Picking asset price bubbles: Financial Express: 15th October 2013

It is not surprising that, in the aftermath of the financial crisis of 2007-08, the Nobel Prize for Economics has been awarded to economists who have made significant contributions in the area of asset prices. The names are familiar—Robert J Shiller (student of behavioural economics), Lars Peter Hansen (expert in building models) and Eugene F Fama (a follower of efficient markets hypothesis). The decision was not surprising, as Shiller’s name was the foremost in the list of probable awardees. Their concern was over assets, their prices and possible bubbles.
Broadly speaking, their contribution goes this way. When we look at asset prices, be it stocks or bonds, it is difficult to conjecture their price movements in the short run, which could be, say, a few weeks or even months, though the same can be guessed well in the long run, which could be 3 or 5 years. This makes sense when we look at our own stock market. On a daily basis, we cannot make guesses because there are new bits of information coming in every now and then (Fama), which guides prices. RBI announcement of new banks can push up prices of bank scrips while an impasse on mining laws in Parliament can push back the stocks of mining and related companies.Therefore, predictability is the issue. If all players knew the price and start buying the stock, the price would automatically move up until such time that it becomes less attractive. The unpredictable pattern is more often the case and the movements are random, and hence it is said that stock prices follow a random walk. Therefore, Fama argued that today’s price is no guide to tomorrow—which is seen in our own stock price movements, where the Sensex or Nifty yo-yo on a daily basis being affected more by distant effects such as the Dow Jones or Fed actions in the interim period.In fact, an interesting outcome of Fama’s work is that lots of the information we are talking of have an impact on just one day. A dividend announcement or a stock split will affect the share price on the day and move back to the trend line subsequently. This also appears to be the case with Indian markets, where the Sensex moves up or down to news for a single day and then gets back to the trend, which has been upwards. Therefore, to put the theory into a diagram, daily movements will have sharp or smooth peaks and troughs, but the direction along the trend will be upwards normally for a growing economy.But, over the long run, these things iron out and there are broad principles that are adhered to. Shiller showed that prices would tend to get related to the future dividends on almost all occasions. Also, periods when stock prices are high relative to corporate earnings tend to be followed by periods of below-par returns, and vice-versa. Hansen's view was that mispricing had to do with fluctuations in how much appetite investors had for risk. When times are bad, investors become more cautious, and when times are good, they are more willing to pay high prices for assets.Simply put, the rationale is that when you take more risk while waiting, the return must be commensurate with the deserved compensation. The models that have been used by them have gotten refined over time, enabling better use of data and deriving more rational conclusions. This has improved the power of forecasting of asset prices in the long term and helped the emergence of index funds in stock markets. An interesting outcome of their research is when it is stretched to the performance of mutual funds. Can mutual funds generate returns above the level of risk taken? Their answer is that their returns would be lower once adjusted for their own fees and expenses.The behaviour of asset prices is important for households as the decision to choose from across alternative assets will be contingent on them. For example, when deciding on, say, a deposit or tax-free bond or a corporate bond or equity stock, the asset price matters. Similarly, asset prices are important as they provide information for economic decisions in investment. The market for corporate bonds is not well developed primarily because pricing is an issue. Once the bond is issued it is not easy to gather data on the daily price due to the absence of liquidity. Unless the asset is properly priced (need to have the yield curve in place), the secondary market will not evince interest, which, in turn, has a bearing on the state of the primary issuance market.Their research also shows that, at times, excessive optimism or other psychological mechanisms may explain why asset prices deviate from fundamental values. These high prices may reflect overestimates of future payment streams. A question raised by them is why more rational investors do not eliminate the excessive price swings by betting against less rational investors. Their response is that rational investors may face various institutional limits, such as credit constraints, that prevent them from going against the market on a sufficiently large scale.The US scene of 2007 is interesting. Asset prices existed for the mortgage-backed securities and the entire gamut of structured products. But the pricing was inaccurate or mispriced as institutions multiplied their risks. Mispricing meant that the asset prices were not reflective of the underlying, which led to the crisis. Keeping in mind the financial crisis, one can understand the importance of such theories because ultimately it was a case of mispricing of the assets under question—CDOs and CDS.Therefore, the clue really is that we cannot do much in the short run, but as policy regulators, must watch out for the building bubble once we smell serious mispricing, especially in a boom

An inside view: Book Review of The Firm Financial Express October 13, 2013

When you pick up a book called The Firm, the first thought that strikes you is one of intrigue. Much like the story told by John Grisham, which is fiction, Duff McDonald unveils the real tale of leading consultancy firm McKinsey in a dispassionate manner. We have all read about how McKinsey has grown to become a leading management consultant and is held in awe in corporate circles. In fact, a large number of them swear by the name. But that is the view from outside. McDonald gives us, almost literally, a 3D version of the firm and shows how, at the end of the day, the brand makes a big difference to all users of its services, irrespective of its follies.
