Low Gas Price ! Good for the US?

I feel low gas price is detrimental for the US, considering the way tax dollars are being used by the government and the paradigm shift in the way economy operates.

No doubt I feel a lot better at the pump these days and regret less driving a performance car. But high gas prices make me happier knowing that in this demand supply equation, high prices indicate that the economy is reviving and people have the funds available to purchase more. Since the Fed is trying all the monetary tools (like cutting Fed rates & funds to failing businesses) to increase money supply and thereby push the overall demand, a deflationary trend in major commodities like gasoline tells me the policy ineffectiveness. But that’s just gas price as an indicator.

Necessity is not always the mother of Invention but innovations and discoveries are normally aimed at incentives when a business pursues it. So low gasoline prices could put to rest many of the R&D efforts in improved technology, new sources or alternatives. For Instance, Toyota sold less hybrids at $2/Galon gas (Check sales number of Toyota Prius when the Gas was $4 and now); It would be less viable to drill newly found oil fields in Brazil or continue exploration in Arctic for fossil fuel at $2/Gallon. Same story is true for the electric line-ups now being demonstrated in Detroit Auto Show. Projects like creating mass transit facilities like electric trains in all cities will have few takers due to low potential demand as people have no incentive for taking a train as compared to riding their own car.

Government makes huge infrastructure investment (with Tax payer dollars) every year to maintain or build roads and bridges. This is where the Washington lobbyists protects the interest of Auto Manufacturers or resist any alternate form of transit.

So going back to the economic principles, we will have to create a new incentive system to motivate businesses and individuals to achieve the bigger goal of reducing fossil fuel consumption. I think it’s fair for the owners of the vehicle to pay for the maintenance of the road infrastructure(Not the whole country). When the auto makers sell cars, people just pay sales tax not a road tax. Many countries charge a road tax on the top of the sales tax and that could be 10% of the cost of the car, paid an yearly basis. Further, the Government should put an additional tax of $1-2/ gallon and that will automatically work as an incentive to consume less. When driving is part of their work, gasoline should be treated like a cost of production and should get the tax credit.

These two additional taxes in place, the incentive system looks lot better for an ordinary Joe. The tax he pays depends on what he buys- let it be car or gasoline. He pays a lot less when he takes a public transport so whatever discomfort he has is paid for. When he buys a gas guzzler he is prepared to pay a lot more, everyday, than his neighbor who rides a fuel efficient car.

India's Enron & Short-term achievers

Ramalinga Raju of Satyam was searching his saul over a decade and finally decided to speak out his conscious yesterday. The news dragged down India's Sensex 7% and wiped out the Satyam shareholders assets 77%. Satyam was in spotlight for a month ago for their decision to buy Maytas constructions, a company with Raju’s sons have significant stakes, as a case of poor corporate governance. The company did show a tainted image to the market then and that news was followed by World Bank banning Satyam from doing IT outsourcing because of their unacceptable business practices. The biggest looser is India as a country – the institutional investors now will require additional premium for compensating for this kind of risk.

Its quite evident that Raju was totally informed in the fraud game. Most of the reported adjustment was in cash balance and its hardest of all to hide. This also raises concerns about what auditors, Price Waterhouse Coopers, was doing in the process. The independent auditing is supposed to bring the credibility to the financial statements but appears like those practices are compromised. The market instantly named it as ‘Indian Enron’ so are we going to see Price Waterhouse going down soon? Satyam is going to get hurt badly as many of their Furtune 500 clients re-evaluate and decide to walk-off from the deal and most probably sign-up with one of the competitions like Infosys or Tata. The question left is how pervasive this kind of frauds are in India ? If Satyam could do this many others also could. Raju admitted that he was riding a tiger without knowing how to get off not being eaten. Something started as a small discrepancy, a decade ago, now grew into a billion dollar problem. This confession allude to a bigger global business issue- chasing short-term profits.



We see all market punishes the companies with lower quarterly earnings. If the earning doesn’t meet the analyst expectation, the share prices tumble and it seems the stock price is the only yardstick of CEO’s performance. Should the quarterly earning be that important? I think its important that the technology and product based companies are evaluated differently because lot of their future earning depends on the brand establishment and innovation, which takes several quarters of waiting. Analysts in Wall Street hardly know anything in engineering or innovations but so good at making judgments by crunching numbers from the financial statements. So none wants to give out a bad news to the market fearing its going to eat them up. Things would eventually culminate into a point of no return, hurting investors and employees and unrelated everybody else in the market.




Now this is not to justify Satyam's action. There is no justification for billions of shareholders lost wealth . Ever since Satyam was in focus for the bad deal to buy Maytas, Raju's back was on the wall and he knew a confession was better than exposing

Ponzi 2008

We all heard the word 'Ponzi' repeateadly by end of 2008. $50 billion Madoff scheme was hard to comprehend. More disturbing was the names of people got hurt in the process - seasoned investors, economists, banks and charities to name a few.

