When the watchdogs slept

One lesson from the Harshad Mehta time is that bringing in the lawmen ensured that the banks haven’t got anything back after eight years

May I begin with two pieces of advice? First, for the small investor: bubbles burst, learn to live with it. Second, for the various wings of the government: you can’t repair a burst bubble with a ‘lathi’, so don’t send the cops into the
exchange.

The first sounds harsh, nevertheless it is true. Playing the market is little more than gambling. Legal, often profitable, but at the end of the day nothing but gambling. It is crazy to believe that the market will climb forever, an illusion many cherish. Another dangerous assumption is that one has some secret insight into the way the market operates.

Have you heard of Robert Merton and M. S. Scholes? The duo won the Nobel Prize for economics in 1997. Some time later the firm they founded, Long Term Capital Management, went bust. If Nobel laureates can’t get it right, can we expect anyone else to do so?

That said, I do believe that there is more to the current falling market than mere misjudgment. Part of it is because the American economy has caught a cold, which means everyone else should take flu shots. Part of it, as Manmohan Singh said on a similar occasion, is because of systemic deficiencies. (Which he did nothing to rectify, but that is another story!) And part of it is because of rumour.

The bit about the American economy faltering should be no surprise to anyone. NASDAQ fell 6 per cent in one day, 30 per cent in a month. NASDAQ is the bellwether of technology stocks all over the world. If Microsoft stumbles, Oracle falters, and the chief executive of Yahoo is replaced, then investor confidence in Satyam and Infosys too is shaken. Not that there is anything wrong with either Indian firm, it is just a case of an ebb tide taking down all ships.

How about structural deficiencies? Well, this is a much more serious matter, and both the ministry of finance and SEBI have finally woken up to the fact. Why does India permit brokers to manage bourses? (The NSE is an honourable exception.) This isn’t allowed in any country that possesses a sophisticated stock market. The conflict of interest and the potential for insider trading are so evident that I won’t expand on them. (However, we must wait for the Lord’s Kalki avatar to usher in a new age before we can eliminate all human frailty. In the United States, rumours are flying about Amazon.com’s Jeff Bezos indulging in insider trading just last week. The SEC, SEBI’s American counterpart, is said to be investigating, but there too the fabled ‘small investor’ has been burned.)

A second jarring phenomenon is that India is one country where brokers’ settlement takes place on different days. It is Tuesday for the NSE, Thursday in Calcutta, and Friday for the mighty BSE. In practical terms, this is an invitation to juggle money. Is there any reason why all of them can’t do it on any one day? Some say that an even better solution is a system of rolling settlements. This means that settlement will be an ongoing process rather than a looming deadline. This will leave no chance of going over.

A third structural fault is that India permits uncovered short sales. Boiled down to essentials, this means speculators can make sales without needing to have delivery of the actual shares. I understand this is unique to India. I also understand this gives the bears a wonderful tool to rig the market!

Uncovered short sales are not the only levers bears employ to shake a market. I am reliably told that some of them took advantage of liberalisation and SEBI’s sleepiness to pose as FIIs (foreign institutional investors). This allowed them to cock a snook at rules against full capital account convertibility. It also, obviously, raises questions about money laundering.

These loopholes — no impartial professionals to manage the bourse, no single day for settlement, uncovered short sales, and Indian bears posing as FIIs — have been around for quite a while. Every government has been content to look away. Now that the issue can’t be ducked, how best does one plug the leaks?

The watchdogs — SEBI for the markets, the ministrŽy of finance for the economy as a whole — were sluggish. Under the Reserve Bank’s guidelines, nationalised banks may pump up to Rs. 25,000 crore into the market. The banks’ actual investment is less than Rs. 5,000 crore. To put it another way, where the rules permit investing up to 5 per cent, the actual exposure for the banks is 0.8 per cent.

If the banks lacked confidence in the market, can you blame other investors for dumping stocks? Governments in capitalist havens such as Hong Kong, Taiwan and Singapore have traditionally stepped in when there is a crisis of confidence. They ordered banks and other financial institutions to buy blue chip stocks. Why didn’t the mandarins in Delhi follow suit? (Buying blue chips at the current low prices is a good idea for small investors too.)

There is one final factor, and this deals with that mysterious thing called ‘market seiment’. The American markets will recover. Loopholes can be sealed. But how do you halt rumours, and whom do you blame for spreading them? The government’s seeming indifference led to the rumour that it was on the rampage. Far from investing, it was out to unleash the cops, the Income Tax authorities, even the Central Bureau of Investigation...

Actually, I can’t think of anything sillier than asking for police intervention. Comparisons, unwarranted in my opinion, are already being drawn to the Harshad Mehta years. Well, one lesson from that time is that bringing in the lawmen ensured that the banks haven’t got anything back after eight years. With a liquidity crisis on the horizon, is that what the doctor ordered? How do you halt the panic? May I suggest a little patience in Delhi coupled with some alertness and action in Mumbai?

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