While there are those like Jamie Dimon of JP Morgan or Mitt Romney who swear by the firm, there are several cases of failure like GM, Kmart, Swissair, Enron and their likes, which tell us that management consultants are not infallible. But still, the firm is considered to be a major foundation of modern US capitalism. McKinsey’s rise has been quite remarkable. Started by James McKinsey in 1926, it was nurtured to become what it is today by Marvin Bower. While the firm commenced operations analysing accounts of companies, it evolved its consultancy services by looking through all these numbers closely. The firm began scrutinising budgets across departments and then wove them all in a story for client companies through a series of recommendations. McKinsey referred to it as management engineering, and not consultancy. But how is this perceived by the public?The firm, as a rule, does not advertise its clients or business. It lets the companies take credit for what goes well, but also distances itself from failure. After all, they only advice clients on what should be done and is appropriate; and it is for the latter to successfully implement the strategy. McKinsey follows the highest code of secrecy and trust, and believes in recruiting the best. The firm is more important than the employees and, while everyone has a large ego, no one is bigger than the firm. Thus, it is not surprising that their staff is rarely well known, and it was only after Rajat Gupta displayed his aggressive persona that things changed. The terminology of the firm differentiates it from others. The firm has clients, not customers. Everyone plays a role and does not work on a job. Theirs is a practice, not business. And McKinsey is not a company, but a firm. They have values and no rules, and have members, not employees. On the other side, McKinsey is responsible for the maximum number of layoffs across organisations as it seems to be embedded into their solutions of cost-cutting. They prefer a constant rollover of employees and believe that the McKinsey brand name will help anyone go anywhere as there is a lot of respect bestowed on anyone associated with the firm. But clients have not always been too happy. When Conde Nast was told to cut cost through right-sizing, they threw a fit and the analogy drawn was whether you can have a football coach who never played football. Some of their more blatant blunders were: asking JP Morgan to get out of lending, the merger of Time Warner and AOL, Kmart’s foray into groceries, Hewlett-Packard’s acquisition of Compaq (the CEO later lost her job on this score) and Wachovia’s purchase of Golden West Financial, etc. But yet, the fact that companies have been hiring the firm means they add value somewhere. In fact, around 85% of their business comes from the existing set of clients, which is a clear indication of their efficacy. The journey of McKinsey has not been without its set of trials. The firm faced competition for the first time when The Boston Consulting Group came in and spoke of strategy and the ‘four square matrix’. More importantly, while McKinsey worked with all firms in an industry, which gave a feeling that they could pass on secrets, Henderson of BCG stuck to exclusivity. The firm proactively changed its approach subsequently and brought in its own ‘nine box matrix’ and exclusive clients. Now, it was a case of saying that while BCG marketed products, McKinsey sold brilliance. McDonald also adds two other important episodes in the story of the firm that are quite revealing. The first is the contribution of Tom Peters and his book, In Search of Excellence, which came out after he left the firm. His focus was on execution and he dismissed strategy, and felt that what mattered were customers, low cost, productivity, innovation and risk-taking. The second is about Rajat Gupta. The overall ethos of the firm changed when Gupta came in, and while it became more aggressive in the market, it compromised on a number of core principles. But no one bothered as long as the firm made money. He brought in growth of around 20% per annum, while the firm aimed for a normal 10%. He hired from more B-schools and recruited PhDs too, but never sold shares to the public. And then the author unfolds the darker side to his regime. The firm started taking equity stake in clients, which, though it was 2% of revenue, was against the core principles. Similarly, the firm would work for anyone