The ten best Nonfiction books of 2014

single-man-coverVivek Kaul

It is that time of the year when media houses go around writing about the best of the year that was. Given this, I thought it would be an appropriate time to put out a list of what I think are the best nonfiction books that I read in 2014. The list is biased to the extent of what I read, which are basically books in the area of finance and economics. Also, some of the titles were released earlier and I only happened to read them in 2014. The books are listed out in a random order. So here we go.

Saving Capitalism from the Capitalists by Raghuram Rajan and Luigi Zingales: I had read this book when it was first published in 2003. At that point of time I was basically trying to figure out what to do with my life, having finished an MBA in information systems in 2002 and at the same time having realized that the MBA degree was one big con job. In 2014, the book was published again with a new afterword. I read it again and appreciated the book much more than I had done in 2003. The book is a great read for anyone who believes in the idea of free markets. It tells you loud and clear that the incumbent capitalists are the greatest enemies of the free market. The book also helped me understand why so many big businesses in India manage to default on their bank loans without the industrialists having to face the consequences of the same.

After the Music Stopped by Alan S Blinder: This book was published in 2013, but I happened to read it only this year. The best books on historical events are written many years after the event has happened. Take the case of what I think is the best book on the Great Depression—The Great Crash 1929, written by John Kenneth Galbraith. The book was first published in the mid 1950s almost quarter of a century after the Depression started. One possible explanation for this is the fact that writing many years later, the author can leave out all the noise and concentrate on the most important issues. Over the last six years many books have been written on the financial crisis, but After the Music Stopped, in my opinion is perhaps the best book on it. It summarises the economic, the political as well as the legal angles of the financial crisis very well. If you are looking for a ready reckoner on the financial crisis, this has to be your go to book. Capital in the Twenty-First Century by Thomas Piketty: This was by far the bestselling title in economics during the course of this year, having been the number one book on Amazon.com for a while. It is very rare for an economics book running into 700 pages to be number one on Amazon. In this book the core argument offered by Piketty, who is a French economist, is that capitalism has led to greater inequality among people over the years. Piketty offers a lot of data from the developed countries to make his point. The book did not go down well with the American economists, and after it appeared many of them tried to discredit it by trying to find mistakes in the data and methodology used by Piketty. Who is right and who is wrong is too long a debate to get into here. Nevertheless, Piketty’s book remains a must read for the fantastically lucid way in which its written and the several original ideas that it offers. The Dollar Trap by Eswar S. Prasad: The United States is in a huge financial mess. Nevertheless, dollar remains the go to currency of the world at large. Whenever there is a whiff of a crisis anywhere in the world, money is pulled out and moves to the dollar. Ironically, even when the rating agency Standard and Poor’s cut the rating of the debt issued by the United States government from AAA to AA+, money moved into the US dollar. Prasad explains this “exorbitant privilege” of the dollar and the reasons behind it. While the US may not be in a great financial shape, but the world at large still has faith in the dollar. Prasad summarizes the situation well when he says: “It is possible that we are on a sandpile that is just a few grains away from collapse. The dollar trap might one day end in a dollar crash. For all its logical allure, however, this scenario is not easy to lay out in a convincing way.” The book is a great read for anyone trying to understand one of the most fundamental disconnects of the times that we live in. Flashboys by Michael Lewis: No one quite writes about finance like the way Lewis does. From his first book Liars Poker to the latest Flashboys, each one of his books on Wall Street and its ways has been a bestseller. One reason for the same is the fact that Lewis started as a Wall Street insider in the investment bank Salomon Brothers (which has since gone bust) and has managed to maintain his contacts since then. Flashboys is essentially a story of the people and systems that make up algorithmic trading that has taken Wall Street by storm. A majority of the trades on Wall Street are not driven by humans any more. They are driven by computers with a lot of processing power. And that is the fascinating story of Flashboys. If you are the kind who likes reading thrillers over weekends, this is just the right book for you.

