Indian at Berkshire?

Mumbai might not be making waves in the world of finance; but Global Indian's quite seem to be. After Rana Talwar at helm of StanC, Pandit's easy takeover at banking giant Citi, this will surely be the icing on the cake....Indian taking over Wizard of Omaha!!? Lets keep our fingers crossed.


New York: Ajit Jain, named by investors as a possible successor to investment guru Warren Buffett, said the biggest opportunities for Berkshire Hathaway Inc.’s insurance business occur when major catastrophes strike.

“It’s the politically incorrect answer, but a ‘major cat’ will certainly separate the men from the boys,” said Jain, speaking on Monday (7 May 2007) evening at the New York University. The 55-year-old is the president of a Berkshire Hathaway division that provides reinsurance, or insurance for insurance firms.

Guiding hand: Warren Buffett looks over the shoulder of Ajit Jain, head of the reinsurance unit with Berkshire Hathaway Inc., while he plays bridge.

The Stamford, Connecticut-based Jain, who specializes in catastrophe coverage at Berkshire, said he prefers a so-called “major cat” to record industry profit. He insured a sweepstakes by PepsiCo Inc. in which a contestant had a chance to win $1 billion (Rs4,100 crore); Chicago’s Sears Tower, North America’s tallest building; and the 2002 Winter Olympics in Salt Lake City after the terrorist attacks on 11 September 2001.

Berkshire gets about half its earnings from insurance and capitalized in 2006 on a retreat by rivals wary of covering the US Gulf Coast after the record storm season the prior year. (The number of storms recorded in 2005 was the highest since meteorological observations began to be recorded.) Net income at Berkshire increased 29% to $11 billion in 2006.

Buffett, 76, has identified three “outstanding” candidates to take over as chief executive officer, he wrote in his 2006 letter to shareholders. Berkshire investors including Gardner Russo & Gardner’s Tom Russo have said Jain, born in India and a Berkshire employee since 1986, is in the running. Jain said he speaks with Buffett daily, discussing potential deals. Buffett taught him to “do things that are rational,” such as selling insurance only when the premium is sufficient compensation for the risk, Jain said. For example, “after 9/11, people got irrational about the risk of terrorism,” allowing Berkshire to increase prices, he said.

Jain, speaking to a group that included the New York University students and graduates, addressed compensation in the finance industry. “These days, the money is so out of whack on Wall Street that I don’t know how you can turn down what they’re offering.”

http://www.livemint.com/2007/05/09000156/Buffetts-possible-successor-s.html

Compensation and Performance measures: Pak used anti-terror aid against India

What happens when you do not compensation is not backed by performance measures


WASHINGTON: More than five billion dollars in US aid to Pakistan has often never reached the military units it was intended for to fight Al-Qaida and the Taliban, and was instead diverted to other programmes, the New York Times reported on Monday.

Much of the money meant to reimburse frontline Pakistani units was channelled to weapons systems aimed at India and to pay inflated Pakistani reimbursement claims for fuel, ammunition and other costs, unnamed US government and military officials told the daily.

Pakistanis critical of President Pervez Musharraf said he used the reimbursements to prop up his government, and one European diplomat said the United States should have been more careful with its money.

"I wonder if the Americans have been taken for a ride," said the diplomat, who spoke on condition of anonymity.

Money intended to repay Pakistan for maintaining 100,000 troops in the restive tribal areas apparently does not reach the troops who need it, officials said.

"It is not making its way, for certain, we know, to the broader part of the armed forces which is carrying out the brunt of the operations on the border" with Afghanistan, a senior US military official told the Times.

Despite the vast funds flowing to Pakistan, a US official visiting the border recounted finding members of the country's frontier corps "standing there in the snow in sandals."

Several soldiers were wearing World War I-era pith helmets and had battered Kalashnikov rifles with only 10 rounds of ammunition each, the official said.

The two countries have never forged clear strategic goals as to how the US military aid should be spent or how Pakistan could show it was meeting Washington's expectations, according to US and Pakistani officials.

US aid to Pakistan has come under scrutiny recently in the United States given the strength of Al-Qaida and Taliban cells in Pakistan's north-western tribal areas as well as the failure to secure the capture of Osama bin Laden.

Musharraf has also been forced by US pressure to ease back on repressive measures, lift emergency rule, shed his military uniform and move the country toward greater democracy.

The United States provides the five billion in aid to reimburse Pakistan for carrying out military operations against terrorist threats. A separate US program delivers 300 million every year to pay for equipment and training for the Pakistan military.

The US Congress on Thursday slapped restrictions on the 300 million in traditional military aid, 50 million of which will be withheld until Pakistan shows it is restoring democratic rights.

