people convicted of offences, barred by regulators etc and their related entities from participating in IBC bids. This is a very wide list of exclusions and given that at least some of these are the norm, most of the country's largest industrial groups get covered. And this is what is happening,
It has become a fertile ground for litigation as bidders come out with reasons to show competitors are ineligible.
Consider this,
The high profile case here is Essar Steel Ltd where lenders are hoping to claw back as much as $6 billion. The eligibility of both its bidders is under a cloud because of their perceived connections with defaulters. NuMetal Ltd has bid in a consortium that includes an entity controlled by a trust that has Rewant Ruia, son of Ravi Ruia, as a beneficiary. VTB, the largest shareholder in NuMetal, has said that is willing to drop the Ruia trust and would go to court if its bid was disqualified. It has also said that cases and judgements in other jurisdictions related to VTB won’t disqualify its bids. Similarly, ArcelorMittal had a 29% stake in Uttam Galva, another defaulter, while its chairman L.N. Mittal held a 33% indirect stake in another defaulter entity KSS Petron. Both these stakes had been sold off before the steel giant bid for Essar, which ArcelorMittal believes is sufficient to ensure its eligibility..In the case of Electrosteel Steels Ltd, Abhishek Dalmia led Renaissance Steel has appealed to the tribunal questioning the eligibility of Tata Steel and Vedanta. Renaissance has alleged that some overseas subsidiaries (or officials) of these firms were convicted.
Could some of these have been anticipated with better framing of regulations?
In its current avatar, the law does not specify whether past associations are relevant for deciding eligibility, but this could very well be grounds for litigation depending on how the committee of creditors, that takes the final call on bids, chooses to view this... the code should clearly specify whether past associations with disqualified entities are relevant and for how long. Another could be to clearly specify what kinds of relationships are relevant instead of an all-encompassing definition of related parties and connected parties.
I'm not inclined to be sympathetic to a Ministry which made regulations without paying attention to such basic details - hard to not have foreseen the problems with not defining the kinds of association with disqualified entities and its duration and leaving them so open-ended. This is just as unprofessional as the original regulation did not anticipate and have some basic safeguards to ensure that promoters do not game the process by capturing the Committee of Creditors. I would classify it a failure of the bureaucracy.

Update 1 (21.04.2018)
Andy Mukherjee makes the good point that the insertion of Section 29A in November 2017 to exclude certain categories of bidders may have been a morality play, which while making a good law appear great, may have actually screwed up the actual implementation effectiveness. Sample this,
The morality was legal overkill; and that’s now evident in the farce that the insolvency of Essar Steel India Ltd. has become. Rather than helping creditors with the best possible recovery for the $8 billion that’s trapped in a 10-million-tons-a-year metals business, the bidding war has disintegrated into a contest to prove rivals ineligible... Rival investor groups led by VTB Capital and ArcelorMittal were the two contestants in the first round. But the creditors’ committee deemed both buyers to be ineligible, and went for a second round of bids. However, in a surprising twist, the National Company Law Tribunal (NCLT) on Thursday held the second round, in which Vedanta Group and JSW Steel Ltd. had also jumped into the fray, to be invalid. Creditors now have to reconsider the VTB and ArcelorMittal proposals...
So what has Section 29A really achieved? Well, for one thing, it’s become an instrument of virtue signalling. Take Indian steel tycoon Sajjan Jindal’s JSW, which stepped in as VTB’s second-round partner, replacing the Ruias, just in case the latter were deemed unfit. Rather than telling creditors what they could do for Essar that the other party couldn’t, Jindal and ArcelorMittal had a public showdown about their relative piety. Whether ArcelorMittal’s sale of shares in another nonperforming asset has cured it of ineligibility to bid for Indian stressed assets, or whether Jindal’s sister’s previous involvement in another bankrupt steel firm makes him less than pure somehow, ought to be irrelevant to resolving Essar’s insolvency.
And as the graphic below shows, it may all well end up in tears for the creditors

Tuesday, March 20, 2018

The economic efficiency Vs social stability trade-off

The challenge posed by the rise of robots and resultant automation is well known. This is a nice summary of the evidence, 
Multiple studies suggest this is just the beginning and that there is more pain that lies ahead. A study by a real estate firm CBRE suggests 50% of occupations today will be gone by 2020. Then there is one by Oxford in 2013 that forecasts 47% of jobs will be automated by 2034. Yet another study has figured that only 13% of manufacturing job losses were due to trade. The rest has happened due to automation. And to make things worse, a McKinsey reckons 45% of knowledge work activity can be automated.
It is not a hyperbole to describe automation as the apotheosis of the search for economic efficiency. Robots make no mistakes, are more adaptable, can work 24X7, are much cheaper than labour, pose not threat of unionisation, and so on. Robots are super-efficient.

