Wednesday, March 19, 2008

Farm loan waivers and Investment bank bailouts

John Ruskin said “the highest reward for man's toil is not what he gets for it, but what he becomes by it.” I wonder what will he make of the global financial system that never seem to learn from its mistakes.

Have governments and central banks finally aligned? Or have they all run out of ideas? I certainly see character here. Very charitable one at that. I see across the board farm loan waiver in India (a massive $15 billion bill on the tax payer) and a massive bailout of failing investment banks in the US. The fed backed it up by cutting interest rates – sixth cut in a row since September,2007.

I see parallels that feed systemic excesses –

In the US, the financial services industry has defied gravity by using debt, securitization and proprietary trading to boost fee income and profits. Why care for capital adequacy if the tax payer is obligated to bail them out? In India, farmers have been pampered for long – tax exemptions, loan write-offs and yet keep them clustered under priority sector. Why repay a debt if it’s likely to be written off?

The value of outstanding credit-default swaps in the US financial system, for instance, has climbed to a staggering $45 trillion. In 1980 financial-sector debt was only a tenth of the size of non-financial debt. Now it is half as big. In India, outstanding agricultural credit is currently less than 10% its net NPA. A couple of waivers like this, and it will get there.

Leverage process practised by Wall Street has turned investment banks into debt machines that trade heavily on their own accounts. Goldman Sachs is using about $40 billion of equity as the foundation for $1.1 trillion of assets. At Merrill Lynch, the most leveraged, $1 trillion of assets is teetering on around $30 billion of equity. In rising markets, gearing like that creates stellar returns on equity. When markets are in peril, a small fall in asset values can wipe shareholders out, as it did with Bear Stearns and many others.

Globally, salaried tax payers can't escape tax cuts because they get checks after deduction of tax. That comfort is making governments smugger and they're emboldened to write more loans off, bailout wrongdoers in one swoop. It is not within our power to not let them cut taxes before they cut our checks. But with a bit of initiative and aided by a stroke of luck, we can certainly turn farmers or investment bankers and benefit from the largess that won’t stop any sooner :-)

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