who had a fat cheque book, and the culture of dissent in the firm was smothered. Simultaneously, the compensation to directors was increased and what was earlier access to exclusive clubs got transformed to gifting of ranches. As he took a pay of $5 million, the ratio of salaries of the highest to lowest worker was 40:1. This is a common feature of capitalism where similar rewards are given to the professionals in companies by professionals! Did the firm always work fair? Yes, as no laws were broken even though the firm worked closely with Wall Street. The only smear was, once again, an Indian, Anil Kumar, who was held for insider trading. The author devotes quite a number of pages to Rajat Gupta and his indictment, and points out, quite curiously, that some of the who’s who in India Inc who supported him were the likes of Adi Godrej, Sabeer Bhatia, Mukesh Ambani and Deepak Chopra. McDonald’s book is definitely very engaging and thought-provoking for the reader and goes beyond the narrative. McKinsey could be representative of the entire fraternity of management consultants, and the stories would be similar everywhere, especially in terms of the awe they command in the market as well as the scorn when it comes to failures. He has taken a very balanced view of the way in which McKinsey has worked and while one may get a feeling that he is a bit critical, he has rightly pointed out that if firms are paying the firm for services repeatedly, there must be value in their work. That sort of sums up the view on management consultants because while critics say they only tell you what you want with the right words and graphs, if you are still paying them, then it must be well worth it. A good way of summarising these emotions can be captured by the author’s major grouse against the firm—Enron. The firm has endorsed Enron and advised them on following a loose-tight culture, where executive decisions can be taken without constant approval. They encouraged off-balance sheet financing and atomisation. He poses three questions with answers: First, did McKinsey hype Enron’s fraudulent rise? Yes. Was McKinsey liable for Enron’s misdeeds? No. Would other clients care? No. That’s why the firm still rules.

Banks’ recapitalisation will achieve little: Financial Express 7th October 2013

The recent announcement by the ministry of finance to provide additional capital to public sector banks to fund loans in the personal loans segment is interesting. The government is evidently going all out to increase the flow of credit to all sectors with focus being on the personal loans segment with the hope that easy, and hopefully cheaper credit, will enthuse households to borrow more and increase demand for consumer goods including automobiles. This can set in motion a virtuous chain of higher industrial growth and provide a stronger foundation for GDP growth. The FY14 budget had already spoken of allocating Rs14,000 crore towards recapitalisation of public sector banks and the message given now is that the budget can accommodate more if the need arises. What is one to make of it?
There are essentially 6 issues which need to be put on the table for debate when viewing such a policy since it sets the precedent of the government actually trying to direct credit into certain areas, which goes beyond the conventional channels of priority-sector lending. First, there has already been a lot of debate on whether the government should be infusing capital in the public sector banks, and if it is committed to doing so, how long will this carry on. The requirements for capital are challenging looking ahead and given the constraints on the fiscal deficit, it will not be possible to keep supplying capital. Also, at some point of time, which could be after 5 years or 10, banks would be moving towards the road of hastened disinvestment not just from the point of view of operations but also to become global players. Therefore, tinkering with recapitalisation for short-term gains may not be a very good idea as it sends all different kinds of signals. Second, directing credit to a sector beyond what is defined as priority-sector is curious. There are two issues which come up for discussion. Can we actually differentiate sectors where lending is going from the point of view of capital as money is fungible? Banks can take extra capital from the ministry and map the same with existing personal loans even while using capital, which would