Obama and moral hazard

Why is it that in the case of Satyam and in the world wide mess it is largely the equity shareholder who is losing? Welcome to the world of moral hazard.

When you lend money to a bank (which may be insolvent even as you are lending) or to a country (which technically cannot become insolvent like USA) there is lesser risk than when you invest in equities. Why is this so? Frankly I think it is because civil servants, ministers and the powers that be keep more money in debt instruments and less in equity instruments!

When Global Trust Bank was in operation it obviously had many shareholders, vendors, employees, and fixed deposit holders. Then the bank audited by the great Pricewaterhouse Hyderabad failed, the government stepped in. It did not ask the vendors why it chose to supply, at what price etc. but went and protected the vendors, employees and its fixed deposit holders. Pertinent to note that all the 3 categories would have chosen to supply their ware (things, time and money respectively) KNOWING the risk, and therefore seeking a risk premium. What this means is a person would have left a Rs. 4 lakh job in SBI and come to GTB at 11 lakhs, a vendor would have priced his supplies at 10% premium, the fixed deposit holder would have got a 3% premium vis-a-vis the fixed deposit of SBI. However when it came to protection, the only guy who paid (pays) the FULL RISK premium is the equity holder. Now with Satyam it is an action replay. Similarly if you are a FD holder in Citibank USA you get protected in all this sham. However, if you are a holder of Citi equity, you have been had.

So Obama, Deepak Parekh, Company Law Board, P C Gupta, are all creating a moral hazard in the corporate sector. All the stake holders should share the suffering – singling out the equity holder will ensure that we cannot grow the equity culture. If we want to become a country of investors from a country of just savers, we should not allow such risk mispricing by behaviour. Mr. Deepak Parekh who has made most of his wealth from the equity markets should appreciate this point of view. I hope he does!

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