But this pursuit of efficiency in the modern economy sits with another trend - declining productivity in services sectors, those presumably most likely amenable to technological disruption and automation. 
Many of these services have seen increase in their share of the US labor force. Noah Smith has a very good article which captures the dilemma posed by this apparent weakness of the services sectors,  
The U.S. economy is sending more and more people into the sectors where productivity is either growing slowly or even falling... Is the stampede of American workers into unproductive industries really a bad thing?


Most economists would answer “yes” -- if construction, health care, education and the rest became more productive, workers would be freed up to go do other, more productive things, perhaps in industries that don’t even exist yet. But it’s also possible that some of these workers would otherwise just choose not to work -- to sit in their parents’ basements and play video games -- or to try to strike it rich in black-market sectors like drug sales. It’s also possible that the economic pressures of automation and trade, combined with the difficulty of retraining for new careers, would be sending some of these workers onto the welfare rolls instead of into new, better jobs.
And this conclusion is very sobering but rarely discussed in the mindless pursuit of efficiency,
So it’s possible that construction, health care, education and other industries are now functioning partly as giant make-work programs. Instead of giving a few people obviously useless jobs, this make-work system hides little bits of useless work in everybody’s job. That could be preserving the dignity of work for thousands, or even millions, of men and women standing around on construction sites, filling out paperwork in hospitals, or filing briefs for frivolous lawsuits. And that dignity, in turn, could be saving the U.S. from greater social unrest than it’s already experiencing.
In the efficiency and evidence maximising world-view that has gripped the worlds of business and academia respectively, the aforementioned would constitute an inefficient and therefore bad equilibrium. But when we step back and take a more comprehensive view, this may actually be a desirable situation. 

Change, especially by way of technological and social progress, is generally good. But such changes generally have an appropriate pace. Expedite the change and stresses will develop to disrupt the system, especially those with too many moving parts. There is no escape from the law of unintended consequences. Despite all its struggles, an organic evolution without too many mutations is the best response to such situations. The role of public policy should be confined to facilitating the process as well as mitigating the adverse consequences. 

This applies as much to a plunge towards automation and efficiency, as with the journey to become formal and shrink informality, or embrace digital technologies to reduce corruption. Press the pedal too early and too fast, and breakdowns or crashes are inevitable. 

Sunday, March 18, 2018

Weekend reading links

1. The Economist on the decline of publicly listed companies in the US,
According to Jay Ritter of the University of Florida, the number of publicly listed companies peaked in 1997 at 8,491 (see chart). By 2017 it had slumped to 4,496... Mr Ritter attributes much of the decline in the number of companies that are listed to the difficulty of being a small public company... listing requirements have become more burdensome over time. For example, he notes that the prospectus for Apple Computer’s public offering in 1980 ran to a mere 47 pages and listed no risk factors, despite its novel product, inexperienced leaders and formidable competitors. The prospectus for Blue Apron, a meal-delivery company that listed last year, weighed in at 219 pages, with 33 devoted to risks, presumably intended to pre-empt litigation. One of those risks was the possibility that Blue Apron would not “cost-effectively acquire new customers”.
2. Staying on with the declining of public markets, Craig Doidge, Kathleen M. Kahle, G. Andrew Karolyi, René M. Stulz have a paper which analyses the trends in US equity markets. Their findings are striking,
Since reaching a peak in 1997, the number of listed firms in the U.S. has fallen in every year but one. During this same period, public firms have been net purchasers of $3.6 trillion of equity (in 2015 dollars) rather than net issuers. The propensity to be listed is lower across all firm size groups, but more so among firms with less than 5,000 employees. Relative to other countries, the U.S. now has abnormally few listed firms. Because markets have become unattractive to small firms, existing listed firms are larger and older. We argue that the importance of intangible investment has grown but that public markets are not well-suited for young, R&D-intensive companies. Since there is abundant capital available to such firms without going public, they have little incentive to do so until they reach the point in their lifecycle where they focus more on payouts than on raising capital.
But, this trend may be unique to the Wall Street capitalist that US follows 