Business Adventures by John Brooks: I first discovered Brooks in the process of writing and researching my books. Someone suggested that I should be reading Brooks’ version of the Great Depression called Once in Golconda: A True Drama of Wall Street 1920-1938. The book was a fantastic read and made me realize that Wall Street had a Michael Lewis even before the real Michael Lewis appeared on the scene. Early this year, Bill Gates wrote a blog on one of Brooks’ other books called Business Adventures. He called it the best business book that he and Warren Buffett had ever read. This blog pushed the book to the top of the Amazon charts. It was re-issued after this. The book is a collection of twelve long articles that Brooks wrote about the American businesses, government as well as Wall Street, for the New Yorker magazine. And it has tremendous lessons for almost everyone connected with business and finance.

Single Man—The Life & Times of Nitish Kumar of Bihar by Sankarshan Thakur: This book is the joker in the pack. In a list full of books on economics and finance, here is a book on politics. Having been born in erstwhile Bihar, I have always been interested in the politics of Bihar. And there is no better writer on Bihar in English than Thakur, who works as a roving editor for The Telegraph newspaper. Thakur chronicles the rather turbulent life of Nitish Kumar, starting a little before the Emergency, and goes on to chronicle the life of the Bihari politician over the next four decades. As he does that he also goes into the history of Bihar over that period. Unlike a lot of other biography writers, Thakur also goes into Kumar’s unhappy personal life. The book is an excellent model for how to write a biography of an Indian politician. What we normally get to read are either hagiographies or out and out criticism (as is the case with so many books on Narendra Modi which swing at both ends). There is rarely a biography of an Indian politician which takes the middle path. If I had to choose just one book to read this year, then Single Man would have to be it. And this would be more for Thakur’s andaz-e-bayan(the way he tells the story) than Kumar’s story per se. How Not to Be Wrong—The Hidden Maths of Everyday Life by Jordan Ellenberg: This is another joker in the pack. I absolutely love to read good books on Mathematics. Ellenberg in this book goes around explaining the practical aspects of Maths in everyday life. He explains in great detail how media often uses Maths incorrectly to draw wrong conclusions. He also tries to answer some really interesting questions: How early should you get to the airport? What’s the best way to get rich playing a lottery? And does Facebook know you are terrorist? If you are feeling a little adventurous and want to go a little out of your comfort zone, this is just the right book for you.

The End of Normal by James Galbraith: I am reading this book currently and am around half way through it. James Galbraith is the son of John Kenneth Galbraith, who I feel was one of the most lucid writers on economics that the twentieth century saw. Galbraith junior writes in the same lucid way as his father did. Since the financial crisis broke out, economists and politicians have tried to tell the world at large that “all is going to be well,” and that the financial crisis was just caused by bad policy and bad people. Galbraith challenges this world view and offers four reasons against it: the rising cost of real resources, the futility of military power, the labour saving consequences of the digital revolution and the breakdown of law and ethics in the financial sector. Long story short: The global economy will not see acche din(good days) any time soon. Hormegeddon—How Too Much Of a Good Thing Leads to Disaster by Bill Bonner: The regular readers of The Daily Reckoning would know by now that this has been one of favourite books of the year, given the number of times I have already quoted from it in my columns. I have been a big fan of Bonner’s writing since I first met him in late 2008. In this book Bonner goes about explaining how too much of a good thing in public policy, economics and businesses, leads to disaster or what he calls FUBAR (f***ed up beyond all recognition). Bonner offers many examples from history to make his point—from Napoleon’s decision to invade Russia to the outbreak of the Second World War to America’s War on Terror. He then goes on to show that these disasters cannot be prevented by well-informed people with good intentions because they are the ones who cause them in the first place. 

