Sunday, February 23, 2014

1984, 1993, 2002: Mass violence in India

Recently, there has been a bit of a flutter in the Indian media regarding an interview given by Rahul Gandhi, heir to the Nehru-Gandhi family legacy and potential prime ministerial candidate from the Congress party  in the upcoming 2014 elections. At issue was a question put to him by the interviewer, asking him to compare two of the most horrendous episodes of collective violence in independent India.
Read more »

Sunday, February 02, 2014

Economic snapshots

There are several different ways in which we can view the relative economic performance of countries. A selection of graphs based on the World Development Indicators (compiled by the World Bank) reveals interesting patterns. All of this is made remarkably easy thanks to Google Public Data. The graphs tell interesting stories, but I have often been surprised at how different people interpret the same data, so I'll refrain from adding my commentary and see if readers come up with any interesting comments on the data, my selection of graphs, as well as my choice of countries for the graphs.

Read more »

Sunday, January 22, 2012

War and Peace

It took me about one and a half months to read War and Peace. Tolstoy's magnum opus, first published in the 1860s,  has been acclaimed as one of the greatest novels ever written, though the popular perception is that it is a very difficult book to finish reading. The length of the novel is clearly a huge barrier to reading it, though unfamiliarity with the historical context adds to the difficulties.
To appreciate the book fully, it is useful to recall the historical context. The story is set in the early nineteenth century, spanning the period from 1805 to 1820. Its main characters all come from the Russian nobility, and the narrative arc follows their fortunes, set against the backdrop of the tumultuous events surrounding Napoleon's invasion of Russia.

Read more »

Sunday, February 15, 2009

The horrors of Sierra Leone

Ishmael Beah's book, A Long Way Gone: Memoirs of a Boy Soldier, recounts his experiences as a child soldier in Sierra Leone's civil war during the 1990s. He was twelve years old when the war engulfed him in 1993. He was away at a town called Mattru Jong with his brother and a few friends when his village was attacked by the rebel forces. Unable to return to his village, he was on the run for months. He had to eat whatever he could find in abandoned villages or rely on raw cassava and coconuts. When they reached occupied villages, he and his companions were often suspected of being killers, since both the rebels and the government troops were regularly recruiting children and turning them into killing machines. During those months, he endured horrors most of us can barely imagine. Beah saw a lot of the aftermath of rebel attacks, in addition to barely escaping them several times. Severed heads, hands chopped off, a baby shot while on her mother's back - these are some of the sights he chooses to mention. He keeps the descriptions to a minimum, but does not shy away from the blood, gore and horror.

After a few months and several providential escapes, Beah finally made it to a village called Yele, held at the time by government forces. A few days of calm resulted. Those days were short-lived, since the government soldiers in the town were battling rebels. Soon, Beah and other boys were conscripted. They were given automatic weapons and very rudimentary training. They were pressed into battle almost immediately. Having already endured sustained fear, violence and death, the boys were barely cognizant of what they were doing. As Beah describes it, they were further desensitized by watching Rambo movies and doses of drugs - "white tablets", marijuana, and "brown brown" (supposedly a mixture of cocaine and gunpowder). The result was that they turned into deadly killers. The description leaves little doubt that the boys had no choice - they would be dead if they hadn't become killers themselves.

After being a child soldier for about two years, Beah was turned over by his lieutenant to a UN program aiming to redeem children like him. What followed was a long and painful process of being weaned away from the violence and drugs. After almost one year, Beah's Uncle took him to live with him in Freetown, the capital of Sierra Leone. He interviewed for a trip to be a representative at a UN conference in New York. There, he met a sympathetic American lady named Laura Simms, who was to later become his foster mother when he emigrated to the US.

In May 1997, the war that Beah had left behind in the countryside came to Freetown. His Uncle died. Knowing that he could not take this any longer, in late 1997, he made his escape to Conakry, capital of the neighboring country of Guinea. His book ends there, but he made it to the US eventually. He finished high school and obtained a college degree. He is now a member of an advisory committee for children's rights for Human Rights Watch and regularly speaks out on issues concerning child soldiers.