US funds are vital for Pakistan's military, with American aid accounting for about a quarter of the military's entire budget, the paper said.

Pakistani officials interviewed by the New York Times denied their government had overcharged the United States for the "war-on-terror" military aid it gets.

But US officials cited helicopter maintenance as an example of the funding programme's failure.

While Pakistan received 55 million dollars for helicopter maintenance for an eight-month period in 2007, the officials said they found out that only 25 million had been received by the Pakistani army for helicopter maintenance for the whole of 2007.

Allegations that generous military aid to Pakistan has been squandered represent another setback for President George Bush's administration, which has viewed Pakistan as an important ally in the "war on terror."

Estate tax: Advantage India?

Will India be the next tax haven? Unlikely, but interesting

India’s economic growth and booming capital markets have generated unprecedented wealth for Indian promoters. Suddenly, India has billionaires coming out of its ears, more than Japan by one count. Yet, India’s entrepreneurs are lucky: they can pass most of their wealth to their children without too much hindrance.

Unlike many advanced market economies, India has no estate tax, or estate duty as it was known in India. Estate duty was introduced in 1953 and was abolished way back in 1985, when V P Singh was the finance minister. It is not payable on deaths occurring after March 16, 1985.

World wide, the estate tax, also sometimes called the death tax, is very much a reality. Wherever it is levied, it is usually payable on the value of the accumulated savings (by way of assets accumulated) of a deceased person. The policy intention is to bring about inter-generation equity, i.e., to ensure the children of the rich don’t have too much of an advantage in life compared to the less privileged.

On the other hand, many tax experts slam the estate tax — known as the Inheritance Tax in the UK — as a-hard-to-collect levy, which penalises savings and investment. It also encourages tax avoidance by way of creation of trusts and shell companies to which property and other assets can be transferred.

Tax rates vary widely across countries. Data collated for 2005 by PricewaterhouseCoopers for 50 countries shows Japan with a top rate of 70%. South Korea’s rate is 50% followed by the US (46%), and France and UK with 40% each. On the other hand, many countries, including India, do not levy estate tax. According to the PwC study, the 24 countries with no estate tax include China, Russia, Australia and Malaysia.

In virtually all countries with estate tax, the nominal rates usually apply only for assets above a certain exemption limit, which is usually set high enough to exclude a large chunk of taxpayers. In the US, for instance, the estate tax is payable after an exemption of $2 million.

The US law is, in fact, very complicated. As part of President Bush’s 2001 tax cuts, the basic exemption limit was raised from $1 million in 2001 to $2 million, at which level the 46% rate kicks in. In 2010, the estate tax is repealed for a year. Then after 2011, the basic exemption drops to $1 million and the tax rate rises to a rather high 55%. There are jokes about the murder rate for rich people shooting up in 2010.

The June 2006 Tax & Budget bulletin of the libertarian Cato Institute states, “The estate tax is probably the most-inefficient tax in the US. It has a high marginal rate and is very difficult for the government to administer and enforce. It has also created a large and wasteful estate planning and avoidance industry. The industry overflows with...lawyers and accountants... creating financial structures to minimise the tax burden using trusts, life insurance and private foundations.” The institute wants the US to scrap the estate tax, which accounts for just over 1% of federal tax revenues.

In the UK, the inheritance tax is payable if the taxable value of the estate is above £285,000 (2006-07 tax year) according to the British government’s website. The term ‘Estate’ is defined as “broadly speaking...everything you own at the time of your death, less what you owe,” according to the website. In addition, it might be payable on assets given away by the deceased during his/her lifetime, including property, money and investments. The tax kicks in over the threshold value.

The main argument in favour of estate tax is that it levels the playing field between the rich and the poor. The main argument against is that it discourages savings and investment, and hence capital accumulation. Obviously, a high rate of estate tax is a disincentive since a person would find it difficult to pass on his wealth to his descendants.

Further, since the tax is levied on the net value of assets, not on income, it can create a major liquidity problem for the inheritor who has to pay. This is because the tax is a lump-sum payment that may exceed revenues from a particular set of assets. Indeed, it can potentially create an incentive to liquidate the business.

In India, estate duty was abolished partly because it amounted to double taxation, since stamp duty is in any case levied on transfer of property to heirs. Stamp duty is currently between 7-9% in most states and is in some way a quasi-estate duty. The Centre wants states to bring it down to the 4%-6% range. A stamp duty is, however, only a rough proxy for estate duty since it is payable on all property sales/transfer while the latter is payable only on the death of a property owner.