Paul Krugman was wondering how Madoff story was different from the investment industry as a whole ? His article convincingly concludes that the story was not very different . Instead of creating value, the whole investment industry was destroying the value of assets .

Financial companies have written off billions of their bad assets, a product of their lax lending practices , and pushed the economy into a financial crisis. Credit markets froze and left many businesses with no operating cash and layoffs. The shareholders lost 7 Trillion - a gain of last 6 years - in just one year. Home prices fell forcing a lot of home investors bankrupt. In short, everyone is some way or other had a negative financial impact in 2008.

There are some good signs in people's behavior - though not necessarily good for the economy to recover.Spending: There is a drastic cut in spending as people manages their finances better. People travel less, eat out less or buy less gifts.

Savings: Other than equities and funds, people are increasingly attracted to gold and low risk instruments as an alternative.

Ponzi schemes will always hunt us in some form - As someone pointed out, Social Security funds may be the biggest legal ponzi scheme -:)

Ways to Use Bailout Billions

The workers of Republic Windows and Doors in Chicago came out victorious from their week long sit-ins after the factory was closed due to credit crunch. Republic Windows workers had media attention and Bank of America and JP Morgan were forced to react.. The workers had a question to them: Weren't the billions these banks drawn from the Government, supposed to help the companies like Republic Windows ?

Last month when I posted about Detroit big 3, i thought they were so close to getting the money from Government. However, yesterday Republicans shot it down saying that unions needs to make more.When the republicans backed off ,Whitehouse stepped in to offer them help under TARP. As Friedman says , the investment in GM will be remembered as pouring billions of dollars into CD music business on the eve of the birth of iPods and iTunes.

Detroits Troubled Big Three and Bail Out plan

The government infusion of capital to banking system did not really impress the tax payers despite the explanation that a financial crisis hurts everyone. An average tax payer felt that Wall Street extorted money from government to stay solvent, magnifying the impacts of financial crisis to the nation.

Treasury Secretary Henry Paulson probably did the right thing in rescuing some institutions and infusing capital to others. However, tax payers can never put these things in perspective - the top executives and shareholders got fat dividends at good times and when there is a crisis government should rescue them. Worst of all, the crisis was a sub product of their own financial engineering.

The big corporations like GE lobbied hard to get their share from the bail-out package and was successful in getting the Government to buy their CPs, when Wall Street was shy in lending. Detroit big threes are also in the race for capital. As I write this, GM unsuccessfully, sought 10 Billion to acquire Chrysler and just now came out with a bleak future statement. When GM goes down millions get impacted and that remains as the selling point to the government.

Ford and Chrysler also joined GM to meet the speaker, Nancy Pelosi, to ‘brief’ her on the impact and surely the lobbyists are trying their best as well. The question is should the Government rescue the auto makers?

Its true millions of people – manufacturing jobs, dealer ships, suppliers – get impacted but they are unlike banking system. A financial crisis not only impact insurance and 401k, it freezes the capital required for small and medium businesses and they primarily depend on banks for working capital. If the businesses do not get working capital, they are going to close the shop and lay-off people.

Big corporations like GE might find a direct window in treasury but that’s not the case with smaller fries. Apart from the credit crunch, financial crisis could impact the exchange rates and inflation and push the country to a deep depression.

Earlier I supported the idea of government making investments in financial institutions as it might be proved to be a best use of tax payers’ money. It not only averts a crisis that impacts the whole nation but brings in a return at some point when the government exits. Additionally, the government gets a commanding voice on how to run the business, including the executive pay J .
Investing in big three makes no economic sense unless they agree to change their business model to make it competitive with the imports. The big threes always lobbied for higher restriction on imports and resisted any alternate fuel /environment friendly legislation. Ford under Alan Mullally, is at least trying to make it more efficient but GM shows no signs of improvement. Its doubtful that the government is going to let any of these fail - especially when many of their unions support the Democratic party. However, any investment in those would not be the efficient use of capital.

Today, Henry Paulson shelved his earlier plan to buy the troubled mortgage assets of bank as part of the rescue plan. He plans to use that funds to help the financial services sector- auto loans and credit card businesses- that started showing trouble already. Considering the large auto loan portfolio of Big Three, its possible that they could get substantial help through that route.

Captive Outsourcing Unit - A derivative prodcuct

GE, the company that pioneered the outsourcing in India, set-up its first captive unit in 1997. Captive outsourcing units are fully owned subsidiaries of the parent company and being so helped the management to have a complete control over the execution and quality of deliverables in the early stages of outsourcing. Additionally, the brand also helped them in negotiating better deals with government and attracting the top talent. Transition of work from U.S to India was not an easy job as there was always resistance from the employees to transition work or co-ordinate work with an off-shore location. The feeling of being the same company helped there as well.