The challenge posed by intangible assets intersects with both the limitations of prevailing accounting practices as well as the excessive transparency of disclosure requirements, 
Public markets are better suited for firms with mostly tangible assets than for firms with mostly intangible assets. This is especially true when the usefulness of the intangible assets has yet to be proven on a large scale. Sometimes the market is extremely optimistic about some intangible assets, which confers a window of opportunity on firms with such assets to go public. But otherwise, firms with unproven intangible assets may very well be better off to fund themselves privately. Accounting information conveyed by U.S. GAAP for such firms is of limited use because GAAP treats investments in intangible assets mostly as expenses, so that these assets may very well not show up on firms’ balance sheets. Private funding allows firms to convey information about intangible assets more directly to potential investors who often have specialized knowledge, something that they could not convey publicly... The issue with disclosure of intangible assets is not what firms have to disclose. Rather, it has to do with the nature of the intangible assets they need to disclose. Once an idea is made public it becomes possible for other firms to use it... Investment in intangible assets is highly sensitive to the legal environment in which a firm operates and to the pace of financial development it experiences. A plant is hard to steal. A new idea is not...
As intangible assets continue to increase in importance, it should not surprise us to see a further eclipse of public markets. This stalling of public equity market development should be more pronounced in a country like the U.S., where intangible assets are relatively more important for the corporate sector... this evolution also reflects that U.S. financial development has evolved in such a way that some types of firms can be financed more efficiently through private sources than through public capital markets because the intrinsic properties of intangible assets make it harder for them to be financed in public markets. No deregulatory action is likely to restore the public markets in this case. Instead, we should focus on creating a fertile ground for investment in intangible assets by having appropriate laws, appropriate financing mechanisms, and maybe new types of exchange markets, as these assets appear to be the way of the future for corporations.
3. Another paper by René M. Stulz, with Söhnke M. Bartram and Gregory W. Brown explore another consequence of the reduction in listed companies - correlatedness among stocks.
Since 1965, average idiosyncratic risk (IR) has never been lower than in recent years. In contrast to the high IR in the late 1990s that has drawn considerable attention in the literature, average market-model IR is 44% lower in 2013-2017 than in 1996-2000. Macroeconomic variables help explain why IR is lower, but using only macroeconomic variables leads to large prediction errors compared to using only firm-level variables. As a result of the dramatic change in the number and composition of listed firms since the late 1990s, listed firms are larger and older. Larger and older firms have lower idiosyncratic risk. Models that use firm characteristics to predict firm-level idiosyncratic risk estimated over 1963-2012 can largely or completely explain why IR is low over 2013-2017. The same changes that bring about historically low IR lead to unusually high market-model R-squareds.
4. Times reports of California's aggressive embrace of transit-oriented development (TOD) by way of a legislative Bill to allow eight-storied buildings around transit stations even if local communities object. The Bill proposes to allow apartments of upto 85 feet tall within half mile of train stations and a quarter-mile of high-frequency bus stops. It would overcome one fo the biggest stumbling blocks to increased densification in the region, entrenched local opposition.

5. Noah Smith point again to the rising business concentration in the US economy.
He describes the resultant dynamics a "toxic cycle"
As industries grow more concentrated, dominant companies become a bigger piece of the stock market, and their profit margins push stock valuations higher. Politicians naturally will be less willing to take steps to make markets more competitive, allowing superstar companies to become even more powerful. All the while, retirement accounts do OK, but workers’ wages and the economy suffer from decreasing competition.
6. Alec Schierenbeck makes the case for a progressive approach to the imposition of all forms of financial penalties. In simple terms, people should be made to pay fines based on their respective income levels. He argues that scaled fines, like in Finland and Argentina which have had them for than 100 years, are more equitable and have greater deterrence value.

7. One more consequence of quantitative easing - rising property prices in the world's largest cities. FT writes,

Over the past 10 years, the life-cycles of global cities such as London, New York and Sydney start to look very similar. They begin with central banks cutting rates; then foreign buyers are welcomed in, prices go up, high-end homes are built, capital appreciation drops and then cities are left with a lot of stock which is too expensive to sell.

8. Finally, from a nice FT essay on long-haul flights, to put air transportation in perspective,
The world has never been smaller, as it spins beneath a web of flight paths; at any one time, there are an average of almost 10,000 aeroplanes in the air, carrying 1.2m people between countries and continents at more than 500mph.
Yes, 1.2 million people in air at any time! 

Thursday, March 15, 2018

Two graphs on India's credit market

It is true that the share of incremental credit flows to non-financial corporates is nowadays more or less equally split between bank and non-bank sources.

But, even among all its peers, the share of the stock of private non-financial sector credit coming from banks is the highest in India. In fact, just about 5% of it comes from non-bank sources. No other major country has this skewed distribution.


Further, the stock of credit to non-financial sectors from all sectors at market value as a share of GDP has hardly changed in India over the past 16 years and is well below the average for emerging economies.

Wednesday, March 14, 2018

Do we need evidence on the efficacy of rural roads and electricity?

