Tell me, which side are you...?

Amidst the high drama and speculation surrounding the prospect of a global recession, I get to hear all kinds of theories from everyone. I just quote a couple that made me snort.

Louis Gerstner, Chairman of PE firm Carlyle Group (Ex- CEO, IBM Corp./ Amex / RJR Nabisco) –

"We are in a welcome period for private equity. Capitalism is not a steady state but goes to extremes and...after excesses have built up...we needed to see a correction. The media and government might have converted this state to a 'crisis' but it is not that."

Here he goes further -

“Carlyle had $30bn of dry powder to strike more deals and the firm was turning towards the developing world where deals were "more unleveraged" and private equity firms took minority stakes. However, there would be fewer secondary buyouts where portfolio companies are switched between private equity firms."

Now turn to famed investor Jim Rogers -

"Conceivably we could have just had recession, hard times, sliding dollar, inflation, etc., but I'm afraid it's going to be much worse".

"[Ben] Bernanke is printing huge amounts of money. He's out of control and the Fed is out of control. We are probably going to have one of the worst recessions we've had since the Second World War. It's not a good scene."

But Rogers is so hooked on China -

"Some parts of the Chinese economy are going to be untouched, however. They won't even know America's in recession. They won't care if America falls off the face of the earth."

I go we are there already... MF portfolios are down by 30%. Quarterly numbers are getting flatter. Sovereign Wealth Funds are buying out American banks on the cheap. Will it look any different than it is now...?

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Rogue trader or a Rogue Bank ?

Société Générale, the French Bank is quick to blame Jérôme Kerviel, the trader allegedly responsible for a €4.9 billion ($7.2 billion) loss it declared earlier this month.

Remember Nick Leeson and the Bearings bank episode? This comes pretty close. Jérôme Kerviel's unauthorized trades may have cost Société Générale €4.9 billion, but they also helped to turn the French bank's $3 billion of subprime losses into something of a sideshow.

Attempt to mask inherent inefficiencies in internal risk management by pinning it on individual traders show bank managements in poor light. May be, they expect to get less sullied by raising this smokescreen to deflect public attention away from subprime induced losses for which they own more direct responsibility. Daniel Bouton, the bank’s chairman, and Jean-Pierre Mustier, Head of SocGen’s investment-banking arm may have hoped to escape with just a smear instead of a much maligning, indefensible subprime bruised image by bringing it up now. Coming at this worst hour for bank CEOs, trading losses emerge as preferred excuses for their plight than subprime losses that nail them straightaway.

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We will never know. But it is hard to digest how Mr Kerviel got away with building up such a big position unnoticed. Do banks only look at net exposure and not a trader’s outsized gross positions? Why didn’t the margin calls on Mr Kerviel’s real trades (likely to have been in the order of €2.5 billion on a €50 billion position) trigger alarms?

I am tempted to call them rogue banks. The trader just played fast and loose – when allowed.

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The Aftershocks

So what are your takeaways from the US mortgage crisis? When things go awry, you can’t do much more than endless finger pointing. If you are a banker, make sure you multi-layer your debt instrument so much and make it as complex as possible so that you always will have someone else to blame.

Lehman Brothers is suing at least six mortgage lenders and brokers, claiming they sold Lehman dubious loans. It claims that borrowers’ incomes were overstated, appraisals were inflated and the homes were in poor condition. In most cases, the lenders are fighting the allegations and Lehman’s demand that they buy back defaulted or otherwise problematic loans.

Meanwhile members of a New Jersey family have sued Lehman for $4.14 billion, saying the firm steered them into complex securities that have become difficult to sell. Lehman denied the accusations.

Bringing securities fraud cases has been made harder by recent Supreme Court decisions that favored Wall Street, companies and professionals like accountants. The court ruled earlier this month that two technology vendors could not be held liable for taking part in a scheme designed by a cable company to inflate its revenue. Last summer, in a ruling favoring the company, Tellabs Inc., the court said that securities cases could be dismissed if investors did not show “cogent and compelling” evidence of intent to defraud. Period.

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A shocker from the Economist

“Having a little bit of inflation is like being a little bit pregnant.” Says the Economist. That opener stoked my curiosity as well as the headline of the article (fears of both inflation and recession). But I was clearly not prepared for the banter. Not from the Economist.

So how can I let go of an opportunity to pick on the Economist and to blog about it? After all, it’s a magazine that I and the whole world respect the most. Here’s my stab.

It says “inflation is a monetary phenomenon and the responsibility lies with central bankers”. Is that so? What can central bankers do to rein in commodity prices that are based on demand-supply dynamics? Suck out money supply or hike interest rates? That would impact productivity across the board and deepen budget deficits.

This is my favorite – “monetary conditions have been loose in recent years, with real interest rates low and credit growth rapid, particularly in emerging economies.” But subprime fiasco had its origins in the Wall Street, bang in the middle of Manhattan - not in any emerging economy, goddammit! Look at the billion $$ write downs at American banks like Citigroup, Merrill Lynch, Bear Stearns, UBS … In fact, these banks are now being bailed out by sovereign wealth funds from Asia and the Middle East !!

“The task of central bankers has become harder as globalization has shifted from being a disinflationary phenomenon to an inflationary one.” I say that depends on who creates value and therefore wealth. Where wealth gets created, there will be increased consumption led inflation. It’s a tenet.

“The downward price pressure from cheap Chinese goods may be abating while the developing world’s rampant demand for resources may continually drive commodity prices higher.” Yeah, but the global consumer is the one asking for better economics, right? China produces cheap goods because there’s a buyer out there. You stop buying Chinese goods and they won’t produce. But how many can really afford costly stuff?

The doubt lingers whether it’s a recession or inflation that the world is staring at. (See pic). That I agree and so I lifted that picture and put it right here on top. I read a lot of humor and find a ton of banter from less venerated journals. It saddens me when the Economist joins that league.

“You’d better be careful, Economist. It takes a lot to build that reputation. Don’t lose it all in one short fling…” I caution.

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Insights from street children

A brief pause (or an interminable wait during peak hours) at a traffic light is a sure invitation to beggars and vendors in Indian cities. But this editorial from the Economist seem to have spun an insightful theory – how to contain the huge forex inflows into India – based on it. Excerpts -

“INDIA, it is fair to say, is not yet reconciled to the new-found strength of its currency. One poor wretch, pressed against the car window at a Delhi traffic light, tries to change a dollar bill she presumably cadged off a tourist. She wants 50 rupees for it. Alas, the dollar now fetches less than 40 rupees.

This vigour is due to a strong inflow of foreign capital, some of it enticed by India's promise, the rest disillusioned by the rich world's financial troubles. The net inflow amounted to almost $45 billion in the year to March, compared with $23.4 billion a year earlier.

The migration of capital from the rich world to the poorer one is a sign of a bleaker season to come in the world's biggest markets. This would, then, seem an inauspicious moment for India to bet its future on export-led growth. If it cannot resist the inflow of foreign capital, it should try instead to make room for it—by observing fiscal restraint—and to make the most of it—by investing it wisely. India may then have an economy worthy of a more expensive rupee; and its children may have better things to do than hang around at traffic lights trying to change a buck.”

Well said, The Economist…

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