have been allocated otherwise to such loans, for other purposes. Further, by directly linking such loans to a sector, the government would be part of the decision-making by banks, which may not be advisable. This leads to the third issue, of asset bubbles.There are already talks of whether or not a housing bubble is building up. Property prices have risen sharply in the recent past at a time when domestic income is down, interest rates high and incomes not growing. In such a situation pushing funds aggressively to the consumer goods segment may just be tempting for banks. Also, borrowers would get a bit enthusiastic as the level of due diligence comes down. This is likely at a time when banks get free capital from the government and feel obliged to lend to a sector. Should we be aggressively pushing credit to a sector at this stage when there may be less voluntary appetite? At present, personal loans (including mortgages) are one of the leading segments in terms of credit allocation. The two specific segments mentioned by the ministry, i.e. auto and consumer durables constituted just 2.4% of total loans as of March 2013. At a broader level, the question that may be posed is whether it is worth setting a precedent for a segment which is not very significant in the overall bank-lending landscape. Fourth, there are two issues which need to be raised when talking of such funding for banks. First, are banks really under-capitalised that they are facing a problem of shortage of capital as a limiting factor? The answer appears not to be in the affirmative as most banks have capital adequacy ratios of above 12%. For nationalised banks it was 12.26% in FY13 and 12.67% for SBI and its associates. Further, is there any shortage of liquidity that is coming in the way of bank lending? The answer again is no, because banks have funds and are anyway preferring such lending today given that delinquencies are lower and demand is stable. Further, if at all liquidity becomes an issue, the RBI could instead just keep using OMO to shore up liquidity, which it has been doing in the last few months or enhance the LAF limits to provide more funds to banks. This leads to the fifth issue—whether the cost of such loans will come down or not. Banks have already stated that they would have preferred the refinancing route on such loans to lower the cost of such credit. This has not been done. Further, the credit risk weight of 125% for consumer loans still remains and in case this was reduced, it could have helped to lower effective cost of such loans. Therefore, on the whole it looks unlikely that the cost of personal loans will really come down through this move.Sixth, from a purely macroeconomic perspective, this route is quite unconventional. The premise is that we want to spur demand to boost growth. The route is not by higher spending through demand for automobiles or consumer goods keeping to the Keynesian model but providing capital for banks, which could lend 9 times that amount for such loans. As mentioned earlier, if it is not proved that capital is a limiting factor that has come in the way of enhanced credit, then this measure will merely help banks swap existing loans into this account. Also, given that the ticket size is small and that it will require several households to come and borrow at a time when job losses and zero increments are the norm, this move could at best be a sentiment-boosting step and may not actually work the way it is hoped it will. Putting all these answers together, it may be concluded that a move to enhance capital to banks to enable more lending to specific sector may not be ideal for the system. Besides setting a precedent, it inadvertently involves the government into lending decisions of banks which may not be desirable. More importantly with the credit

Captivating potential investors: Financial Express: October 4, 2013

It is now accepted that one reason why FIIs are pulling out of emerging markets is that interest rates are increasing in the developed economies. This is happening on the back of the twin expectations of a recovery in the west, which in turn, will lead to the premature withdrawal of QE in the US. The result would be a reversal of flows at a faster pace. Therefore, there is merit in the argument that if India is looking to stem the outflow of dollars, RBI may have to give primacy to rupee stabilisation which necessarily means taking a call on interest rates.