In the book, Beah is able to present the horror of the civil war graphically, without making it appear dramatic. Nevertheless, the descriptions are revolting. Much to my surprise, I found that I was able to stomach the violent episodes more easily as I progressed further into the book. Either I was getting inured, or my mind was prepared for the shock, having encountered similar shocks earlier. Perhaps that mechanism reflects, in a small way, how people in the middle of it all managed to cope without losing their minds.

There is some controversy, raised by Australian journalists, about how autobiographical the book is. Beah has strenuously defended his account of events. This may not be unlike what happened with Rigoberta Menchu. To me, it is not terribly relevant that Beah may have incorporated the experiences of others into what he claims to be an account of his own life. The horror that he and others endured needs to be told as a story. News accounts, reports by the UN, and human rights groups have also done a great deal to document the horros of the civil war in Sierra Leone. Somehow, a personal narrative such as the one written by Ishmael Beah brings home the reality in a much more powerful way.

The civil war in Sierra Leone continued after Beah left the country in 1997. The capital Freetown experienced terrible atrocities in 1999. The war was symptomatic of the chaos of the post cold war decade, with all sorts of groups from around the world being involved. Among these were mining companies, diamond traders, mercenaries and weapons dealers. Indeed, the mercenaries and gunrunners were involved in other conflicts during the decade as well. The diamonds from Sierra Leone were used by the RUF rebels to buy weapons and supplies. In this, they were helped greatly by Charles Taylor of Liberia, who was a friend and sponsor of the RUF leader Foday Sankoh. For more than a decade, Taylor and Sankoh managed to make parts of West Africa a living hell for its people. Sankoh died before he could be tried and convicted, while Taylor is being tried by an international tribunal.

Sierra Leone's civil war ended in 2002, and the country has seen peace for the last few years. According to this report, Ishmael Beah managed to revisit Sierra Leone in 2006.

Saturday, November 15, 2008

Understanding the financial crisis - Risky Assets

In order to achieve returns, financial firms have to take risks. Over the last several years, securities firms and hedge funds have traded heavily in investments known as mortgage-backed securities. Let us try and understand how these instruments work.

Mortgages are familiar to people the world over. Buyers take a loan in order to buy a home and pledge the home as collateral. They also agree to make regular payments of interest and/or principal on the loan. If they fail to make payments, they are considered to be in default and the lender can repossess the home. Now look at this transaction from the point of view of the lender. A loan is an asset for a lender, because it yields periodic cash flows. Just as other assets can be bought and sold, loans can be bought and sold as well. The widespread availability of home loans in the US has been facilitated by the existence of an excellent secondary market for loans.

The secondary market in the US had its beginnings in the setting up of the Federal National Mortgage Association (FNMA or “Fannie Mae”), the Government National Mortgage Association (GNMA or “Ginnie Mae”), and the Federal Home Loan Corporation (“Freddie Mac”). These organizations have functioned quite well for decades, providing a secondary market for mortgage loans originated by banks and other depository institutions.

The secondary markets have worked well due to the securitization of loans. The concept of securitization is quite clever. A pool of mortgage loans is assembled and claims to the cash flows generated by the pool are sold. These claims, or securities, are like bonds: there is a promised interest paid on the principal amount. Buyers of these securities are protected from losses by guarantees provided by the agencies, Ginnie Mae, Fannie Mae and Freddie Mac. To understand the mechanism in some detail, let us borrow the following example from the Wikipedia article on Ginnie Mae:

For example, a mortgage lender may sign up 100 home mortgages in which each buyer agreed to pay a fixed interest rate of 6% for a 30-year term. The lender (who must be an approved issuer of GNMA certificates) obtains a guarantee from the GNMA and then sells the entire pool of mortgages to a bond dealer in the form of a "GNMA certificate". The bond dealer then sells GNMA mortgage-backed securities, paying 5.5% in this case, and backed by these mortgages, to investors. The original lender continues to collect payments from the home buyers, and forwards the money to a paying agent who pays the holders of the bonds. As these payments come in, the paying agent pays the principal which the home owners pay (or the amount that they are scheduled to pay, if some home owners fail to make the scheduled payment), and the 5.5% bond coupon payments to the investors. The difference between the 6% interest rate paid by the home owner and the 5.5% interest rate received by the investors consists of two components. Part of it is a guarantee fee (which GNMA gets) and part is a "servicing" fee, meaning a fee for collecting the monthly payments and dealing with the homeowner. If a home buyer defaults on payments, GNMA pays the bond coupon, as well as the scheduled principal payment each month, until the property is foreclosed. If (as is often the case) there is a shortfall (meaning a loss) after a foreclosure, GNMA still makes a full payment to the investor. If a home buyer prematurely pays off all or part of his loan, that portion of the bond is retired, or "called", the investor is paid accordingly, and no longer earns interest on that proportion of his bond.