So that was my list of what I thought were the ten best books that I read this year. Happy reading. The India edition of The Daily Reckoning will be taking a year end break and will be back early next year on January 3. Here is wishing you a Merry Christmas and a Happy New Year. Meanwhile you can continue reading the international edition of The Daily Reckoning authored by Bill Bonner. The article originally appeared on www.equitymaster.com as a part of The Daily Reckoning, on Dec 24, 2014

Sensex 4,20,000: Coming in 15 years at a stock market near you

rakesh jhunjhunwalaVivek Kaul

It is that time of the year when stock brokerages forecast their Sensex/Nifty targets for the next year. A few such reports have landed up in my mailbox and the highest forecast that I have come across until now is that of the Sensex touching 37,000 points by December 2015.
I was thinking of writing a piece around these forecasts, until I happened to read an interview in which big bull Rakesh Jhunjhunwala said that
he would disappointed if the Nifty doesn’t hit 1,25,000 by 2030.
Nifty currently quotes at a level of around 8,500 points. The logic offered by Jhunjhunwla is very straightforward. He said that the earnings of stocks that constitute the Nifty index will grow by fifteen times over the next fifteen years. And that would take the Nifty to a level which is fifteen times its current level ( actually 15 times 8500 is 1,27,500, but given that Jhunjhunwala was talking in very broad terms let’s not nitpick). Hence, Nifty will be at 1,25,000 by 2030.
How reliable is this forecast? Not very, is a straightforward answer. A period of 15 years is too long a time to make such a specific forecast on the stock market or anything else for that matter. There are many things that can go wrong during the period (or go right for that matter). Hence, such forecasts need to be taken with a pinch of salt and seen as something that has an entertainment value more than anything else.
In matters of forecasts like these it is important to remember the first few lines of Ruchir Sharma’s
Breakout Nations – In Pursuit of the Next Economic Miracles: “The old rule of forecasting was to make as many forecasts as possible and publicise the ones you got right. The new rule is to forecast so far into the future that no one will know you got it wrong.” Jhunjhunwala has done precisely that.
If earnings have to grow by 15 times in 15 years, the Indian economy also needs to grow at a breakneck speed. Over a very long period of time, the companies cannot keep growing their profits unless the economy grows as well. For 15% earnings growth to happen, the economy needs to grow at a real rate of 8-10% per year (the remaining earnings growth will come from inflation).
The trouble is that this kind of rapid long term economic growth in countries is an extremely rare phenomenon.
As Sharma points out in
Breakout Nations:“Very few nations achieve long-term rapid growth. My own research shows that over the course of any given decade since 1950, only one-third of emerging markets have been able to grow at an annual rate of 5% or more. Less than one-fourth have kept that pace up for two decades, and one tenth for three decades. Just six countries (Malaysia, Singapore, South Korea, Taiwan, Thailand, and Hong Kong) have maintained the rate of growth for four decades, and two (South Korea and Taiwan) have done so for five decades.”