In fact, investors in debt would tend to look at the ‘real return’ on such investment as well as the perception on the exchange rate before taking any decision on where to invest. This means that inflation matters, not just present inflation, but also expectations of the same. When critics highlight our obsession with inflation and exchange rates, they probably err as these are genuine considerations for any central bank. Also, while industry would like interest rates to come down to bring about growth (though anecdotal experience does not justify the same), a central bank, which takes a more macro look, has to look at all these factors when taking a call on policy options. Looking at various markets in the world, an interesting commonality is that nominal bond yields have actually moved up over the last year by varying degrees in different countries. The yield on 10-year GSec or its equivalent has increased by more than 100 bps in countries like Brazil (281), Indonesia (230), South Africa (137), UK (118), USA (114) and Sweden (102). It has been over 60 bps for Mexico, Thailand, Korea, China, Switzerland, and Germany. In case of India it has been almost flat at the current rate of 8.27%. Quite clearly, we will have to compete with markets where yields are increasing—both developed countries as well as competing emerging markets. On the positive side, as the accompanying table shows, at the present level of ‘real yield’ (which is what matters to investors) where the nominal rate is adjusted for the inflation number, our real rate is at 2.48%. It is at the upper end of the ladder—third in the list of 18 selected countries, with Latin American countries such as Brazil and Mexico ahead of us. Inflation has been high in countries like Brazil, India, Mexico, Russia, South Africa and Indonesia. Again, due to structural reasons, inflation tends to be higher in emerging markets than in developed countries where price increase is more controlled. Investors will, necessarily, take a call on future inflation and hence, inflationary expectations play a role.It is here that the monetary policy approach is important as it provides a signal to the potential investors indicating the will of central banks in controlling inflation. Any laxity in policy approach in the midst of high inflation will cause apprehension in the minds of investors. RBI is cognisant of this factor and hence, talks very often of real interest rates as a driving factor behind monetary policy. In a globalised world, where foreign investment is providing succour to the CAD, real interest rates become even more important as investors do not suffer from money illusion. The accompanying table also provides information on exchange rate movements across countries vis à vis the dollar over the last year. Currency depreciation is another factor looked at by investors when investing in any market. Irrespective of whether the funds are flowing into equity or debt, the final purpose is to remit gains back home where the exchange rate plays an important part in their strategy. As seen in the table, the real return is one way of choosing across markets when it comes to debt. But the exchange rate is a clinching factor because an inherently volatile or weak currency will lower effective return for foreign investors when money is to be repatriated. Again two factors matter—the nominal and the expected depreciation. Based on nominal depreciation, the rupee has been more adversely affected and is third in the list with Japan and South Africa being above us. Intuitively, it can be observed that when the currency falls by 16% in a year, the returns on both debt and equity are actually wiped out in real terms even if inflation is under control. Therefore, having a stable currency is a pre-requisite to getting foreign investment. As a corollary, central banks also need to provide a signal that they are serious about protecting their respective currencies and hence would have to have policies in place that stabilise their currencies. A normal depreciation which will vary across countries following trends will be acceptable, but volatile currencies would be a deterrent.Given the overall state of uncertainty relating to the Fed action in the coming months and the wide array of choices that foreign investors have, RBI and government have to take a call on how they would like to prioritise the goals for our economy. As long as the CAD is high, foreign funds are a necessity, especially through the investment route, as they help to stabilise the balance of payments and hence, the rupee. In these circumstances, we do need to see what other countries are doing and the opportunities being offered through returns—nominal and real—which is backed by currency policies. Based on the approach to interest rate policy, the revealed preference of RBI appears to be firm and consistent towards maintaining a stable regime of exchange rates while ensuring a positive real return on debt to retain India as an option for potential investors. This will be painful to industry as it prolongs the recovery process but appears to be inescapable under these testing circumstances. RBI’s actions on interest rates, inflation and exchange rates have definitely been pro-investor even though the policies may not have always delivered according to script.

Demystifying macroeconomics: Book Review of Tim Harford's Undercover Economist Strikes Back: 29th September 2013

Reading Tim Harford is not very different from picking up a book by PG Wodehouse. Harford’s books are easy to read, feature examples that are fairly predictable as we keep looking deeper at things that we experience but don’t generally notice, have a good dose of wit and, most importantly, leave the reader with a good feeling. His latest book does not disappoint, as he takes us through the labyrinths of macroeconomics this time. The style is the same and he brings in everyday examples to explain difficult situations. This time around, he uses a different approach where there are questions and answers. The questions are also posed in terms of the disbelief, or doubt, that the reader might come across while reading his answers. This adds novelty to the discussion.