This paper on rural electrification program in Kenya finds,
We do not find meaningful medium-term impacts on economic, health, and educational outcomes nor evidence of spillovers to unconnected households. These results suggest that current efforts to increase residential electrification in rural Kenya may reduce social welfare. 
This paper on India's rural roads construction program finds,
There are no major changes in consumption, assets or agricultural outcomes, and nonfarm employment in the village expands only slightly. Even with better market connections, remote areas may continue to lag in economic opportunities.
The fact that we are trying to generate evidence on rural roads and electricity baffles me. What is it that we takeaway from such papers? What is it that the "headline readers" among development professionals would takeaway?

Is it that the high upfront investments that are required with any kind of rural infrastructure (since it cannot leverage economies of scale) is social surplus reducing, and therefore undesirable (in econ-speak)? Or is it that grid electrification/BT roads is not cost-effective to comparable alternatives? Or that rural infra works have leakages which make them social surplus reducing or engendering incentive distortions? Or that the measurement approach that the researchers take is limited in that it is not able to capture all the potential general equilibrium effects - after all without electricity and roads you cannot have a life of modernity, which I guess is a salient material objective of development? Or is it even that developing countries should make choices between roads and electricity for their villages and nifty innovations like deworming, nudges, shiny technology Apps, micro-insurance, self-help groups, cash transfers, and so on? Or is it that the short-term benefits of roads and power are small - if so, what about the long-term benefits? 

Note that neither paper even qualify its findings with such a preface.

In fact, a cursory reading of the abstract, as is what happens most often, can easily leave one with the takeaway that rural roads and rural electrification are a bad use of public money. We only need to look at how much damage this one work contributed to misleading the fiscal austerity debate. Clearly, this time is no different. No pun intended.

A more appropriate response to such papers and the comes from Lant Pritchett's description of these as "kinky development",
What the World Bank chose to highlight in its official publicity about Dr. Jim Kim’s visit (to Somalia) was that it had figured out a way to use mobile phone surveys to track the poverty status of people in Somalia on a quarterly basis. Imagine the joy and celebration among Somalis to know that the World Bank was going to promote Somalia’s national development not with a port upgrade, or a road or electricity or water, or even a school or a clinic, but by being able to track and tell them every quarter just how poor they really are—something I suspect they know quite well already...
Perhaps promoting energy source diversification is why President Obama, while touring a power plant in Africa, thought it politically expedient to promote the Soccket ball. For those of you who still have not been introduced to this technological marvel, the Soccket ball is a soccer ball containing a battery that is charged by the kinetic energy of being kicked. This contraption is perhaps one of the best illustrations of the gap between development realities (the average Ethiopian consumes 52 kwh of electricity and the average American 13,246 kwh) and the “solutions” being proposed by the world’s elite: ban coal and limit hydro and if Africans want power, let them kick some soccer balls round.
This nails it
In another 2013 Center for Global Development study, Benjamin Leo used the authoritative Afrobarometer and Latinobarometer surveys to document the discrepancy between poor country citizen preferences and U.S. foreign assistance allocations. In Africa, surveys asked the question “In your opinion, what are the most important problems facing this country that government should address?” and grouped the responses into eight broad categories. In Africa, 71 percent mention jobs/income among their top three problems, 52 percent mention infrastructure, and 63 percent name either jobs/income, infrastructure or economic/financial policies as their priority. Independently of what we may think African priorities ought to be, only seven percent named health, four percent education, and one percent governance as among the top three problems the government should address. Yet of American assistance to Africa from all agencies (e.g. USAID, PEPFAR, and MCC), only six percent goes to jobs/income and only 16 percent to jobs/income and infrastructure. Fully 60 percent of American assistance goes to areas that the Africans surveyed think are distinctly lower-tier priorities.

Monday, March 12, 2018

The implementation validity problem with RCTs

Randomised Control Trials (RCTs) are extensively used in development today. Funding decisions by multilaterals and other donors are swayed by evidence from RCTs. In fact, in certain rarefied confines of international development, RCTs have become the definition of evidence itself. 

A typical RCT is a small experimental pilot with the smallest sample size consistent with statistical requirements done under the supervision of some principal investigators and with the field support of smart and committed research and field assistants. This poses a problem.

How do we separate these two effects?
  1. The immense energies of reputed researchers and their committed and passionate young RAs to protect the integrity/fidelity of the experiment
  2. The effect on Sl No 1 (which would be absent in business as usual implementation) contributing to the experiment's effective implementation. 
In other words, how do we evaluate the treatment (or the innovation being proposed) in the business as usual environment?

An RCT typically establishes the efficacy of the treatment. But it does not tell much about its effectiveness, a measure of both the efficacy and implementation fidelity.

This assumes great significance since the same innovation or treatment is generally implemented through government systems, which are notoriously enfeebled. In fact, given the weak state capacity, trying out innovations whose efficacy has been established through RCTs is akin to pumping all kinds of exotically engineered liquids through pipes which leak everywhere.