Outsourcing was primarily to reduce the cost of operations(rent, wages, benefit- to name a few). However, GE showed the businesses that there are multiple ways to make money on outsourcing.

When GE built a big outsourcing unit in India, lot of jobs in the U.S /Europe were moved to their Indian operations. By conservative estimates, there should be at least 30% cost savings- Otherwise there was no point in outsourcing. GE engaged their workforces to train their counterparts in India and implemented the quality processes smoothly over a period of 10 years. Within 10 years , GE India unit was supporting most of the business units with different back office works - including analytics, financial transaction processing and customer service centres. That's the time GE businesses globally was aligned with the off-shore operations and the processes become smooth . Then came the news that GE was selling the India unit!

I think it was a brilliant decision GE took to make money out of their BPO operations. GE sold 60% of their Indian BPO operations in 2004 to two U.S private equity companies- Oak Hill Capital partners and General Atlantic Partners -for $480 million and the Indian unit become an independent BPO, Genpact.

GE never had any real estate holding in India. All their equipments were leased. So what did they really sell ? Knowledge about their own processes and the team that possessed it!

Savings to GE actually starts with the deal. GE committed for alt east 5 years of business - this means they continue to enjoy 30% discount on their operations cost. Now GE is a customer, they could always ask for more productivity - Something GE does with other IT vendors in India, where they insist 10% of productivity every year - This mean if you support a project with 10 people this year, you are expected to support the same with 9 people next year through process improvement or expertise building (or just working longer hours for some managers ?). Also, when Genpact renews the contract, pricing could be done based on a competitive bidding. So to an extend GE is insulated with increasing cost of doing BPO business. And who knows, there could be cheaper ways inthe future.

On the other hand, GE still holds a 40% stake in Genpact - good enough to control them along with their committed business(read dependency of Genpact). When Genpact flurishes, GE could still reap the benefit through dividends or capital appreciation. Genpact was listed in NYSE (G) in 2007 and this month we saw GE is offloading another 3% stake for $ 100 Million when the liquidity in U.S market dried up. ( That was another smart move as the Genpact shares crashed since then : from $14.32 to $6.92 as of today).

Well, I am impressed about GE management, ever since I joined them in 2001. What made me write this blog is a 'me-too' deal by Citibank to sell their BPO unit ( Citibank Global Services) to TCS for a $505 Million, with a commitment of business for next 9 years. May be half a billion is not too big for Citi or GE but the idea of capitalising their captive units and ensuring a low cost operations for years to come is definitely a smart move.

In other words, its possible to package the back-office work into a finacial product called captive unit. It has a revenue stream and hence a valuation ( Say 2.5 Billion in case of latest TCS deal). Now its safe to assume that Citi saves close to a 1.25 Billion when they sell their own work to TCS (505MM + 30% savings on outsourcing). And since it was captive, they made sure the new company could deliver the way want.

Not every one is happy. Employees feel betrayed as they signed up for an MNC brand but now they ended up with a less known Indian brand. Uncertainties like what will be the impact on the benefits when the clients squeeze for more productivity every year coupled with increasing cost of doing the business.

So the question is who is next ? Amex, HSBC, IBM ?. Thanks to GE.

Can Washington Beat Warren Buffet ?

While doing my economics program back in India, there was always an inherent conflict when we studied International Finance, Monetary Policies and free trade in one semester and rural development, public distribution and Public sector planning and management in another semester. I was always told the government intervention was necessary for a under developed country and especially the ones that followed a socialistic principles. People there lived with inefficiencies that government intervention brings in and the corruption that politicians and bureaucrats injects to the system.

America was always a case study for students across the world to demonstrate how a laissez-faire capitalism could work to brings in efficiency. However, today's news is not the best for free market advocates. Following the European governments, the U.S Govt is going to take stake in financial institutions by injecting capital to halt the worst financial crisis. Ben Bernake studied depression and crisis closely before his current job so he probably knows what's needed best at this juncture.

Forget about the ideologies - its a luxury good in times of crisis. And here, the government is not talking about taking over the entire institution or controlling the paycheck of the senior management. What they are talking is using tax payers money to stabilize the market.

When we take a look at the market valuation of financial companies, its probably at rock-bottom compared to other sectors. When the government injects capital, its equivalent to buying their stock in the market. I believe America is fundamentally a strong country so the the market is going to bounce back in 2-3 years so this is a great opportunity for the U.S government to make some money for the tax payers.

Warren Buffet is also doing the same thing but the only difference is he pays tax and keep the rest to himself.