He begins with rudimentary concepts and links them together. Starting with recession, he moves over to the concept of money, which leads to inflation as he reconciles the concept of a stimulus with growth and inflation, which we keep reading of. Next, he moves to employment and output, and covers the various definitions of domestic product, including the more abstract concept of theoretical happiness by weaving behavioural economics in the network. While also raising issues on inequality, he talks of management quality in a highly entertaining manner. He reconstructs the age-old classic debate about recession and its solutions, and while Keynes and classical economics form the core of these arguments, he relates them with simple examples to make them comprehendible. He takes the case of a babysitting forum among members of a group, where all parents get points for babysitting other’s kids. These points or scrips, as he calls them, can be used by parents who accumulate them for going out for a party while leaving their kids behind. A classic case of a Keynesian recession comes in when all parents want to accumulate scrips and do not want to go out. This is a case of fall in demand, which can be met by increasing scrips to a prudent extent, because, if there are excess scrips to be had, everyone will want to go out and no one would want to babysit. He, therefore, leads this to the debate on flexibility of prices and inflation. He acknowledges that this idea is borrowed from Paul Krugman, but the difference is that he takes this to its logical conclusion. From the standpoint of classical economics, he explains the case of a recession through what happened in a prisoners of war camp in Germany during the war. Prisoners got stuff such as cheese, blades, beef, etc, from the Red Cross and traded products with each other. But when supplies stopped from the Red Cross, trade ceased. This was a supply-side problem and hence the cure could not be to get people to spend more, which would be inflationary, as was the case during the oil crises when countries misread the situation leading to stagflation.Harford gives such examples to engage the reader. While relating the current financial crisis with Keynes, he explains that for the spending theory to work, based on what Obama did, three factors need to be kept in mind. First, there should be a recession. Second, money should not be spent on, say, French wine, which helps France, not the US. In fact, this point is valid because even when we talk of the quantitative easing programme of the Federal Reserve today, most of these funds have moved to the emerging markets, not the US. So has this really helped? This is worth thinking about. And third, he warns us that we should not get into situations where we allocate money and spend on new projects that would be abandoned and not completed when conditions improved. Working on work-in-progress is a pragmatic option.Speaking on unemployment, he gives a very interesting example: How Henry Ford doubled wages in his factory and lowered the number of hours of work to ensure that the issue of labour became permanent. More importantly, they could not move out due to non-availability of similar wages outside. This reduced costs because Ford had employed more than three times the number required, as few worked for more than three months, and as the labour market was flexible, they could find work elsewhere at the low wages. Higher wages changed this possibility.At one point, which we may not like, Harford is quite harsh on India, where he says we probably have the largest number of badly-run companies, in a chapter titled Bossonomics, simply because of the absence of competition. This should be a takeaway for us. He narrates the story of Accenture Consulting, which was paid by World Bank to carry out an audit on textile firms in India, but got the service free of cost. But most were not willing to get this service for obvious reasons. And their own results showed that when companies were also guided by them to change their strategies, it really helped. The point they make is that Indians are unwilling to take such advice, which comes in the way of their efficiency. The book is obviously worth reading. For the layman, it is a good and easy-to-comprehend book on macroeconomics. For the professional, it is light and some of his anecdotal examples are of interest; though for one familiar with the subject, some pages can be skipped. While the first taste of the undercover economist was obviously engrossing for all, this one could look a bit repetitive to the hardcore professionals. This is a challenge for all authors who have a brilliant first book. But then this may not be meant for the professional or academic who is well past the stage of basic concepts.

Building blocks: Brick by Brick: Book Review Financial Express September 22, 2013

There have been a lot of books written on how to make a company succeed and the leadership qualities that go with it. But rarely do we come across one where the authors look at the role of innovation as the driving force in transforming a traditional company into a dynamic one, more due to the force of circumstances. It is even more compelling when the story is about a company that manufactures mere plastic bricks—LEGO.