In general, all taxes which are levied on assets, such as estate tax or the wealth tax tend to result in the creation of complex tax avoidance structures. Sweden’s new centre-right government has recently decided to scrap the country’s 1.5% wealth tax, which in that country is levied on all persons with wealth exceeding $2,00,000.

The tax is estimated to have led to billions of dollars of capital flight. Ingvar Kamprad, the owner of iconic furniture maker Ikea and Sweden’s richest man controls his wealth, estimated at over $20 billion, through foundations based outside Sweden.

Enormous donations to foundations with a charitable purpose, most famously by Warren Buffet and Bill Gates, may well be part of the Christian tradition but high estate tax is undoubtedly a major driver. Typically, the children of the wealthy tend to be associated with the trusts set up by mega creators of wealth like Buffet or Gates. In both Europe and the US, broadly speaking centre-left parties tend to support estate taxes while centre-right parties (such as Republicans in the US and Tories in Britain) tend to favour their abolition.

Can India attract tax tourists from the US or other high estate-tax countries? That’s right now a theoretical possibility, experts feel, given the poor physical infrastructure and lack of adequate legal framework, including the absence of complete capital account convertibility.

Also, it is far from clear what view the IRS, the US government’s famous tax arm, will take of persons relocating to India. The US claims to tax income generated worldwide by all its citizens, though in practice major companies use tax havens such as the Cayman Islands to minimise the dues payable to Uncle Sam. Still, it’s a possibility that India can exploit in the future as it gets richer.

(With inputs from Bakul Chugan)

Re has appreciated less than yuan

leave the economists behind; its the populist who decides the numbers....I was badly looking for someone to come out with some good analysis on this and who else other Aiyar would!
-----------------
9 Dec, 2007, 0230 hrs IST,Swaminathan S Anklesaria Aiyar, TNN

Hundreds of columns have been written on the exchange rate policy of the Reserve Bank of India, and its decision to let the rupee appreciate sharply this spring. However, what was earlier a debate mainly between technocrats has suddenly assumed populist, alarmist tones.

In Parliament, commerce minister Kamal Nath has said the appreciating rupee has hit labour-intensive exports such as textiles, leather goods and gems & jewellery, and that one to two million workers may have lost their jobs. Following up, industrialist and Rajya Sabha member Rahul Bajaj has written in this newspaper suggesting that 2.8 million people have lost their jobs.

The numbers are so huge that, if they were anywhere near the truth, we would have a major human tragedy on our hands. In fact, we have only tall stories and data inflation aimed at scaring people rather than informing them.

I toured Gujarat in the run-up to the state election, and talked to a wide range of people about the many issues that might determine the outcome. Not a single person mentioned worker distress in export industries as an election issue. Nor did I see this mentioned in the innumerable TV discussions of the Gujarat elections.

Now, at election time opposition parties are given to exaggerating rather than hiding distress issues. Narendra Modi was fighting principally on an economic development platform, and Congress speakers were looking desperately for flaws in his platform. Gujarat is a major centre for exporting both textiles and gems. If indeed workers were being thrown out of work by a strong rupee, this would have been a huge election issue. In fact, it was a non-issue.

I myself toured Ahmedabad and Saurashtra. I can state categorically that the garment and textile areas there were not hit by mass unemployment. Indeed, at least one textile magnate, Vinod Arora of Aarvee Denims, was positively gung-ho about the future of his industry.

I did not visit the diamond-cutting areas around Surat. But my Economic Times colleagues went there, and found no unemployment arising out of a strong rupee. They found signs of declining foreign orders, but this had not translated into fears of job losses among diamond cutters. The electoral impact was negligible. In which case the economic impact must be close to zero too. Proponents of a weak rupee are altogether more agitated than the people on whose behalf they claim to be agitating.

Now, ET correspondents have reported job losses running into thousands in Tiruppur. Clearly, there is some distress in some areas. But it is not an all-India calamity. There is a world of difference between losing a few thousand jobs and two million. Some job losses are inevitable, indeed desirable, in a market economy, and constitute transitional pains, not human disaster. Those who claim that a strong rupee is costing millions of jobs are talking through their hats. We need to shout this from the rooftops, since many media folk are falling for false propaganda on this score.

Indeed, the notion that modest changes in the exchange rate can produce such huge swings in employment is obviously false. If a modest rise in the rupee can kill two million jobs, a corresponding fall in the rupee should create a similar number of jobs. Alas, that did not happen when India had big currency declines in the past. Nor will it happen if the rupee now falls by 13%.

Export growth in April-September was 26.9% in dollar terms, and provisional data suggest 35.6% growth in October. Even allowing for rupee appreciation of 13%, this constitutes solid export growth. Exporters may be under somewhat more pressure than before, but are not throwing millions out of work.

