Intellectual Thoughts by Sanjay Panda


The Crisis of confidence

The old-fashioned financial system was like Old Maid, a parlour game once beloved of small children. The banks were like players, dealt hands from a pack of cards, which they swapped among each other. At the end, one player was left holding a lonely queen—a bad debt, if you will—and lost. Over the past few decades the game has changed. Securitisation has snipped the old maid into pieces; new faces, such as hedge funds, have joined the party, enabling the banks to distribute those pieces among a larger number of players.
When the game is over, lots of players are left holding small losses instead of one player holding a big one. During two exceedingly prosperous decades, that theory seemed to work just fine. But the swings in almost all financial markets this month have made dispersed risk suddenly morph into dispersed mistrust. The uncertainty has been magnified .Meanwhile, collateralised-debt obligations (CDOs), made up of clumps of those securities and laced with leverage, have become almost impossible to trade. So none of the players really knows how much he has lost. While this uncertainty lasts, investors are taking it out on the banks that peddled the securities by dumping their shares; and the banks are taking it out on those they sold them to by demanding more collateral on their loans.
The banks have even grown cagey about lending to each other. The doubts burst into the open on August 9th when central banks were forced to inject liquidity into the overnight money markets because banks were charging punitive rates to lend to each other. At first, the problems appeared more serious among European banks. The pain in America was concentrated in the largest hedge funds, including those run by Wall Street’s biggest name, Goldman Sachs. Increasingly, however, analysts worry about the exposure of American, Canadian and Asian banks.
On Wednesday August 15th shares in Countrywide Financial, a large American mortgage lender, fell 13% after an analyst gave warning of possible funding difficulties. Despite liquidity injections by the Federal Reserve on August 15th, the S&P 500 index fell 1.4%. The heavy selling spread to Asian and European stocks on August 16th. Every crisis begets finger-pointing, and the blame now is falling on the rating agencies that helped structure these exotic instruments. Currently, they are guided by a voluntary code that aims to tackle potential conflicts of interest. The biggest is that the agencies are paid by the firms they rate. Rating CDOs was a profitable business. If these securities are now downgraded, banks could be forced to offload lots of illiquid instruments into a falling market—one of the fastest ways to lose money yet devised. But if there are no buyers, banks may have to sell something else to shore up their balance sheets. Something like this indiscriminate selling has been affecting hedge funds over the past couple of weeks. Faced with more demanding standards from their banks and investors, some have been forced to unwind positions in order to realise cash. That has led to unusual movements in debt and equity markets, which have only got some funds deeper into trouble. Quantitative funds have been hardest hit, as investment models that had made money for ages briefly proved worse than useless. Since banks lend to hedge funds, any problems there quickly become their concern. On top of this, both Bear Stearns and Goldman Sachs have found that when funds bearing their name get into trouble the desire to preserve their reputations soon leads to a rescue. Sometimes risk is not as far away from the banks as it seems. At the end of Old Maid as banks used to play it, the loser would take a big write-off and then everyone could start playing again. In the new version, the use of leverage means the game is being played with hundreds of packs of cards and by thousands of different players. Working out who has won and who has lost in this round will take a long time.

Economist

Dow acquires Rohm and Haas

Dow has signed a definitive agreement to acquire all outstanding shares of Rohm and Haas, one of the largest manufacturers of specialty chemicals, for $78 per share in cash. This acquisition would transform Dow into the world's leading specialty chemicals and advanced materials company. The companies are targeting completion of the transaction by early 2009.

The acquisition would be financed through an equity investment by Berkshire Hathaway and the Kuwait Investment Authority in the form of convertible preferred securities for $3 billion and $1 billion, respectively. Citi, Merrill Lynch and Morgan Stanley have committed debt financing.

Rohm and Haas is expected to help Dow make a mark in a number of industry segments like electronic materials and coatings that are poised for significant growth in the long term. Besides, Rohm and Haas has a strong presence in a number of other attractive areas such as water solutions, adhesives, personal care, biocides and building and packaging materials. The acquisition will unlock value from Dow's existing portfolio by delivering a range of innovative new products and technologies to these high growth downstream sectors, while at the same time expanding the product offering for sale through Dow's own existing market channels. Dow also anticipates that the transaction will produce significant revenue synergies, through the application of each company's innovative technologies and as a consequence of the combined businesses' broader product portfolio in key industry segments with strong global growth rates.

Dow will establish an advanced materials business unit at Rohm and Haas' current headquarters in Philadelphia and intends to contribute complementary Dow businesses to Rohm and Haas' existing portfolio, such as coatings, biocides and personal care. The total revenue of this new unit will approach $13 billion. Dow will retain Rohm and Haas' corporate name for this advanced materials business unit in order to capitalise on the company's brand value.

China to suspend exports of all HAZ chemicals for 2 months from mid July

The Chinese government is likely to suspend the export of all the hazardous substances including pharmaceutical chemicals for the two months starting from mid July to mid September, in connection with Olympics 2008. The decision is likely to create a major crisis situation for the Indian pharmaceutical industry.

According to industry sources, the Chinese government's decision is to suspend the movement of any hazardous substance, including pharmaceutical chemicals, in the region from one month prior to the beginning of Olympics. The restriction is expected to last till 15 days after the Olympics. For the next two months, therefore, the companies in India would find it difficult to import any chemical substances including bulk drugs and intermediates from China.

"This will have a double effect on the Indian pharmaceutical industry, as almost 20 per cent of the bulk drugs and around 70 to 80 per cent of the intermediates in the country are imported from China. Most of the companies are now collecting stocks as much as they can with their financial and storage capacity to meet the situation. The price increase of Chinese raw materials is already posing a problem for those who have to buy large quantities.

However, the sources informed that the restriction is only around Beijing, where the Olympics 2008 is to be held, and the supplies from other parts of China will be continued though the prices will be very high. The prices are expected to shoot up with increase in demand as the companies from Beijing and its outskirts cannot supply products to its customers.

The prices of active pharmaceutical ingredients (APIs) and intermediates imported from China have already gone up from 50 per cent to 200 per cent in the last couple of months. Further, the Chinese government has ordered closure of several major API manufacturers as the environment rules were made stringent prior to organising Olympics