Brick by Brick, as the title suggests, is the story of LEGO, a Danish company that has become a household name, literally, with the maximum number of bricks existing in this world. The genesis of this book is quite unique. The authors, Robertson and Breen, were on the lookout for separate stories on companies that were models for innovation. While researching the same about LEGO, they realised it was worth more than a chapter, and that nothing less than a book would do justice to the tale. With the exception of probably Apple, no other name strikes a similar chord with the customer and the LEGO brand is probably on a par with those like Coca-Cola and Disney. Quite surprisingly, while the brand is well-known, the organisation is not, since it is a family-run business and not listed on Wall Street. Some of the terms associated with the company are creativity, educational, imaginative and so on. But the story of its rise has been quite inspiring because there is a lot which went behind building the bricks of this storyline. This book is really about the lessons from the strategies put in place by LEGO to reconstruct in turbulent times. Some glimpses of what it has shown can be sampled here: The company has given room for innovation while retaining focus, provided autonomy with responsibility, delivered in short run while building for the long term and, more importantly, has operated within the limits of business orthodoxy while creating value. LEGO is a family-run business started by a master carpenter in 1932 in Billund, Denmark. From wooden toys to plastic bricks to Star Wars, it has had it all. The authors research the practices of the company and find that there are six core principles, which have remained untouched over the years and which can be templates for other companies to consider. The first is that core values should never change irrespective of circumstances, howsoever adverse they may be. Second, companies must focus on relentless experimentation, which, in turn, will beget innovation. Third, companies should look at creating not just products, but a system. By not doing so and focusing on a narrow corner, they lose sight of the bigger picture. Fourth, to have profitable innovation, we need to stay focused on the business. Fifth, the product should be authentic as far as the customer is concerned, which will separate it from competition and imitation. Sixth, the focus should always be on the store and then the customer, not the other way round, as it is the store that sells your product. This may sound contrary to what we normally hear. In the context of these principles, there is an interesting anecdote shared of how LEGO reacted to the Star Wars mania, when the US office suggested they tie up with Steven Spielberg to create these characters in 1997. Internally, they were against the idea of such partnerships and more so as they were against getting into the concept of ‘war’ in children’s play kingdom. It was finally agreed upon only after a survey among parents to ask for their views.The dream run of the company actually carried on till the end of the 20th century. But it lost lustre when the group’s patents ran out on the interlocking brick. Low-cost competition hit it hard, and the response was to bring out more toys every month. This pushed up costs, but not sales, which had reached a plateau, putting pressure on profit lines. By the late Nineties, kids preferred interactive games and other innovative software, leaving conventional toys behind. Compared with Game Boy and Xbox, the brick appeared to be quite a part of a bygone era. As losses mounted, they had to change track with a new management and their new approach is what the book is mostly about. To reinforce these ideas, the authors give examples across companies which have done similar things. P&G followed the connect-plus development initiative, where it formed 1,000 successful agreements with top innovators around the world. Southwest Airlines redefined their industries as they sailed to blue ocean markets that others ignored. Canon’s digital cameras were a case of disruptive innovation, where the film camera was made obsolete. Apple sustained its hold on the MP3 music player as it surrounded the iPod with a full spectrum of complementary innovations. But as is the case with most books on innovation, the lessons matter more than the story. The internal restructuring and the names that go with the story are more for local consumption and may not mean much for the reader. A differentiator in this story is the distinct focus on the retailer, which is a lesson, because to push any product you have to make it attractive for the final seller. The fact that innovation is the driver in this competitive world should be remembered by companies, as otherwise all of them would enter the syndrome of low growth and stagnation, and would have to foster a culture of innovation within to emerge successful.

Five years after Lehman: Financial Express 12th September 2013

Indiscriminate household borrowing supported by banks (through sub-prime lending), with repackaging from Wall Street (to spread the risk across institutions) after getting a nod from credit rating agencies in an unregulated environment with tacit political support (as it led to economic booms), was what constituted the Lehman crisis in 2008. Five years on as the financial world looks back on September 15, which was more catastrophic than 9/11, are we in a better state today?