What exchange rate policy should we have? I have written much less on this topic than many other observers, because I do not have strong views on the subject. I see some substance in the position of those who say the RBI should focus only or mainly on inflation control, letting the exchange rate find its own level. I also see some substance in those who think the RBI should focus on macroeconomic management over and above inflation. Finally, I see some substance in the argument of those who want the RBI to focus on the exchange rate above all, to promote exports and employment.

Most people measure the rupee’s strength against the US dollar. The RBI is more sophisticated: since 1973 it has aimed to keep constant the real effective exchange rate, to protect exporters after accounting for changes in the nominal exchange rate and inflation. Many technocrats see this as a successful policy worth maintaining. Others point to China as a superior example of a country that has refused to kow-tow to foreign pressure to appreciate.

However, the notion that the rupee has appreciated much faster than its rivals does not stand up to detailed examination. Certainly the 13% appreciation of the rupee since early 2007 is steeper than experienced by most rival currencies. But if we start our comparison in July 2005, when China first began to let its currency rise, we find that the rupee has actually risen less than the yuan!

See the accompanying table. It shows that, compared with July 2005, the rupee has risen only 9.4% against the dollar. Much stronger rises have been registered by China (10.9%), South Korea (11.1%), Malaysia (12.6%), Thailand (20.2% and Brazil (25.4%). In no way can the rupee’s appreciation be called steep or extraordinary.

So, what’s the fuss about? The answer lies in the fact that the rupee actually weakened against the dollar from mid-2005 to mid-2006, at a time when other Asian currencies were strengthening. This has now been reversed in 2007, somewhat sharply. Had the RBI allowed rupee appreciation from 2005 onward in line with China, the change in 2007 would not have been so sudden.

Seen in this light, the main failing of the RBI is not that it has made the rupee too strong, but that it should have started the process two years earlier. Had it done so, the change in the rupee’s value would have been more gradual and corporations would have adjusted much more smoothly.

The RBI’s second failing is that inflation in India has been higher than in most rival countries. This erodes our competitive edge. Whether rising productivity offsets this remains to be seen.

------------------ more to add onto Aiyar is that rising rupee also helps in controlling import prices. Given that many Indian textile manufacturers are expanding, this is the time to import those expensive machines. And yes go on the M & A rampage. Leave alone capital expenditure, think about the good effect it has in acting against the rising crude oil prices. All I want to say is that 'every coin has two sides'! -Vj

The new wars of religion

An old menace has returned, but in very different forms

after a long time ...an unbiased of religion and conflicts

EARLIER this year Iran's President Mahmoud Ahmadinejad, speaking to his country's parliament, posed two questions: “Who are our enemies?” and “Why do they hate us?” He described an axis of evil, with Iran's enemies being “all the wicked men of the world, whether abroad or at home”. The root cause of their hatred was religious—a loathing of “whomsoever should serve the glory of God”. Having described George Bush's atrocities, he told the cheering MPs, “Truly, your great enemy is the American—through that enmity that is in him against all that is of God in you.” Fortunately, Iran would not fight alone: it had the support of Muslims around the world. Be bold, he advised, and “you will find that you act for a very great many people that are God's own.”

The Bridgeman Art LibraryOliver's army

For Mr Ahmadinejad, read Oliver Cromwell; for Iran, England; and for America, Catholic Spain. The quotes above come from a speech made by Cromwell to the English Parliament in 1656. Parliament then passed an oath of loyalty in which English Catholics were asked to disown the pope and most of the canons of Catholic belief, or face losing two-thirds of their worldly goods. Shortly afterwards Cromwell invaded Ireland.

“Faith is a source of conflict,” reads a sign at St Ethelburga's Centre for Reconciliation and Peace in the City of London—adding that it can also be “a resource to transform conflict”. Appropriately, the centre was built in a church blown up in 1993 by Irish terrorists, brought up, no doubt, with tales of Cromwell's atrocities.

Conflict, of course, does not necessarily equate to war. But there are some depressing echoes of Cromwell's time.

•Faith is once again prolonging conflict. Religion is seldom the casus belli: indeed, in many struggles, notably the Middle East in modern times, it is amazing how long it took for religion to become a big part of the argument. But once there, it makes conflicts harder to resolve. A squabble over land (which can be divided) or power (which can be shared) or rules (that can be fudged) becomes a dispute over non-negotiable absolutes. If you believe that God granted you the West Bank, or that any form of abortion is murder, compromise is not really possible.