The GNMA said in its 2003 annual report that over its history, it had guaranteed securities on the mortgages for over 30 million homes totaling over $2 trillion. It guaranteed $215.8 billion in these securities for the purchase or refinance of 2.4 million homes in 2003.



These arrangements, especially the guarantees provided by the agencies, allowed a vast market in mortgage-backed securities to develop. In fact, Fannie Mae guaranteed securities were bought even by foreign governments such as China.

Before loans could be packaged into pools and obtain a guarantee from the agencies such as Fannie Mae, they had to meet certain criteria set by the agencies. These were basically designed to limit potential defaults and ranged from a limit on loan size, a minimum credit score for the borrower, documentation of income, a maximum loan-to-property-value ratio etc. There were always some loans that did not meet the criteria laid down by the agencies. These loans were securitized by private companies. The resulting securities are known as non-agency or private-label mortgage-backed securities or as residential asset-backed securities. These securities are based on pools of loans which had
  • high loan amounts, such as the ones common in California (known as jumbo loans),
  • were issued to borrowers who had good credit scores, but did not meet other criteria such as verifiable steady income levels (known as Alt-A or Alternative-A loans),
  • were issued to borrowers who had low credit scores (“subprime” loans).
[In the US, creditworthiness for individuals is measured by a score which is calculated by consumer credit measuring companies. A “prime” borrower is generally one who has a credit score of 660 or higher and usually is able to borrow at the lowest prevailing interest rate at a given time. Hence the terminology of “subprime” borrowers and “subprime” mortgages].

Starting in the early years of this decade, interest rates in the US have been at historic lows. In 2003 and 2004, individuals with good credit scores could get home loans for an annual interest rate of about 4.5%. Since many buyers tend to look at home buying purely in terms of the affordability of monthly payments rather than in terms of the size of the loan, the low interest rates meant that they could get bigger loans and bid up the prices of the houses in the market. What followed was a remarkable real estate boom.

The boom was fuelled by the easy availability of credit, and it in turn justified further lending by the financial firms. Many people were able to obtain several loans in order to buy second and third homes as investments. Some of the most astounding loans made were the so-called “stated income” or the “no documentation” loans. This meant that in order to meet whatever minimal lending standards the lenders required, the borrower could invent any income level and claim any assets. This practice was rubber-stamped by mortgage brokers and lending institutions alike. Because securitization allowed lenders to offload loans, they had little incentive to make sure that good lending practices were being followed.

You might justifiably ask why the buyers of mortgage-backed securities were not insisting on stricter lending standards. One major factor was that non-agency securities (the ones based on pools of Alt-A or subprime loans) were given good ratings by credit-rating agencies such as S&P, Moody's and Fitch. This was in turn possible because the non-agency sponsor would provide credit enhancements or buy insurance to guarantee that the principal would be paid back. In other words, inherently risky investments were dressed up to look acceptable by referring to dubious guarantees.

This kind of game, if played by a few players at a low level, can go on for a while. However, when many firms start doing this, it sets up the system for a major failure.

Tuesday, November 04, 2008

Understanding the financial crisis - Leverage

The financial crisis currently sweeping the United States and much of the world for more than a year now has claimed many innocent victims. Many people unconnected with the crisis have suffered losses of 40-50 % on their investments. The magnitude of the crisis can be judged from the fact that governments around the world have had to intervene with massive infusions of money, with the $700 billion intervention by the US leading the pack. Many financial institutions and agencies from around the world are tangled up in this mess. Among these are banks in the UK, continental Europe and Asia, sovereign wealth funds from the middle east, Singapore and Korea and governments with large foreign exchange reserves, such as China.

