It is interesting to look at events in the US and India through the same prism. Last week’s action in the US centred on the takeover of the two large government-supported entities, Freddie Mac and Fannie Mae. As this column is read, the US Fed and the US treasury would have taken a decision on the sell off or restructuring of Lehman Brothers, one of the four major investment banks. The total write-down so far due to last year’s banking crisis has exceeded $500 billion, and is likely to cost as much more before the pain is over.
The bailout approach taken by the Fed and the treasury has evolved over the last year. In the beginning, there was the traditional belief in market behaviour that said companies, shareholders and the markets must find a solution. The first major intervention was in the Bear Stearns case, where the Fed created a special purpose vehicle, lent it $28 billion, and allowed JPMorgan to access these funds for the bailout. JP Morgan now owns and runs Bear Stearns and there is no clarity about how and when the public money will be repaid to the Fed. In the case of the Freddie and Fannie bailouts, there has been a direct infusion of funds from the treasury, a replacement of management, and a promise to scale down their future operations. Lehman Brothers has not yet unravelled, but there appears to be a reluctance on the part of the Fed and the treasury to intervene directly, hoping for potential buyers. In the three interventions so far, existing shareholders have been punished — they lost significant value, but customers and clients have been protected.
We had done likewise under similar circumstances.
In 2002, the Unit Trust of India (UTI) was close to a collapse. The NAV (net asset value) of Unit 64, a mutual fund launched in 1964, had been the bulwark of the savings efforts of the middle class for 40-plus years, and the scheme, along with others from UTI, had more than 20 million subscribers. Poor management had eroded the value of the investments, and in 2002, the real value of the UTI unit was less than Rs6, against a face value of Rs10 and a quoted NAV of Rs13. Though an independent entity, the general belief was that UTI was backed by the government, and initial redemption pressures were handled through loans to UTI from the government. In July 2002, the finance minister decided on a permanent fix. UTI was split into two parts, one that would contain the stressed assets, whose value was less than the quoted value, and the other got the healthy assets, which could continue to be managed profitably. The entire portfolio was redeemed at par, with the unit holders being offered an option of cash or a tax-free interest-bearing bond of a six-year tenor that was better than market rates. It was expected that better management of these portfolios, coupled with asset sales, would help recoup the advances, direct and indirect, given by the government, crossing Rs10,000 crore. It was an unusual and bold decision, much discussed and criticized in the media and by free market economists — but the government of the day felt it was important to keep faith with the 20 million-plus investors.
Over the years, with rising asset prices, the residual companies were able to successfully pay back the dues with interest to the government. When the bonds were finally redeemed in May this year, the government made a handsome profit in the transaction, as asset prices had increased considerably over the years. It is no surprise that the success of this major intervention is not much talked about, given that it is not an Indian trait to give any credit to preceding governments. A similar approach had been proposed then for two other ailing institutions, IDBI and IFCI, but was not followed through after 2004, and the latter is still languishing.
The solution being attempted for the stressed companies in the US is identical to that successfully executed in India for UTI. It involves separating stressed and healthy assets, giving the latter to professional management, and slowly tweaking the former to get best value over time, while guaranteeing the small investor at least his capital. The same model is at work now in Bear Stearns; it will be attempted in Freddie Mac and Fannie Mae, and it was proposed by Lehman last Friday, though in the form of a sell-off.
Two thoughts emerge. First, our solutions in similar situations have been validated by the passing of time and by the soundness of logic, and they are universal — applicable to other institutions in other countries even today. Second, the strident opposition encountered in 2002 in India is not seen in the US today, signalling the maturity of analysts, and better understanding of the economics, the politics and the sociology of economic policy decision making processes. I do wish that for India as well — instead of strident comments on every proposal, one could see a consensus at least on all those decisions that are good for the largest numbers, and for the country.
S. Narayan is a former finance secretary and economic adviser to the prime minister. Your comments are welcome at firstname.lastname@example.org