•Once again, politicians are stirring up religious passion. Mr Ahmadinejad may not have told Muslims that the Israeli “has an interest in your bowels” (as Cromwell did of Spaniards), but he has called for Israel's removal and denied the Holocaust. Osama bin Laden rages that Islam is under sustained attack: any Muslim who “collaborates” with the West is an apostate.

American leaders have been more careful, but many use religious imagery. In his new book, “God and Gold” (see article), Walter Russell Mead compares Ronald Reagan's denunciation of the Godless Soviet Union (the “Evil Empire”) to Cromwell's speech. Franklin Graham spoke for many on the religious right when he denounced Islam as a “very evil and wicked religion”. American conservatives seem undecided on whether the battle against “Islamofascism” is the third world war (Newt Gingrich) or the fourth (Norman Podhoretz).

•Once again, outsiders are rushing to defend their religions: religious scraps attract money and soldiers. Just as Guy Fawkes, Britain's most famous religious terrorist, hardened his radical beliefs when fighting for Catholicism in the Netherlands, European Muslims have gone to defend their faith in Kashmir, Chechnya and Iraq. Some of the most fervent supporters of India's Hindutva movement come from the diaspora. Many migrants define themselves by their faith, not their new home.

•One of the world's great religions, Christianity, split into Catholic and Protestant in the 16th century. Now Islam is having to contend with a sharpening split between Sunni and Shia. Once again nation states are weak: most Middle Eastern countries are recent creations. And there is a ring of instability on Islam's southern frontier, which runs roughly along the 10th parallel from West Africa to the Philippines.

•Terrorist outrages are once again presumed to have religious connections, as they would have done in Cromwell's time. In the 1970s terrorism seemed to be the preserve of Maoist guerrillas, middle-class Germans and Italians or the then very secular (and partly Christian-led) Palestine Liberation Organisation. Now three out of the four most likely flashpoints for nuclear conflict—Pakistan-India, Iran and Israel—have a strong religious element. The only exception is North Korea.

Wars can be Godless too

It is possible that these similarities could escalate into something horrifying. A confrontation between nuclear Iran on one side and Israel and America on the other would reverberate around the globe. But the idea that the world is reverting to a former age is too simplistic.

Most obviously, humanity can find plenty of reasons for genocide and suffering without troubling God. “The 20th century was the most secular and the most bloody in human history,” argues George Weigel, a leading American conservative. What he calls “the Godless religions of Nazism and communism” killed tens of millions of people. Each had its theory of salvation, its rites, its prophets, its sacred places and its distinctive idea of morality; but communists and Nazis did not use God to stir up passions. The Cambodian genocide was similarly secular.

Where it does exist, religious conflict is now far less of a top-down affair. No government officially approves of killing people solely because of their religion, and no significant religious leader sanctifies that killing by blessing armadas or preaching crusades. Last year the pope took issue with Islam in a speech at Regensburg, but he also opposed the Iraq war. Most Islamic authorities preach non-violence. Ayatollah Sistani, the most revered Shia on the planet, has often urged restraint in Iraq.

Of course, this does not prevent individual clerics from committing appalling acts of brutality: Catholic priests helped torture people in Argentina, Buddhist monks have led murderous attacks in Sri Lanka and imams have encouraged suicide-bombing in Israel. But every zealot interviewed for this special report, including those with blood near their hands, insisted that his religion was peaceful.

Meanwhile, the power of governments to control religious politics has declined. The wars of religion took place in an age of “cuius regio, eius religio”, where the monarch dictated the religion. England once turned to Protestantism because Henry VIII found the Catholic church's rules on matrimony irksome. Nowadays, nobody is trying to improve America's relations with the Middle East by marrying off the Bush twins to Arab princes.

The new battles

With national armies no longer marching under religious banners, grievances have reappeared in several guises. None of them is easy for the West to deal with.

The one that gets most attention is terrorism—especially Islamic terrorism. States are certainly actors in this: Iran may not openly wage religious war, but it has been happy to back Hizbullah in Lebanon and Hamas in Palestine. But then neither Hamas nor Hizbullah is a purely sectarian organisation. Like the IRA in Ireland, they both have political-territorial objectives.

Most of the main jihadist terrorist organisations are bottom-up affairs. Mr bin Laden would no doubt like to control another state (as he once did from Afghanistan). But his organisation has been able to mount attacks and recruit volunteers without help from a government.

The second way in which religion thrusts itself into politics is inter-communal violence. Once again, other forces are often at work, such as tribalism in Nigeria or nationalism in India. But religion supplies the underlying viciousness. Sectarian violence has been responsible for most of the killing in Iraq in the aftermath of the war. Some 68,000 Sri Lankans have died since 1983. Other, lower-level conflicts, such as Catholics and Protestants attacking each other in Mexico's Chiapas, occasionally flare up. Outside parties can play a role in stoking up such struggles (and supplying arms), as Iran has done in Iraq and Syria has done in Lebanon. But most of these fights have a local, tit-for-tat feel. The violence is often set off by events such as marches, feast days or elections.