It is also the reason why practitioners are lukewarm to many headline RCT findings which generate intense interest among academics and the global development talkshops.

Do we call this the implementation validity problem?

It is surprising that while papers and books have been written about the internal and external validity problems associated with RCTs, this arguably more important challenge, given the weak state capacity in all the implementation environments, hardly gets a mention. 

Saturday, March 10, 2018

Weekend reading links

1. Is there a bigger endorsement of the death of PPPs and the return to nationalisation than this,
A recent poll by the Legatum Institute found that 83 per cent of respondents favoured renationalising the water industry that Margaret Thatcher, then prime minister, sold in 1989. For energy and the railways, 77 per cent and 76 per cent respectively backed the reversal of their privatisations.
Another interesting snippet from the article is that three-quarters of UK's train operating companies in the 20 franchises are foreign state-owned firms.
Talk about privatisation of rail in one country to public operators of other countries! Are the most efficient rail operators state-owned?

2. Rajan Govil's assessment of Indian economy is not very promising.
The government’s expenditure policy does not appear to be conducive to increasing investment or potential GDP in the near or medium term. The central government’s overall capital expenditure declined from 1.9% of GDP to 1.6% of GDP in 2017-18 and is expected to stay at 1.6% in 2018-19 at a time when investment has stagnated. Additionally, not all of the capital expenditures are for investment—some of these are for bank recapitalization. Moreover, expenditure on “social services”, which include education, public health, water supply and sanitation, has been reduced progressively from 0.61% of GDP in 2016-17 to 0.59% of GDP in 2017-18 (revised estimate) and finally to 0.57% of GDP in 2018-19. Current expenditure for the Central government increased in 2017-18 by 0.5% to 11.6% of GDP from 2016-17 and it would be very difficult in an election year for this to be reduced even to 11.4% of GDP in 2018-19 as per budget estimates. At the same time, the government wants to provide a higher subsidy to the farmers as well that might prove to be too costly.
3. Underlining the importance of public subsidy for urban mass transit, the FT reports that Transport for London (TfL) - the public body formed in 2000 which oversees Tube, overground trains, and buses - will run an operating deficit of close to £1 billion in 2018-19.

4. Lucas Chancel busts three myths of globalisation.

Globalisation has increased inequality,
The top 1% income share rose from 7% to 22% in India, and 6% to 14% in China between 1980 and 2016... Between 1980 and 2016, inequality between the world’s citizens increased, despite strong growth in emerging markets. Indeed, the share of global income accrued by the richest 1%, grew from 16% in 1980 to 20% by 2016. Meanwhile the income share of the poorest 50% hovered around 9%. The top 1% – individuals earning more than $13,500 per month – globally captured twice as much income growth as the bottom 50% of the world population over this period.
Income doesn't trickle down - high growth at the top is necessary to achieve some growth at the bottom,
When we compare Europe with the U.S., or China with India, it is clear that countries that experienced a higher rise in inequality were not better at lifting the incomes of their poorest citizens. Indeed, the U.S. is the extreme counterargument to the myth of trickle down: while incomes grew by more than 600% for the top 0.001% of Americans since 1980, the bottom half of the population was actually shut off from economic growth, with a close to zero rise in their yearly income. In Europe, growth among the top 0.001% was five times lower than in the U.S., but the poorest half of the population fared much better, experiencing a 26% growth in their average incomes. Despite having a consistently higher growth rate since 1980, the rise of inequality in China was much more moderate than in India. As a result, China was able to lift the incomes of the poorest half of the population at a rate that was four times faster than in India, enabling greater poverty reduction.
Policy, and not technology, is responsible for inequality,
The U.S. and Europe, for instance, had similar population size and average income in 1980 — as well as analogous inequality levels. Both regions have also faced similar exposure to international markets and new technologies since, but their inequality trajectories have radically diverged. In the U.S., the bottom 50% income share decreased from 20% to 10% today, whereas in Europe it decreased from 24% to 22%... After the neoliberal policy shift of the early 1980s, Europe resisted the impulse to turn its market economy into a market society more than the US — evidenced by differences on key policy areas concerning inequality. The progressivity of the tax code — how much more the rich pay as a percentage — was seriously undermined in the U.S., but much less so in continental Europe. The U.S. had the highest minimum wage of the world in the 1960s, but it has since decreased by 30%, whereas in France, the minimum wage has risen 300%. Access to higher education is costly and highly unequal in the U.S., whereas it is free in several European countries. Indeed, when Bavarian policymakers tried to introduce small university fees in the late 2000s, a referendum invalidated the decision. Health systems also provide universal access to good-quality healthcare in most European countries, while millions of Americans do not have access to healthcare plans.
5. Fascinating Businessweek essay on Chinese outsourcing of textiles making to Ethiopia. Buoyed by fiscal concessions in the newly established industrial estates, Chinese companies have been flocking to invest in the country. China has given the country $10.7 bn in loans in the 2010-15 period.

