Alice in Financial Wonderland

Some polarisation between equity and debt has happened with start ups and bank crises. Equity has found new ground in the unlisted space and has ceded forts in the listed space. The listed companies now are prone to taking debt both on balance sheet and off balance sheet for various reasons including equity shares buyback. In the unlisted space, equity owners are not passive onlookers, but make effort to evaluate the top tier management all the time.

Between the debt and equity there is no way defined for a temporal distribution in the context of a hypothetical business. The internal rate of return of any business has a temporal distribution and hence should dictate the debt and equity proportion that it must carry. But the way debt and equity are markedly distinct and can be raised from different set of players having differing expectations, it makes it quite difficult to achieve proportionality of debt and equity.

Either there are safeguards and warning lights built into the levels of debt a company can source, leaving equity holders at the mercy of the collective thinking of the equity market, or we can envisage a differential return between equity and debt holders, that allows splitting of rate of return of the business, and hence breaking the gridlock of coupons and tenure of debt. In the latter case, thus the debt and equityholders are tied to the returns generated by the business.

Thus all financing institutions become safer and trustworthy without the stress of stress-test because they would get higher return in good times and lower or even zero returns in bad times. Presto! we have shrunk the cancerous non-performing assets. Automatically the usurious lending to individuals shall vanish as well.

Clearly this is a quixotic idea because the essential characteristics of debt and equity have been compromised. But if we are prepared to look for new solutions, you would say that this is an intermediate step. Ultimately the method of differential returns depending on tenure of the finance, can only suggest that debt and equity are fungible. Depending on the rate of return coming to a business in the next two to three years, the management should take a call of converting debt into equity or equity into debt. Why would any management incur the cost of engaging with the financial markets until and unless it comes with the agenda of growing size or making an acquisition ? Some autonomy in determining the debt to equity ratio should be in-built and hence could be a powerful signals to hare-brained volatility of the markets. 

Can Financiers take a Hippocratic Oath ?

Equity market is a set of balloons (sector-wise) tied to the bedrock of debt. Debt should be flowing easily enough for the balloons to distend a bit more. That is debt should pay from the economy’s cashflows. Debt can choke on itself and clog the economy if it crosses sustainable limit and if it is not paid from the economy’s cashflows. Rarely do analysts believe debt to exist beyond individual balance sheets. But debt exists everywhere and one needs to knock off the excess above the sustainable limits against the entirety of market capitalisation. (If measurement of debt is a problem, banks can be asked to declare the total debt originated and outstanding against each unlisted / listed company and within conglomerates against each individual business. This is a measure that will help banks to become self-prudential.)

To carry the argument to the sectors, even consumption is backed by (government and private) debt although the individual FMCG company balance sheets and automobile corporate balance sheets are mostly free of debt. The lenders and the stock market have a right to know the financial performance of all players in a sector. And they should knock of the excess debt above sustainable levels against the sector’s performance. This penalises the sector where the new entrants are creating the competitive stress by taking on unwarranted debt, and rightly so. The Hindu Shastras say that individual’s tragedy, stress and unhappiness has to be shared socially and so it should be logically carried into the sector’s performance. Then determination of multiples is a matter of regression. Cannot say what McKinsey thinks on this kind of valuation. Probably if they would concur, they would give us adjustment of capital flows in the economy.

The strangeness of this theory surfaces when we apply it to the banks. They originate the debt, and due to competitive pressure of selling debt are most vulnerable. The central bank should calculate and note the sustainable level of corporate debt in each sector and not allow banks to go beyond it. The market cap of housing sector finance should be adjusted for the excessive mortgage debt, and it is here that the maximum impact is likely to be found. Currently some people think that the banks need to be breaking up, but there is no need if we agree that the exposure can be capped sector wise.

The stock market has a distant / volatile wealth effect compared to the real estate for those who can afford to own it. Especially both stock market and real estate are dependent on the level of debt in the economy. Most likely the sector will end up having zero market cap. So the listing of real estate corporates on the stock market affords some bit of ridicule at the expense of the stock market.