Third, there is state-based repression, where religion is either the target or the motivation. In the Muslim world the repression is sometimes by theocracies (like Iran or Saudi Arabia), against irreligious sorts, such as adulterers, heretics and homosexuals. But it also goes the other way, with secular states (Syria, Egypt, much of North Africa) discriminating against religious dissidents. In the most bizarre example, China recently banned Buddhist monks in Tibet from reincarnating without government permission. The religious-affairs agency explained that this was “an important move to institutionalise management of reincarnation”. The real purpose is to prevent the Dalai Lama, Tibet's exiled spiritual leader, from being succeeded by someone from outside China.

Yet the foremost way in which religion has expressed itself around the world has been more peaceful: the ballot box. Religious people have either formed religious parties (such as India's BJP) or converted secular ones into more faith-driven outfits (such as America's Republican Party). In places where religion was frowned upon by the state, such as Mexico or Turkey, greater freedom has allowed the pious to form parties, such as the Catholic-oriented PAN party or the Islamic AK Party.

And it has not just been a case of democracy helping religion. Timothy Shah of the Council on Foreign Relations argues that it can go the other way too. By his calculation, more than 30 of the 80 or so countries that became freer in 1972-2000 owed some of the improvement to religion. Sometimes established churches helped to push for democracy (eg, the Catholic church in Poland), but more often it was pressure from the grassroots: religious people usually look for a degree of freedom (if only to pursue their faith).

All this means that the modern wars of religion are mercifully less violent and all-consuming than their predecessors; but also that tackling the politics of religion is more awkward than it used to be. Culture wars are now global (a subject to which this special report will return).

This complicates foreign policy enormously. Should America focus on the tiny number of angry Muslims with guns, or the millions who have voted for Islamic parties in Egypt, Pakistan, Turkey, Algeria and Palestine? If most religious fanatics were bent on conquest and terror rather than democracy, their causes would be easier to discredit. And if religion were the sole cause of the conflicts, it would be easier to work out “why they hate us”.

Enron suit: A new tempest for Citi?

twist twist

A $20 billion claim charges the bank helped the firm manufacture financial statements. Bethany McLean investigates.

By Bethany McLean, Fortune editor-at-large

(Fortune Magazine) -- "When Enron blows up, will it be worse than Long-Term Capital?"

So wrote one Citigroup banker to another in April 2001, some seven months before Enron's bankruptcy. That e-mail is, of course, a vivid reminder of two big blowups that rocked the capital markets. But -- surprise! -- it's not just a remembrance of things past.

The e-mail is also part of a series of lawsuits filed against Citi after Enron's bankruptcy, one of which is supposed to go to trial this spring, in which Enron -- or what remains of it -- is seeking more than $20 billion from Citi. In the inflated numbers, the aggressive posturing, and the mind-numbing complexity, the lawsuit itself is totally Enronesque. The funny thing, though, is that this time around it's not clear which actor is playing Enron.

Let's get this out of the way first: Yes, Enron still exists! But it's called Enron Creditors Recovery Corp., it has just 36 employees, and it exists for one reason: to pay creditors. To date, those creditors have gotten 36 cents on the dollar, double the original estimate, which Enron has paid by selling assets such as pipelines and power plants -- and extracting money from Wall Street banks that, like Citi, helped Enron fool the world.

The 'Mega Claims' suit

This campaign against Wall Street began in 2003, when Enron filed a suit that it aptly called Mega Claims against 11 banks, alleging that they helped manufacture its financial statements. Nine of the 11 settled, paying what Enron says is $1.7 billion in cash (some of this was payment for claims the banks took back) and giving up almost $1 billion more in claims. A small case remains against Deutsche Bank -- and a big one remains against Citi. "We believe the suit is without merit, and we intend to defend against it vigorously through the courts," says Citi.

The Mega Claims case is separate from the lawsuit by Enron's shareholders that Citi settled in 2005 for $2 billion to "put a difficult chapter in our history behind us," as then-CEO Chuck Prince put it. Oops. It appears that Citi may have settled the wrong case, because last spring an appeals court sidelined the shareholders' suit. It is currently awaiting a relevant Supreme Court decision.

But Enron itself has a shot against Citi, thanks partly to provisions in bankruptcy law. Mega Claims has its genesis in the 4,235 pages of analysis produced by the Enron bankruptcy examiner, who concluded that Citi helped Enron "produce materially misleading financial statements."