There are ten pictures that meet the eye in the periscope as one looks back on how things have turned out and how we have moved. First, the concept of investment banking has changed and it is no longer sexy to be an investment bank as it is now associated with all kinds of negatives. Several of them have turned into commercial banks with better regulatory oversight. In fact, a recent estimate drawn on the market value to book value for two top banks—Goldman Sachs and Morgan Stanley show that this ratio came down from 1.8 times to 1.11 times and 1.4 times to 1.02 times respectively between the onset of the Lehman crisis and the first week of September 2013. The 12- month forward EPS delivered a P-E multiple of less than 12 for both of them. Such has been the moderation. Second, the world of financial derivatives which came as part of the financial engineering revolution has been looked at with circumspection. The ABS, MBS, CDO, CDS, etc markets have all become less prominent than they were at that time when home loans were multiplied through securitisation. Regulators are putting structures in place before going for them in a big way. Third, the regulatory world has moved ahead with Dodd Frank talking of single regulators and the Volcker rule distinguishing client trading from proprietary positions. This, combined with the Basel III version where focus is more on liquidity than capital, has meant that the financial world is more cautious than before. The benefit of the crisis has been that we have started putting systems in place before the markets. Fourth, the credit rating agencies did come in for some criticism, and there has been a fresh set of regulations in place to eschew conflict of interest in their operations. This has been hastened with the sovereign debt crisis where similar questions have been raised. But more importantly, the door appears to have been opened up for more rating agencies to join the fray as it has been felt that oligopolistic structures may not be the best fit in such an industry. Fifth, the three big names that have been associated with the crisis, who worked towards saving and then reviving the system have or will move on—European Central Bank's (ECB) Jean-Claude Trichet was succeeded by Mario Draghi, Bank of England's Mervyn King by Mark Carney and Fed's Ben S Bernanke is likely to be succeeded by either Janet Yellen or Larry Summers. These were the wise men that could not help the Lehman collapse but worked towards getting others like AIG, Morgan Stanley, Fannie Mae, etc back on their feet. They will be known more for their innovative minds and unflinching resolve to ensure that the crisis did not go out of hand.Sixth, the fiscal stimulus, which was the solution to the crisis, was pursued everywhere in the world with mixed success. The USA ran into trouble with the debt levels reaching unsatisfactory levels which required presidential intervention and came off with a downgrade by a rating agency. Some of the euro nations which had been inflating their budgets ran into a crisis of confidence which led to ECB and IMF action as they came close to default status. India had also inflated its way out of trouble; but now it is believed that we have lost our way somewhere and whatever was done was just too artificial and at the cost of high inflation which we are not able to get out of.Seventh, banks have become much stronger today with a lot of capital being infused across the world. One estimate says that banks have raised as much as 60% risk-weighted capital in the last 5 years to ensure that they are back on the prudential path. Clearly, banks have gotten their bearing right this time. They have also written off a large proportion of their impaired assets. Curiously, the market estimates that 6 of the largest US banks have become even bigger today in the last 5 years and the old dilemma of ‘too big to fail’ continues to haunt us. Eight, banks have become more conscious of risk which has had unintended consequences. They are shy to lend if they are not sure of the quality of assets which has put global growth in jeopardy. Therefore, while liquidity has not been an issue, lending is. Central banks have lowered interest rates across the world to ensure that lending takes place freely. But banks have been more worried about their assets—on and off the balance sheets.Nine, following from the earlier point on risk aversion, banks had stopped trusting one another after the crisis as no one was aware of how rabid the other’s portfolio was. This compelled the use of non-conventional measures called quantitative easing which went under different names such as QE, LTRO, and Abenomics, etc. This was probably the most significant fallout for the rest of the world because buyback of bonds by the central banks meant more liquidity that was not put to full use in these countries but invested in the emerging markets in a big way which helped to spur the economies of the latter. Just while the analysts discussed the decoupling hypothesis where global growth was largely due to the emerging markets, there has been a reversal of fortunes with all these countries now under pressure from the fear of a withdrawal of these programmes. Last, while the US economic supremacy was questioned in 2007, and capitalism chided for wanton greed, the cycle seems to have returned to the start with the US economy still calling the shots. As much as central bankers have argued that domestic monetary policy is based on local conditions and is not determined by the Fed, any action here has a deep-rooted impact on such policy framework. Quite clearly, the world financial order has moved on learning lessons, where the core is on better regulation and stronger institutions. The easing programmes have had a lot of collateral effects—both positive and negative—and would probably be the last of the vestiges of the sordid episode as we go ahead. Schumpeter’s creative destruction may have just struck the right cord here.