I have been frustrated by the reporting on this crisis, especially by the implication that the whole crisis is too complicated for anyone except the experts to understand. This I hold to be untrue. There is complexity, but most of it lies in the myriad linkages between participants in the world financial system. Part of it also arises from some unusually involved financial instruments. I believe however, that it is possible to get a pretty good grasp of the situation by abstracting those details. Thus, while you may not be able to predict which institution will fail next or which country will be jolted by the still evolving crisis, you should be able to understand why this crisis is taking place at all. Secondly, when you hear competing assertions about this one thing or that other thing being responsible for the problems, you can make your own judgements. Finally, you should be able to see the pros and cons of the proposed intervention schemes.

Leverage and its effects.
Let us first make up a model of how a financial firm works. Our firm starts with initial capital C. It then borrows money. Let us call the amount borrowed D, for debt. It then buys assets, worth A. Initially, C = A – D, or, owners' capital is the difference between assets and debt. After the initial stage, as the assets rise and fall in value, the difference between the assets and debt is referred to as owners' equity, E. So, in general, E = A – D. If the value of assets goes down enough, E can become zero or negative. If this happens, we say that the firm is insolvent. If, as in good times, the value of assets goes up, E can be greater than C, which means that the owners' equity has increased through profits.

All of this is simple enough. In fact, it applies to any entity, including households. What then is specific to financial firms ? Financial firms borrow a lot of money relative to their capital. This is known as leverage (or gearing). Leverage can be measured using A/E, or the assets-to-equity ratio. Leverage has the property of magnifying returns. For our model firm, the initial leverage is A/C. After some time passes, the assets appreciate or depreciate, yielding a percentage return (profit or loss) R. From the firm's point of view, its initial investment was C = A/L. The firm's return, therefore is

Leveraged return = (Amount of return)/(Initial investment)

= (R x A) / (A/L) = L x R

So, if the leverage ratio is 5, an asset value appreciation of 10% becomes a spectacular return of 50% on the firm's investment. The unfortunate part of this is that any losses are also magnified. Continuing with our example, a leverage ratio of 5 means that the initial capital is only a fifth (or 20%) of the initial value of the assets. If the assets fall in value by 20%, the firm becomes insolvent (the return is 5 x -20% or -100%). The creditors then take over the firm in order to try and recoup their money.

[My example of a leverage ratio of 5 is somewhat deliberate. This leverage is common in homebuying, where the buyer makes a 20% down payment. It is interesting to note that historically, real estate returns have been similar to stock returns. It is the leverage effect that makes homebuying such an enticing investment].

This simple principle of magnifying returns through leverage is employed by many financial entities, from banks to hedge funds. The difference lies in the kinds of assets they purchase and in how they borrow money. Commercial banks “borrow” by inviting deposits. Their assets (predominantly) consist of the loans they make to businesses, companies and individuals. The source of funds for insurance companies are policyholder premiums. Securities firms such as Bear Stearns or Lehman Brothers borrow from the capital markets by issuing securities of their own. Many hedge funds borrow from banks or from the established securities firms.

The creditors of a firm see equity capital as a cushion against losses and thus a buffer before their money is at risk. When the assets fall significantly in value, creditors demand that the firm raise additional capital or turn over its assets. If a firm is unable to raise capital, it files for bankruptcy in a court, seeking protection from creditors. Bankruptcy resolution takes a long time, and creditors inevitably lose a significant chunk of their money.

Banks and other financial institutions in the US have usually kept their leverage ratios at about 10. International standards usually specify a maximum leverage ratio for financial institutions of about 12. During the boom years, large securities firms in the US had much higher leverage ratios. In 2004, the US Securities and Exchange Commission, which supervises these firms, approved a waiver for five large securities firms – Goldman Sachs, Merrill Lynch, Morgan Stanley, Lehman Brothers, and Bear Stearns. They promptly took advantage of the waiver. Leverage ratios of 30 and more were not uncommon. At these levels of leverage, a fall in asset values of about 3 – 4 % makes a firm insolvent. It was a disaster waiting to happen.