In fact, India and China which have been among the fastest growing countries over the last ten years, were laggards when it come to economic growth. “During the 1950s and the 1960s the biggest emerging markets – China and India – were struggling to grow at all. Nations like Iran, Iraq, and Yemen put together long strings of strong growth, but those strings came to a halt with the outbreak of war…In the 1960s, the Philippines, Sri Lanka, and Burma were billed as the next East Asian tigers, only to see their growth falter badly,” writes Sharma.
Long story short: Rapid economic growth cannot be taken for granted and given this forecasts like Nifty touching 1,25,000 at best need to be taken with a pinch of salt. Indeed,
Jhunjhunwala had predicted in October 2007 that the Sensex will touch 50,000 points in the next six or seven years.
Its been more than seven years since then and the Sensex is nowhere near the 50,000 level.
In October 2007, India was growing at a rapid rate. At that point of time it was almost a given that the country would continue to grow at a very fast rate. In fact, this feeling lasted almost until 2011, when the high inflation finally caught up with economic growth and the first set of low economic growth numbers started to come.
Also, Jhunjhunwala and most other stock market experts did not know in October 2007 that more or less a year later, the investment bank Lehman Brothers would go bust, and the world would see a financial crisis of the kind it had never seen since the Great Depression.
The stock market fell rapidly in the aftermath of the crisis. Once this happened the central banks of the world led by the Federal Reserve of the United States, printed and pumped money into their respective financial systems.
The idea was to flood the financial system with money so as to maintain low interest rates and hope that people borrow and spend, and in the process get economic growth going again. That happened to a limited extent. What happened instead was that big financial institutions borrowed money at low interest rates and invested it in financial markets all over the world.
In the Indian case the foreign institutional investors have made a net purchase of Rs 3,19,366.35 crore in the Indian stock market between January 2009 and November 2014. During the same period the domestic institutional investors sold stocks worth Rs 1,27,280.1 crore. The massive financial flows from abroad have ensured that the BSE Sensex has jumped from around a level of 10,000 points to around 28,450 points, during the same period, giving an absolute return of around 185%.
The point being that despite this massive inflow of money from abroad, the BSE Sensex is nowhere near the 50,000 level that Jhunjhunwala had predicted in October 2007. Over the long term a lot of things can go wrong and which is what happened after 2007.
To conclude, let me ride on Jhunjhunwala’s forecast and make my own forecast. Jhunjhunwala has predicted that the Nifty index will touch 1,25,000 points in 2030. This means the Sensex will cross 4,16, 420 points in 2030.
How do I say that? The Sensex currently quotes at around 28,450 points. In comparison, the Nifty is at around 8,500 points. This means a Sensex to Nifty ratio of around 3.33.
Hence, when Nifty touches 1,25,000 points, the Sensex will touch 4,16,420 points (1,25,000 x 3.33). For the sake of convenience let’s just round this off to 4,20,000 points. I know, the world is not so linear. If forecasts were just about dragging a few MS Excel cells, everybody would be getting them right.
But then it is the forecast season and everyone seems to be making one, and given that even I should be making one. And if in 2030 I am proven right, I will search this column and tell the world at large that I said it first way back in late 2014 on
The Daily Reckoning.
To conclude, dear reader, remember you read it here first. That’s the trick and I know how it works.