6. I have been a China pragmatist, not believing the bears, despite all the economic pressure points building up. But I am inclined to agree with Nitin Pai about the risk of the beginning of difficult period for China in the aftermath of Xi Jinping's ascension as a dictator. There is some inherent strength to institutional consensus of whatever kind. It can hold systems together against centrifugal forces. But once the institutional glue is replaced by that of an individual, howsoever impregnable he may look in the present, it is one crisis away from threatening to unravel.

7. Latin American bureaucracies are going through their version of decision paralysis. The trigger has been the Lava Jato investigations involving political influence buying by large corporates, especially infrastructure contractors,  
A big setback was the Lava Jato (Car Wash) investigation, which began as a money-laundering case in Brazil and has engulfed the governments of a dozen Latin American countries. Odebrecht, a Brazilian firm that built highways, dams, power plants and sanitation facilities across the region, admitted to paying $788m in bribes. Its money financed political campaigns, including those of Colombia’s president, Juan Manuel Santos and Juan Carlos Varela, now Panama’s president. Pedro Pablo Kuczynski, Peru's President, has admitted that companies linked to him have taken (legal) payments from Odebrecht. The scandal has left a trail of unfinished projects, frightened politicians and bureaucrats, and wary bankers. A $7bn contract with Odebrecht to build a pipeline to transport natural gas from the Amazon basin across the Andes to Peru’s coast has been annulled and work has been suspended. Ruta del Sol 2, a 500km (300-mile) stretch of highway to help connect Bogotá to Colombia’s Caribbean coast, has stalled. Panama’s government cancelled a contract with Odebrecht for a $1bn hydroelectric project. Mexico’s biggest scheme, a new airport near the capital, has been plagued by corruption allegations. Andrés Manuel López Obrador, the front-runner in Mexico’s presidential election, scheduled for July 1st, has threatened to scrap it.
And the modus operandi of PPPs remain the same,
Public-private partnerships (PPPs) are open to abuse by construction firms such as Odebrecht, which make low bids to secure contracts and then renegotiate them to push up the cost, often by bribing a politician or two. More than three-quarters of Latin American PPP contracts in transport have been renegotiated within about three years of signing, according to José Luis Guasch, a professor of economics at the University of California.

Friday, March 9, 2018

The psychology of the financial markets

Consider this. Someone scares you by inflating the likelihood of an imminent disaster. If the disaster does not materialise, you are relieved and happy. But does the happiness have any real basis?

The same applies to financial markets. They respond favourably to a positive news about the economy. But it is perhaps not incorrect to say that it responds even more positively in relief when an anticipated negative news does not materialise. Consider the following instances
  1. The collapse of global financial markets in the aftermath of the GFC and its impact on the economy in the form of a repeat of Great Depression
  2. Catastrophe in Europe with the Greek and Irish crisis spilling over to Italy and Spain, thereby causing the unravelling of the EU itself
  3. The debt-bomb ticking in China would bring down the entire economy
  4. The end of commodity cycle, global economic slowdown, and imminent collapse of China would herald the end of the emerging market story
  5. The exit from quantitative easing would lead to a rise in rates and devastate debt-laden governments, corporate sector and households
  6. World economy has entered a deflationary loop and negative rates are here to stay
  7. In the aftermath of Brexit, far-right parties will emerge as important players in the political scene across Europe
  8. The Trump Presidency will lead to protectionism and trade-wars, exist from NAFTA, American isolationism, and global economic collapse
It cannot be denied that there was a likelihood of each one of the above. And the consequences could have been bad. But what is debatable is whether they were as grave and imminent as was made out to be by public commentators and academic scholars. I am inclined to believe that their views of these scenarios were painted as doomsday prophecies in the financial press and opinion makers.

These narratives shaped expectations and prayers that they not materialise. In the circumstances, once the likelihood of their incidence declined, markets responded with relief. In fact, once the danger passed over, markets rebounded excessively. 

Over the last few years, each one of these dangers have receded, thereby boosting market confidence and the associated animal spirits. The extended bond and equity market booms owe a lot to animal spirits engendered by the market relief from having avoided these dangers. But do they have any real basis?

Tuesday, March 6, 2018

The Great Indian Banking Cleanup?