Sunday, September 21, 2008

Sacred Games: a review

Sacred Games is Vikram Chandra's third work of fiction, published in early 2007. It is a large novel, both physically as well as in scope and ambition. Judging by its 900 pages, it doesn't appear that the author was slacking off during the seven years that it took him to complete it . The book is set in turn-of -the-century Bombay and has as its central characters a mafia don, Ganesh Gaitonde, and a police inspector, Sartaj Singh. The broad plot could be straight out of a thousand thrillers: a nuclear device is about to be set off in Bombay. The intention is to make it appear to be the handiwork of Muslims, in order to ensure all manner of mayhem. The don Gaitonde has unwittingly helped in the importation of nuclear material, but panics after realizing this. He builds a bunker in the middle of Bombay to try and survive the nuclear explosions. For some reason, he then commits suicide, but not before tipping off the police inspector to his presence there.

The book has the police procedural and popular detective fiction as its templates, but these are merely structural frames. Chandra's real skill is as a weaver of stories. Much of the book is devoted to the career of Ganesh Gaitonde, narrated in the first person: his rise from a small-time crook to a major don, his criminal exploits, his going international, his living on a yacht in Thailand, and his spiritual awakening and involvement with a guru. This narrative is interleaved with the present, where Sartaj Singh is involved in other police work. In addition, there are so-called “insets” in which Chandra brings in additional stories, of characters who impinge upon the lives of Gaitonde and Sartaj Singh. Here is where Chandra's remarkable skill as a teller of stories is revealed. In particular, his account of the traumas of Sartaj Singh's mother's family during the partition of India is very well done. This inset has little to do with the main plot, but adds immeasurably to the reader's experience. Indeed, this kind of loving attention is lavished upon almost all of the characters in the book. This is really what sets this book apart. Even if you are not particularly impressed with the detective work or titillated by the Pulp Fiction type of gangster narrative, you can soak in the warmth of knowing the characters intimately.

The characters themselves are swept up by circumstances beyond their control. While their stories begin very far apart from each other, they are eventually linked with each other. In one inset, we are told about K. D. Yadav, the intelligence operative, who kills two people involved in the Naxalite movement in the late 1960s or early 1970s somewhere in eastern India. In another inset very late in the book, the son of one of these people recruits a struggling but educated Muslim youth called Adil. After a career as a revolutionary, Adil becomes disillusioned and escapes to Bombay, where he organizes small robberies. We then realize that this ties up with an encounter described earlier in the book, where Sartaj Singh's partner, constable Katekar, is killed. Sartaj Singh has to report upon his progress in the Gaitonde suicide investigation to Anjali Mathur, K. D. Yadav's protege in the intelligence establishment. This is but one of the intricate connections in the book. This common literary conceit, of stories tied together, runs the risk of becoming too obvious and predictable. Chandra's success can be gauged by the fact that the reader never loses interest in the characters or their stories. His dexterity at tying the various strands together is remarkable – the metaphor of a delicately woven carpet comes to mind.

While Mumbai is the setting for much of the action in the book, this novel is not about the city. Nevertheless, it does capture much of the ambience and the lingo, down to the mandatory cussing in Hindi. As far as the cussing goes (and it does go quite far), one does not expect any less in a gangsters-and-policemen saga. I do think though that Chandra's experiment integrating Hindi cuss-words with English is largely successful. The words are not italicised, some of them are used in their verb forms, and the glossary at the end, while reasonable, is not exhaustive. Judging by reader reactions on Amazon.com, this does not seem to be much of a stumbling block for people unfamiliar with Hindi or with the Mumbai variant of it.

Although the tale is told from several perspectives, Chandra is quite sympathetic to the enforcers of the law, be they lowly constables and police inspectors or the cloak-and-dagger types from RAW or IB, India's spy agencies. The regular violence and the petty and middling corruption of the police are depicted in a very matter-of-fact manner. Yet, the policemen turn out to be quite competent, street smart, and on the whole, good guys. The intelligence agencies are shown to be on top of everything. These are the parts that strain credulity, but do not detract much from the book. As with most fiction, we have to allow the author his or her premises, and watch what he or she builds from them. Vikram Chandra builds a very readable novel, but what stays with the reader long after the lurid details are forgotten, are the embedded nuggets of the smaller stories.