The article originally appeared on www.equitymaster.com as a part of The Daily Reckoning, on Dec 4, 2014 

Why governments, politicians and businessmen hate gold

gold
Yesterday Switzerland voted on whether its central bank should be holding more gold as a proportion of its total assets. Gold currently makes up for around 7% of the total assets of Swiss National Bank, the country’s central bank.
The proposal dubbed as “Save Our Swiss Gold” had called for increasing the central bank’s holding of gold to 20% of its total assets. It was more or less rejected unanimously with
nearly 78% of the voters having voted against it.
This proposal was backed by the right-wing Swiss People’s Party and came out of the concern that the Swiss National Bank had sold too much of its gold in the years gone by.
Interestingly, Switzerland was on a gold standard till 1999 and was the last country to leave it. In a gold standard the paper money issued by the central bank is backed by a certain amount of gold held in the vaults of the central bank.
What this means is that the central bank and the government cannot issue an unlimited amount of paper money. The total amount of paper money that can be issued is a function of the total amount of gold that the central bank holds in its vaults.
In April 1933, when the Great Depression was on in the United States, the Federal Reserve of the United States had around $2.7 billion in gold reserves, which formed around 25 percent of the monetary gold reserves of the world. At the same time, the ratio of paper money to gold was at a healthy 45 percent, more than the decreed 35–40 percent. (Source: J.W. Angell, “Gold, Banks and the New Deal,”
Political Science Quarterly 49, 4(1934): pp 481–505)
That’s how the gold standard worked.
Getting back to the Swiss vote on gold, other than the Swiss People’s Party, the other parties as well as businessmen were opposed to it. As
the Wall Street Journal reports “The initiative was widely criticized by Switzerland’s political and business communities.”
This isn’t anything new. The politicians over the last 100 years have not liked the gold standard because it limits their ability to create money out of thin air. And as far as businessmen are concerned they usually tend to go with what the politicians are saying.
As Raghuram Rajan and Luigi Zingales write in
Saving Capitalism from the Capitalists: “The First World War and the Great Depression created great dislocation and unemployment… Workers, many of whom had become politically aware in the trenches of World War I, organized to demand for some form of protection against economic adversity. But the reaction really set in during the Great Depression, when they were joined in country after country by others who had lost out—farmers, investors, war veterans, the elderly.”
The politicians could not do much about it given that most of the world was on the gold standard. And given this, they could not print money and flood the financial system with it. “The gold standard … imposed tight budgetary discipline on governments, which made it difficult for them to intervene much in economic affairs… Politicians had to respond, but such a large demand for protection could not be satisfied within the tight constraints imposed by the gold standard. Hence, the world abandoned the straitjacket of the gold standard… With their ability to turn on or turn off finance, governments obtained extraordinary power,” write Rajan and Zingales.
This explains why governments hate gold.
In 2012, I had the pleasure of speaking to the financial historian Russell Napier. And he made a very interesting point about the rise of democracy and paper money having gone hand in hand. As he put it: “The history of the paper currency system, or the fiat currency system is really the history of democracy… Within the metal currency, there was very limited ability for elected governments to manipulate that currency.”
Napier further pointed out that most people don’t have savings. As he explained: “And I know this is why people with savings and people with money like the gold standard. They like it because it reduces the ability of politicians to play around with the quantity of money. But we have to remember that most people don’t have savings. They don’t have capital. And that’s why we got the paper currency in the first place. It was to allow the democracies. Democracy will always turn toward paper currency and unless you see the destruction of democracy in the developed world, and I do not see that, we will stay with paper currencies and not return to metallic currencies or metallic based currencies.”
With paper currencies around, politicians (even honest ones) feel that they have the ability to bring an economy out of a recession, by getting their central banks to print money and flood the financial system with it, so as to maintain low interest rates.
At low interest rates the hope is that people will borrow and spend more. In a gold standard all this wouldn’t have been possible. But that as we have seen over the last few years has led to other problems.
Having said that, the fundamental problem with paper money, that it can be created out of thin air, remains. Or as Ben Bernanke, the former Chairman of the Federal Reserve of United States, put it in 2002: “The U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost.”
This is what the US government has done with the help of its central bank, the Federal Reserve, over the last few years, largely during the years in which Bernanke was the Chairman.
As on September 17, 2008, two days after the investment bank Lehman Brothers went bust, and the financial crisis well and truly started, the Federal Reserve held US government treasury bonds worth $479.8 billion. Since then, the number
has jumped up to $2.46 trillion. Where did the Fed get the money to buy these bonds? It simply printed it. And then it bought bonds to pump that money into the financial system.
In fact, it also printed money to buy bonds other than treasury bonds as well. This was done so as to flood the financial system with money, in the hope of keeping interest rates low, in order to get people to borrow and spend again, and hopefully create economic growth.
While that has happened to a limited extent, financial institutions have borrowed this money at low interest rates and invested this money in large parts of the world chasing returns.
The Fed decided to stop printing money towards the end of October 2014. But now it needs to keep telling the financial markets that it won’t go about withdrawing the trillions of dollars that it has printed and pumped into the financial system, any time soon. We need to see what happens when it decides to start withdrawing all the money it has printed and pumped into the financial system.
To conclude, it is worth remembering what economist Stephen D. King writes in 
When the Money Runs Out “A central banker who jumps into bed with a finance minister too often ends up with a nasty dose of hyperinflation.”