Tamal Bandyopadhyay has an outstanding chronicle of India's banking sector saga. What stands out is the progressive evolution and tightening of the process of recognition, 
the banks have been directed to do many things—ranging from integrating the core banking system with SWIFT to checking all bad loans worth Rs50 crore and more for possible frauds to consolidating their foreign operations, among others—to get their house in order... (under) the 12-February midnight directive of RBI... all existing frameworks for addressing stressed assets have been withdrawn and the joint lenders’ forum (JLF), an institutional mechanism that was overseeing them, has been dismantled. Now, the banks have no choice but to classify all large loans worth at least Rs2,000 crore as non-performing assets (NPAs) immediately when they restructure it. The clock started ticking from 1 March 2018. Such an NPA should be resolved within 180 days, failing which the account gets referred to the Insolvency and Bankruptcy Code (IBC) court. Simply put, when a borrower fails to pay a bank loan in time, it becomes a defaulter, unlike in the past when the account was classified as “stressed” – often an excuse for the banks to postpone the inevitable...


The war against NPAs started with the so-called asset quality review, or AQR, in the second half of 2015 under which RBI inspectors checked the books of all banks and identified bad assets. Bankers were directed to come clean and provide for all bad assets by March 2017. On top of that, the central bank started forcing banks to disclose the divergence between RBI’s assessment of the loan books and the banks’ recognition of bad assets in the notes to accounts to their annual financial statements to depict “a true and fair view of the financial position” of each bank. An ordinance was promulgated in 2017, amending the Banking Regulation Act, 1949, giving powers to the central bank to push the banks hard to deal with bad assets. It authorized RBI to direct the banks to invoke the IBC against the loan defaulters... Also, from now on, banks need to report all default cases involving at least Rs5 crore every week (at the close of business hours every Friday) to a central repository of information.
When you step back and see the banking sector cleanup that is being played out, assisted by the Bankruptcy Code, you cannot but not feel that this is perhaps a paradigm shift in India's banking sector - it beggars my belief as to why the regulator did not even have the basic reporting requirements on the different types of stressed assets till recently. If our banking regulation stood on such shaky foundations, what confidence can we have about the other, arguably less competent and more compromised, regulators being able to effectively regulate the capital and other financial markets?

Anyways, this is one massive achievement for this government. Maybe, when the history books are written, this would count as 2-3 of the biggest achievements of the government. It should shout from the roof tops and I would not mind...

After all, the muck within the banking system - the ever-greening, gold-plating of loans, the diversion to other purposes, political cronyism in loan advances etc - were well known to insiders for long, and could have been addressed by previous governments too. I believe the regulator would have resisted excessive reporting and disclosures, transparency and intervention (like breaking the distinction between restructuring and NPA and aggressive provisioning requirements) arguing that it would shake the confidence in the banking system. And the government, like the Bootlegger to the RBI's Baptist, would have happily acceded. Is there something this government had going differently - its anti-corruption commitment, arrival of IBC etc? 

For sure several things can (and likely will) still slow down the process - banker's becoming risk averse thereby slowing down lending; the IBC led resolution process getting stuck in a few high profile corruption scandals; the capital markets not being able to absorb the deluge of assets hitting the market; the courts intervening to slowdown the process, and so on. But that would be par for the course with such transformational changes. It cannot detract from the achievements till date. 

It would be great to hear someone, preferably an insider, write the story of the evolution of the Great Indian Banking Cleanup - how much of it was government's and how much RBI's contribution; how much despite the government and how much despite the RBI; how much role did specific individuals - in govt and RBI - play; how were the corporate vested interests overcome; were the consequences of each step of tightening oversight discussed in detail and how did a risk-averse system pull itself to bite the bullet at each stage; how much of the clean-up momentum owed to initiatives like the anti-corruption drive and the demonetisation; how much of the momentum owed to the public pressures from high-profile cases like Vijay Mallaya and now Nirav Modi; how much of it was shaped by various other less known opportunistic shifts and how much part of conscious comprehensive planning; is there a path dependency associated with where we are now - should we have necessarily done CDR, S4A, SDR, AQR, breaking the distinction between restructuring and NPA etc before going for broke with blanket disclosure and transparency...

I am sure this would be one hell of a chronicle of how public policy is made emerges. 

Google and the anti-trust challenge

Charles Duhigg has an excellent longform chronicle in the Times on the rise and rise of Google. And it is a disturbing story, symptomatic of the pervasive trend of regulatory capture and business concentration.

This is the anti-trust challenge that is being faced,
Standard Oil controlled 64 percent of the market for refined petroleum when the Supreme Court broke it into dozens of pieces. Google and Facebook today control an estimated 60 to 70 percent of the U.S. digital advertising market.
Anti-trust lawyer Gary Reback has this comparison about the tactics of Standard Oil and Google,
“They don’t need dynamite or Pinkertons to club their competitors anymore. They just need algorithms and data.”
Are algorithms and data any less morally and legally reprehensible than dynamites and snooping?

