Update Wednesday, 12/1/11, 6 am Nicolas Haque’s follow up report below on the rebound. He says it happened within a “matter of minutes”. Rumour has it that the government-backed/owned banks and agencies purchased these shares massively so that investors’ losses were minimised. In the West, they call that a “bailout”. We call it “stabilisation”. More on that after the video.
A possible explanation might be hidden beyond the stock market. While a fracas was going on in downtown Motijheel, many forgot that a great challenge looms ahead for the government — the municipal election. A non-partisan affair by book, it is essentially a political battle which the government must win to have its grasp on the grassroots..
With a crashed stock market and broken investors — remember that the reach of this market penetrated even the remote places, as brokerage houses opened branches across the country and pooled money of the unsuspecting small savers — there is little chance for the government-backed candidates to win.
So a great deal of scurry must have happened in the offices of policymakers. Many great heads must have met greater heads. And decisions were made that the market must be yanked back on track for the time being. It did not matter whether fundamentals had enough gravitational force to keep the market on track.
Update Tuesday, 11/1/11, 8 am: They’re already calling it Black Monday. The FT picked it up an hour ago (highlights below the video). Nicolas Hoque’s report for Al-Jazeera below. For those of us outside Dhaka, the scenes speak volumes about the amount of anger out there.
The central bank then indicated it would become more aggressive in enforcing long-standing, but largely ignored, rules that cap bank exposure to the stock market at 10 per cent of deposits. The order prompted banks – some of which are believed to have as much as 75 per cent of their deposit base in the market – rapidly to cut exposure, sending prices tumbling and prompting allegations of foul play and share price manipulation from retail investors.
Reflecting the government’s nervousness over the political fallout from the stock market drop, the Rapid Action Battalion of the Bangladeshi police – the elite anti-crime and anti-terror squad – on Sunday arrested a local journalist covering the stock market for a leading newspaper. He was later released.
In the comments section, idune and I have been wondering aloud all day about the rules governing commercial bank exposure and why BB did not limit their exposure till now. Clearly the SEC is not the only regulator to blame.
The Financial Express reports that the DSE general index has fallen 600 points, a 7.7% downward decrease. The headline for the story is instructive: “SEC takes steps to boost share prices”.
The SEC’s purpose for existing is given in detail here, on its website. Its self-proclaimed mission statement reads:
Mission of the SEC is to:
Protect the interests of securities investors.
Develop and maintain fair, transparent and efficient securities markets.
Ensure proper issuance of securities and compliance with securities laws.
I argue that by capitulating to investors for the last few months, especially on the issue of margin requirements, the SEC is undermining its own credibility as a strong regulator and helping to increase leverage in the market, making an unwinding of any potential bubble even more painful than is necessary.
Now some might say that “boosting share prices” falls under “protecting the interests of securities investors”. It does not. An investor is rewarded for taking on the risk that her/his investment might fail. An investor is not a lender – s/he should not even expect the principal back if things go wrong. Given these conditions, there is a great need for a market regulator in equity investments. The SEC protects the interest of securities investors by ensuring that only trustworthy companies are allowed to sell shares on the bourses, that these companies adhere to a certain standard of corporate governance, that they regularly publish statements on their financial positions etc. All this can be found on the web page above.
Additionally it has certain duties towards ensuring the proper functioning of the secondary market – i.e. where investors buy and sell shares from other investors. The investors usually buy/sell through brokerage houses and merchant banks, putting down only a fraction of the money needed for investment. The exact fraction is usually determined by the SEC. This fraction (the so-called margin loans) is what the SEC has been tinkering with over the past few months. The best rules are those that are enforced through thick and thin. But one may make an exception for the extraordinary circumstances in which the SEC finds itself: namely, having to tackle a bubble that the Bangladesh Bank seems incapable of handling.
Basically every time it sees trouble (DSE index falling from its lofty heights, investors burning cars), the SEC loosens the restrictions on such loans*. What good does this do really? This simply increases investors’ leverage (see the simple example presented below), allows greater speculative activity and increases the value of the index based on liquidity and “animal spirits” rather than fundamental value. The very definition of the bubble the SEC is seeking to prevent.
I understand it is quite scary to have an angry mob in front of your office. The government has taken the right step by deploying the law enforcers there. Investors need to take responsibility for their own decisions to invest, and yes, it will be painful (again). The SEC is not and should not be a paternal organisation that ensures win, win, win, all the time.
Perhaps now, feeling a bit safer, the SEC can play the role it is expected to play: promote fundamental analysis among investors rather than making it easier for them to fuel the speculative bubble that has lifted the DSE to this improbable level. And maybe- I know this is asking too much – finding out what led to the initial meteoric rise in the index in the first place and why they did nothing about it then. Some introspection is warranted.
The signs don’t look good so far. The SEC issued directives today to increase more “liquidity” in the market. It essentially has loosened the margin requirement as much as possible, and is now tinkering with waiting times for the margin facility. Previously a new investor would have to wait a month before s/he could take out such loans. As of today, the new investor has to wait 2 weeks. Again, speculative trading becomes easier. It also repealed the 100 million taka loan cap to any single investor – ensuring that the bigger players can take larger positions. This smacks of desperation on the SEC’s part. I doubt that the institutional investors will be foolish enough to start taking large, long positions in this market.
Next time, one hopes the SEC has enough spine to hold its ground and say “enough is enough”. Not holding my breath.
*The examples below have been simplified intentionally. To understand the SEC’s motive behind loosening, one has to appreciate that the falling prices of stocks – the collateral for (most? all?) margin loans – has resulted in margin calls for most investors, including the big ones. That, however, is no reason for rule changes that simply undermine its own credibility in the long term.
The progression of margin loan requirements over the past few months goes like this:
July 8th, 2010: SEC rules that loans will be given on a 1:1 basis. So if you wanted to buy shares worth 100 taka, you needed to put down only 50 taka of your own money. The other 50 taka could be borrowed from the merchant bank/broker. (50 = 1X50)
November 22nd: it rules that loans up to 0.5 the investors’ margin/collateral can be given. This means that an investor wishing to buy 100 taka worth of shares needs 66.6 taka in downpayment and can borrow 33.3 taka from the bank. (33.3 = 0.5 X 66.6 approx.) This was a tightening of the rules as talk of a DSE bubble went mainstream.
December 13th: SEC loosens its stance so that loans could be given on a 1 to 1 ratio again. It’s “tight” stance lasted all of 21 days.
December 19th: it loosens further, ruling that an investor could borrow at 1.5 terms their “margin”. Put simply, if you want to buy 100 taka worth of stock, you need to put up only 40 taka of your own money. The bank lends you the rest (60 = 1.5 X 40).
January 9th: Unable to loosen the margin requirement any further without prompting serious concerns, it loosens other legal restrictions, such as cap on loan to any individual client and the waiting time before margin loans can be issued.