The article appeared originally on www.equitymaster.com on Dec 1, 2014

Beedis are fine, but smoking cigarettes stick by stick is injurious to health

beedisNews-reports suggest that the government is planning to ban the sale of loose cigarettes. Sagarika Mukherjee an analyst with SBI Caps points out that 70% of the cigarettes sold in India are sold loose.
Further, a November 26
news-eport in the Mumbai Mirror says “The union health ministry on Tuesday recommended a ban on the sale of unpackaged cigarettes to deter smokers from graduating to buying full packs.”
The health minister JP Nadda said in the Rajya Sabha on November 25 that the ministry had accepted the recommendations of a seven member committee on the “prohibition on sale of loose or single stick of cigarette, increasing the minimum legal age for sale of tobacco products, increasing the fine or penalty amounts for violation of certain provisions of the Act as well as making such offences cognizable”.
On the face of it this seems to be a good decision. We all know that cigarette smoking is injurious to health. Nevertheless, before the sale of loose cigarettes is actually banned there are several other points that need to be taken into account.
Governments normally tend to see what is only immediately obvious and ignore the secondary consequences. The economist Henry Hazlitt calls this the broken window fallacy. He explains this through an example in his book
Economics in One Lesson.
A young hoodlum throws a stone at a shop’s window and breaks it. By the time the shopkeeper realises what has happened and comes out of the shop, the boy has already escaped. As often happens in these cases, a crowd gathers around, first trying to figure out what has happened and then offers its own analysis on the scenario. In sometime, the crowd decides rather philosophically that what happened was for the good.
As Hazlitt writes “After a while the crowd feels the need for philosophic reflection…It will make business for some glazier….After all, if windows were never broken, what would happen to the glass business?”
With the shopkeeper now having to repair the window, the glazier would earn more money. He would thus have more money to spend and would spend it in the days to come. And this would benefit other businessmen. “The smashed window will go on providing money and employment in ever-widening circles. The logical conclusion from all this would be…that the little hoodlum who threw the stone, far from being a public menace, was a public benefactor,” writes Hazlitt.
All this sounds very straightforward. But what it does not take into account is the fact that the shopkeeper would have to spend money in order to get the window repaired. And he may have earmarked to spend the money on something else.
In Hazlitt’s example, the shopkeeper wanted to buy a suit. Now that he has to spend money on getting the window repaired, he would have no money to buy a suit. As Hazlitt writes “The people in the crowd were thinking only of two parties to the transaction, [the shopkeeper] and the glazer. They had forgotten the potential third party involved, the tailor [who would have made the suit]. They forgot him precisely because he will not now enter the scene. They will see the new window in the next day or two. They will never see the extra suit, precisely because it will never be made. They see only what is immediately visible to the eye…It is the fallacy of overlooking secondary consequences.”
Many government decisions are plagued with the fallacy of overlooking secondary consequences. The recommendation to ban the sale of loose cigarettes also overlooks several secondary consequences. Also, it stinks of hypocrisy and is the kind of micromanaging which governments should be avoiding.
Typically, most people who buy loose cigarettes are ones who cannot afford to buy a packet at one go. If loose cigarettes are banned will these people stop smoking? Most likely not. They will either save up and buy a packet every few days.
Or they will simply move on to a cheaper substitute, which in this case would be
beedis. Beedis because they do not have a filter are a bigger health hazard than cigarettes with filters are. And chances are the government will end up spending more money in trying to cure tobacco related illnesses, in the years to come.