The legal problem, especially in the US, is with the narrow definition of what constitutes the requirement for anti-trust action. US courts have been more inclined to interpret anti-trust action in terms of consumer interest than competition - to what extent are consumers, rather than competitors, being harmed by Google? But such narrow framing poses problems,
Antitrust has never been just about costs and benefits or fairness. It’s never been about whether we love the monopolist. People loved Standard Oil a century ago, and Microsoft in the 1990s, just as they love Google today. Rather, antitrust has always been about progress. Antitrust prosecutions are part of how technology grows. Antitrust laws ultimately aren’t about justice, as if success were something to be condemned; instead, they are a tool that society uses to help start-ups build on a monopolist’s breakthroughs without, in the process, being crushed by the monopolist. And then, if those start-ups prosper and make discoveries of their own, they eventually become monopolies themselves, and the cycle starts anew... Put differently, if you love technology — if you always buy the latest gadgets and think scientific advances are powerful forces for good — then perhaps you ought to cheer on the antitrust prosecutors. Because there is no better method for keeping the marketplace constructive and creative than a legal system that intervenes whenever a company, no matter how beloved, grows so large as to blot out the sun. If you love Google, you should hope the government sues it for antitrust offenses — and you should hope it happens soon, because who knows what wondrous new creations are waiting patiently in the wings.
And this counterfactual is very difficult to establish,
If Microsoft had crushed Google two decades ago, no one would have noticed. Today we would happily be using Bing, unaware that a better alternative once existed. Instead, we’re lucky a quixotic antitrust lawsuit helped to stop that from happening. We’re lucky that antitrust lawyers unintentionally guaranteed that Google would thrive.
The popular narrative, resonant with the pervasive anti-government and pro-market ideological beliefs, holds that the decade long anti-trust pursuit of Microsoft in the nineties failed to achieve anything beyond token gains, and finally it required a more innovative competitor, Google to keep Microsoft away from dominating the search business.
it was companies like Google, rather than government lawyers, that humbled Microsoft
This narrative is repeated ad nauseum by opponents of regulatory actions to support their arguments in favour of the market mechanism. But a less discussed counter-narrative claims that the anti-trust actions "made all the difference" and "condemning Microsoft as a monopoly is why Google exists today". There was a  transformation in Microsoft's internal culture and business practices,
In the days when federal prosecutors were attacking Microsoft day and night, the company might have publicly brushed off the salvos, insiders say. But within the workplace, the attitude was totally different. As the government sued, Microsoft executives became so anxious and gun-shy that they essentially undermined their own monopoly out of terror they might be pilloried again... In public, Bill Gates was declaring victory, but inside Microsoft, executives were demanding that lawyers and other compliance officials — the kinds of people who, previously, were routinely ignored — be invited to every meeting. Software engineers began casually dropping by attorneys’ desks and describing new software features, and then asking, in desperate whispers, if anything they’d mentioned might trigger a subpoena... Every time a programmer detailed a new idea, the executive turned to the official, who would point his thumb up or down like a capricious Roman emperor... as Microsoft lived under government scrutiny, employees abandoned what had been nascent internal discussions about crushing a young, emerging competitor — Google... Microsoft was so powerful, and Google so new, that the young search engine could have been killed off, some insiders at both companies believe. “But there was a new culture of compliance, and we didn’t want to get in trouble again, so nothing happened,” Burrus said. The myth that Google humbled Microsoft on its own is wrong. The government’s antitrust lawsuit is one reason that Google was eventually able to break Microsoft’s monopoly.
And this only presaged earlier similar occasions where newer technologies spread,
In 1969 the Justice Department started a lawsuit against IBM for antitrust violations that lasted 13 years. The government eventually surrendered, but in an earlier attempt to mollify prosecutors, IBM eliminated its practice of bundling hardware and software, a shift that essentially created the software industry. Suddenly, new start-ups could get a foothold simply by writing programs rather than building machines. Microsoft was founded a few years later and soon outpaced IBM.
Or consider AT&T, which was sued by the government in 1974, fought in court for eight years and then slyly agreed to divest itself of some businesses if it could keep its most valuable assets. Critics complained AT&T was getting the deal of a lifetime. But then start-ups like Sprint and MCI made millions building on technologies AT&T championed, and AT&T found itself struggling to compete. It’s completely wrong to say that antitrust doesn’t matter, Reback argues. “The internet only exists because we broke up AT&T. The software industry exists because Johnson sued IBM.”