When we read the theorists of the credit market they are heavily dependent on statistics and lightly dependent on the macro-prudential framework. They pretend like the five blind men of Hindoostan feeling an elephant because they are directly / indirectly paid by the banks themselves. When the central banks are targeting inflation and inflation is seen helping loosen/ shrink the millstones of debt, the fact is that they are know about the macro-prudential theory in private but do not bring it out in public domain.

The banks have too much access to data for any non-bank to compete effectively. Hence the banks have to be banned from the stock market. One with stricter moral standards can even ask the banks to de-list because listing of debt originators is tantamount to having your cake and eating it too.

In developing countries, governments have there are two liabilities, infrastructure and pensions. Infrastructure is something that can be mostly done by the state government and local government provided the population has an appetite for it. Technically pensions is part of government’s debt and hence has to be knocked off the total market cap in case it is above the sustainable level.

Holy Pigs, Incredulous Pleasures and such Pixelated Fixations in Flatland

Diggers of rigour, toil their vigour and ex-pale the warm daylights

Foiled by the foibles of Human Capital, that double crosses forever 

Herding about the ticker, a fireplace to exchange technical tricks
Air dry the data to crispen, the tipsters deep fry to make it tastier

Porous reporting galore, the faithful cannot read good from bad 

Nudging forecasts to consensus, they torque the language a-wear

Amid media glower, galleries of wealth-makers bask and brighten

For investing is a pantheon and the legion of analysts its worshipper.  

Epitomising Oracles, Parroting Bigots and all other Omniscient Orders

The current model of doing research inside universities is flawed.

If research itself becomes a fort of citationers, going around the topic without making it relevant to the real world, without investigating any context, it is dead wrong. Paid or commissioned research fails easily if it does not address a heroic assumption, a logical failure or a painful inflammation of ill-fitting results. If start ups are devices to build entrepreneurs, we even need vehicles to do  meaningful research.

The guide of the person who enrols into research is often the weakest link.  His knowledge of the latest developments is suspect. He has neither written enough research nor experimented with ideas after his own initial foray into research. This model is supplanted by the model of presenting papers and citations. Papers rarely elucidate methodologies to guarantee reproducibility and mostly talk about results. It forces a new researcher to investigate whatever is trending, but research that way is nettled by groupthink. Neither by the guide, nor by the peer group, do we pose large, challenging questions.

Western companies are smart to cherry-pick best ideas from government funded research and build it into saleable goods and services. Oriental companies just reverse engineer or imitate, and even then mostly the product of the previous generation. Western companies now know it better that world markets are divided mongst those which are willing to pay for innovation and those which aren't. Hence when FB comes to India it makes Free Basics its agenda.

Mostly companies want to keep a boiler room atmosphere of securing short term results. This is not conducive to research. Research needs a focus group approach to find a way forward. It has to churn history of achievements and failures and see which can be cornerstone for another. It even requires some time to shut the white noise. Thanks to data mining and computational methods, a lot of work can be done without hit and trial.

The government bodies or 1% mandatory funding by corporates should enable us to do the following. We have draw up a canvas of cross disciplinary agenda. There should be a body to handle knowledge management (unlike the idea of museums) that critically runs the gauntlet and points out what was the past, what is the present and what is trending. There should be another body to hold public seminars on the questions to be investigated as the way forward. Yet another public body of scientists should verify and reproduce results before publishing. Research can be motivated by recognition and ample reward. That way we can weed out irrelevant topics and drive focus on building an equitable and secure future.

Obviously those from finance would like to clinch achievements ideas and turn them into saleable companies. Nothing objectionable there but that then it should carry a reverse patent protection. For the first ten years the royalty should accrue to the public / government bodies. In some cases the public good should prevail and pricing should be low enough for everyone to benefit.