Further, the question is how will the government implement such a ban? Cigarettes aren’t exactly sold through a few big stores around the country which can be monitored. They are sold by millions of
paan wallahs through the length and the breadth of the country. Mukherjee of SBI Caps puts the number of shops selling cigarettes from anywhere between seven to eight million.
I used to live in Hyderabad in the early 2000s, when the erstwhile Andhra Pradesh government decided to ban
gutka. All that happened was that the paan wallahs stopped displaying gutka packets in the open and started keeping them in their pockets.
Further, they even demanded a premium to the maximum retail price. The police was suitably bribed to look the other way.
Gutka which was freely available in states around Andhra Pradesh continued to be smuggled in.
Another logic offered in support of not allowing the sale of single sticks is that when a packet is sold, it contains graphic images showing the ill-effects of smoking. When loose cigarettes are sold, individuals buying those cigarettes don’t see those graphic images. Hence, sale of loose cigarettes should not be allowed.
Other countries in Asia have banned the sale of loose cigarettes using the logic explained above. So, the cigarette companies there simply moved to producing smaller packets. The committee whose recommendations the health ministry has accepted has already recommended that smaller packets should not be allowed. But this is where you start to discriminate between those who can afford to buy a cigarette pack and those who can’t.
Mukherjee of SBI Caps points out that only 12% of the tobacco consumption in the country happens through cigarettes. And cigarette companies contribute a major portion of the excise duty and other taxes collected from the tobacco industry. So, if the government is serious about tackling tobacco consumption why not look where the real problem is? Attacking the beedi sector will be a difficult thing to do, given that the beedi barons are politically very well connected.
Another thing that needs to be pointed out here is that the government of India owns around one third of ITC, a company which controls 80% of the Indian tobacco market. The Life Insurance Corporation of India owns 14.5% stake, followed by the Specified Undertaking of the Unit Trust of India (SU-UTII) which owns 11.25% and the four general insurance companies together own 6.78% in the tobacco major.
This stake of LIC, SU-UTI and the four general insurance companies, in ITC, as on November 26, 2014, was worth a whopping Rs 94,241 crore. The actual stake of the government will be worth much more once one takes into account the holdings of government owned mutual funds as well.
If the government is serious about discouraging tobacco consumption, the first thing it needs to do is sell its stake in ITC and then take it on from there. This money could be put to good use by helping specialized cancer hospitals in the country to expand their infrastructure or to even set up new ones. Then there is also the case of the government subsidizing fertilizers, a portion of which goes into tobacco farming as well.
The
beedi industry does not face the same kind of taxes that the cigarette industry does. Why not do away with that anomaly? In a recent column Swaminathan Aiyar talks about a column he wrote in 2009. At that point time Indians consumed around one trillion beedis per year against 106 billion cigarettes. If the taxes on beedis and nonfilter cigarettes were equalized it would have yielded an additional revenue of Rs 15,000 crore per year, back then. If taxes on beedis were equalised to the level of tax on a standard filter cigarette, it would have yielded an additional tax of Rs 80,000 crore per year. If such a tax is implemented now, the numbers will be higher.
What all this clearly tells us is that targeting just loose cigarettes doesn’t make any sense. If tobacco consumption is to be brought down, it needs a more holistic solution than what is being currently offered. The current government like most governments before it has fallen victim to the broken window fallacy.