For instance, Citi, which averaged a stunning deal a month with Enron from 1997 through the company's bankruptcy, helped Enron improperly record more than $5 billion in cash flow from operations and understate its debt by billions. As a result, Enron alleges that Citi knew the company's real condition ("When Enron blows up ...").

Karma on Wall Street?

And so Enron argues that Citi should return what it says were $3 billion of payments from Enron to Citi in the years before Enron's bankruptcy. Enron also argues that Citi should have to fill the $18 billion gap between what other innocent creditors are being paid and what they are owed. (This number is obviously out of whack with what the other banks paid.)

The most Enronesque part of the lawsuit has to do with the billions that Citi lent Enron. In the late 1990s, Citi began to get nervous about its exposure to Enron. So Citi crafted some fiendish structures under which, in the event of an Enron bankruptcy, third-party investors -- who believed such a thing was highly unlikely -- would step into its shoes as Enron's creditors.

Not only did those investors end up with Enron's debt, but they wound up with Enron debt that may be worthless because of a concept known as "equitable subordination," under which a bankruptcy court can penalize a creditor's misconduct by making sure that the creditor is paid last.

It appears that Citi knew that was a possibility. A few days before Enron's bankruptcy, one Citi executive wrote, "Remember the risk is equitable subordination.... Think 'jammed to the bottom of the pile.'"

Today Enron argues that what it says are $5 billion of original Citigroup claims can indeed be jammed to the bottom of the pile. Citi says that because third parties now hold the claims, those claims have been cleansed of any bad acts that may have occurred. (Call it claims laundering.) But Citi still has to care, because it's also being sued by those third parties, who want to force Citi to pay if Enron doesn't.

This issue is at the cutting edge of bankruptcy law. Judge Arthur Gonzalez, who is overseeing Enron's bankruptcy, ruled that the claims should be subordinated. Citigroup and a current holder of a small claim appealed Gonzalez's decision to the district court, and in August, in a closely watched decision, Judge Shira Scheindlin ruled that claims were subject to different sorts of treatment based on how the holders acquired them. It's still unclear what her decision means for the bulk of the original Citi claims.

Of course, all this couldn't come at a worse time for Citi (Charts, Fortune 500). Maybe the real question is, Could there be such a thing as karma, even on Wall Street?

Gulf Currencies: Time to break free

unpegging from the dollar seems to be the flavour of the decade for monetary policy makers; after emerging economies its is time for the Gulf.

The Middle East's oil exporters should end their currencies' peg to the dollar.

IN THE past week Iran's president, Mahmoud Ahmadinejad, has damned it as a “worthless piece of paper” and China's premier, Wen Jiabao, has moaned that it is causing his country “big pressure”. The dollar's relentless decline—it hit a new low of $1.49 against the euro on November 21st—is prompting jibes from America's critics, jangling investors' nerves and giving policymakers headaches.

Nowhere are the dilemmas more acute than in the Gulf, where virtually all the oil-rich states peg their currencies to the greenback. The combination of soaring oil prices and the tumbling dollar is distorting their economies and fuelling inflation. When the Gulf states meet on December 3rd in Qatar, they should agree to loosen their ties to the dollar.

The argument for linking to the greenback was to provide an anchor for the region's economies, many of which are small, open and financially immature. In effect, the Gulf states import America's monetary policy. The trouble is that a fixed currency makes it hard for oil exporters to adjust to swings in the price of oil. And monetary policy in the world's largest oil-importer is not always right for those who sell the stuff.

Soaring oil prices have brought the Gulf Arabs huge riches. Their real exchange rates, as a result, ought to rise. The simplest way to do that is for the currency to strengthen, but the peg prevents nominal appreciation. Worse, the dollar itself has been falling. The result is rising domestic inflation. Some smaller Gulf economies now have inflation rates of around 10%.

What is to be done? The two most widely discussed options are to revalue or to shift to a currency basket (which Kuwait has already done). By repegging their currencies to the dollar at a higher rate, the Gulf states would alleviate some of today's inflationary pressure. But they would not address the underlying mismatch between any oil exporter and a dollar peg. Switching the peg to a basket of currencies that included, say, the euro and yen as well would give the Gulf states a bit more protection against oil-price swings, but it is hardly a perfect fit. Since most big currencies belong to oil importers, the Gulf States would still be linking their currencies to monetary conditions that may not suit them.

Eventually, the currency pegs should be abandoned. After all, developed economies that are big commodity exporters, such as Norway, allow their currencies to float. In recent years many emerging economies have shifted from exchange-rate pegs to a “managed float”. Instead of aiming for an exchange rate, their central banks have an inflation target. If the Gulf states move to a single currency, as they plan to in the next few years, that currency should surely float. But floating is not feasible in the short-term. These countries have no history of independent monetary policy and few institutions to conduct it.