Disclosure: I do not smoke. And I would like to thank PV Subramanyan for explaining several points that I made in this piece.

The article appeared originally on www.equitymaster.com on Nov 27, 2014

What Uday Kotak should learn from Citi: Bigger banks can end up as liabilities

635266189203244874_Kotak Mahindra Bank
Over the weekend Pramit Jhaveri, the CEO of Citi India, had a thing or two to say about the size of Indian banks. He said that other than needing more banks, India needs bigger banks to compete on the world stage. “At this point, sensible consolidation would be one way to achieve scale,”
he said.
The comment comes right at a time when the Kotak Mahindra Bank has decided to acquire the ING Vysya Bank. The irony here is that Citigroup, of which Jhaveri is a part of, was rescued by the Federal Reserve of the United States from going bust, only a few years back.
The Fed came into rescue Citigroup because it was too big to fail. And if it had been allowed to fail, the repercussions would have been felt by the entire financial system.
The United States Congress passed the the Glass–Steagall Act in1933. This Act was passed after the stock market crash of 1929 and essentially drew a line between commercial banking and investment banking on the grounds that the riskiness of the latter would lead to the required safety and soundness of the former being compromised upon.

This made banking a very boring business with commercial banks having to stick to borrowing money from depositors, and lending it out, and making the difference in interest rates as their income. This meant banks which raised deposits could not trade in stocks and other financial securities. They could not get into the brokerage business either.
The Glass–Steagall Act was replaced with a new Act in 1999 (the Gramm-Leach-Bliley Act) to clear the merger of Citicorp, a commercial-bank-holding company, with the insurance company Travelers Group. This led to the formation of Citigroup, which was a company that had several different financial service brands under it. There was Citibank, which was a bank, Smith Barney, a stock brokerage firm, Primerica, a firm that sold insurance products and Travelers, an insurance company.
Long story short, what emerged was basically a very unwieldy company. A firm which was too big to fail.
On October 31, 2007, Meredith Whitney, an analyst of financial firms at Oppenheimer and Co., went all out against Citigroup. She said that the bank had so mismanaged its financial affairs that it would have to slash its dividend or go bust. The market heard out Whitney. The share price of Citigroup was down by 8.8 percent, to $38.51, by the end of that day.
Chuck Prince, the lawyer CEO of Citigroup, quit seven days later, on November 7, 2007. The stock price by then had fallen by 20 percent, to $33.41, from where it stood before Whitney’s pro­nouncement on the bank. What was interesting was the way Prince looked at things. Only a few months earlier, on July 7, 2007, he had said that things could get complicated in the days to come “But as long as the music is playing, you’ve got to get up and dance.” “We’re still dancing,” he had remarked.
The troubles for Citigroup just erupted after this. It had made huge investments in subprime securities and other financial securities using the structured investment vehicles (SIVs) route which started to go wrong (this story is too long to go into detail here). Once the financial crisis broke out in September 2008, the market did not expect Citigroup to survive.
But Citigroup was too big to be allowed to fail. On October 14, 2008, the treasury department of the United States (or what we call the ministry of finance in India) invested $250 billion in 10 financial institutions as a part of the capital purchase programme.
The Citigroup was a part of this and got $25 billion from the US government. After receiving the investment from the government, the then CEO of the firm, Vikram Pandit, said that the investment would give his firm more flexibility to borrow as well as lend.

But the market wasn’t too confident about the chances of Citigroup surviving, given its huge investments in subprime and other shady securities through the structured investment vehicle route.
The trouble was that like AIG, Citi was also deemed to be too big to fail. So, on November 25, 2008, the government decided to inject $20 billion cash into the firm. This was over and above the $25 billion that Citigroup had already received as a part of the capital purchase programme a little over a month earlier. The government also decided to guarantee $306 billion worth of troubled mortgages and other assets of the firm. And this is how Citigroup, like many other financial institutions was rescued by the government, simply because it was too big to fail.
A firm like Citigroup, which is present in a large number of financial service businesses as well as investment banking businesses, was and continues to be extremely unwieldy to manage. But, at the same time, the firm was so big and into so many different businesses that letting it go, would have led to a lot of job losses and other firms going bust as well.
To his credit, Alan Greenspan, who was the Chairman of the Federal Reserve of the United States from 1988 to 2006, had pointed out the risk of big banks as far back as October 1999. He had said in a speech that “megabanks being formed by growth and consolidation are increasingly complex entities that create the potential for unusually large systemic risks in the national and international economy should they fail.”
Hence, it is important to make sure that there are no institutions which are too big to fail. As Bob Swarup puts it in
Money Mania,If the vanishing of an institution will destroy the network of our economy, it is too large to survive. Citigroup will one day go bust. Probability and evolution tell us that. Therefore, we can either keep trying to postpone the inevitable or remove that anomaly. This can be done over time by shrinking the institution through incentive or breaking up the institution.”
Interestingly, research carried out by the Federal Reserve has been unable to find any economies of scale of operation beyond a certain size. As Greenspan asks in
The Map and the Territory: “I often wondered as the banks increased in size throughout the globe prior to the crash and since: Had bankers discovered economies of scale that Fed research had missed?”
In fact, there is little to suggest that banks benefit from any economies of scale, when they grow beyond $100 billion in assets, suggest Anat Admati and Martin Hellwig in
The Bankers’ New Clothes. (On a different note Kotak Mahindra Bank had Rs 1,22,237 crore as on March 31, 2014. Hence, as far as economies of scale are concerned it is still well below Admati and Hellwig’s cut off point).
Moral of the story: bigger banks aren’t necessarily better, especially in an environment where governments cannot let a bank go bust in case it runs into trouble. As Swarup points out “No government will ever take the electoral risk of bank failure. Governments throw money at the problem, even if it is in vain, because the incentives are based on perpetuating their political hegemony.”
And this is something worth remembering every time a banker talks about bigger being better.

The article originally appeared on www.FirstBiz.com on Nov 25, 2014