Look beyond a basket

For the moment, the Gulf states are stuck with a currency peg. But they could do better than the dollar. One intriguing idea is to include the oil price as part of a basket that includes the leading currencies (see article). This would ensure their currencies absorbed some of the impact of oil-price swings.

A big uncertainty is what such a shift would mean for the dollar. In the short term, the effect on the Gulf states' appetite for greenbacks would not be dramatic, since the dollar would have a big weight in any basket. And there should not be a sudden sale of the oil exporters' dollar reserves. The worry is that the end of the Gulf states' dollar peg would send jittery investors into a panic. That risk is real. But with oil prices rising and the dollar falling, the dangers of inaction are greater. The Gulf states need to get rid of their dollar peg now.

Northeren Rock: Pulling the plug

The market has said what it thinks of Northern Rock. The British government should listen

Getty Images

EVERY banker knows John Paul Getty's dictum: “If you owe the bank $100 that's your problem. If you owe the bank $100m, that's the bank's problem.” What then of a bank that owes taxpayers some £24 billion ($49 billion), with another £18 billion or so of deposits underwritten by the public purse? Northern Rock, it seems, is everyone's problem.

The bank, once Britain's fastest-growing mortgage lender, is now a wreck. Having turned to the Bank of England for an emergency bail-out in August, it is unable to repay its loans unaided. Its debt to the central bank is growing. A mortgage book that was the envy of the industry looks less robust by the day. Its share price plummeted this week to less than £1, down from more than £12 at the beginning of the year.

The government finds itself in a deeply unenviable position. It is propping up Northern Rock's liabilities, yet the bank's assets belong to its shareholders. European rules prohibiting state aid to industries require ministers to cut the lifeline by March, or come up with a plausible reason not to. The Treasury is desperately casting around for buyers to take the bank and its problems off official hands, but none of the financial world's best and brightest is willing to assume full responsibility for it. All bidders so far have valued the bank well below even its current market capitalisation; all have asked for public-sector credit lines or loans.

There can be no good ending to this sorry saga, which had its origins in slack supervision, bad central-bank calls and a panic-stricken rescue that left offending bank bosses in charge for too long. But some outcomes are better than others.

Any solution must have two main goals in mind. The first is maintaining the stability of the financial system. For all that the first panic of the credit crunch seems past, there are too many uncertainties abroad to ride rough-shod over fairly fragile sentiment. The second is to get the taxpayer off the hook as fast and as thoroughly as possible. Depositors are protected by the guarantee the government has extended. It is hard not to feel sorry for the 145,000 retail investors who still hold Northern Rock stock; but they are entitled to no such guarantees and they must be aware that share prices go down as well as up.

There are three broad options confronting Alistair Darling, the chancellor of the exchequer, who will, in the end, decide Northern Rock's fate. The first is to sell the bank. The main bidders propose pumping more capital into Northern Rock, organising private lines of credit, repaying part of the government's loan quickly and keeping at least some jobs. Such a deal would annoy the bank's shareholders, who would be bought out for some variation of a pittance; but if Mr Darling could find a private-sector buyer with a firm promise to repay taxpayers quickly, it would be a tidy solution.

The problem is that no such private-sector buyer seems to exist; everybody relies on Mr Darling underwriting the deal for a considerable amount of time. Such a subsidised sale would give the bank's new owners most of the upside, should gains emerge, while leaving the taxpayer with most of the risk, if losses ensued instead. This asymmetry is more than galling: it might well create a perverse incentive for the bank's new owners to gamble even more recklessly than its old ones. And other banks would rightly complain of unfair competition.

A second option is to force the bank into bankruptcy. This too holds few attractions. Deposits would most likely be frozen for weeks or even months. News of savers struggling to get their money back could spark runs on other banks. In the resulting firesale, Northern Rock's assets would probably fetch less than they are worth. And administration would trigger the winding-up of Granite, a vehicle that holds half the bank's mortgages as collateral against bonds issued. If it is liquidated, its cash would be used to pay those bondholders first. Some £7 billion in extra assets that it holds could be tied up for years.

Take it over

This newspaper has, to put it mildly, never been a fan of nationalisation. But with Northern Rock this increasingly looks like the least bad option from a taxpayer's point of view (unless a credible buyer appears). And, in any case, the damage is half-done: in effect the state already owns a chunk of it.

Were the government a distressed-debt hedge fund, it would be trying to assume control, squeeze out existing shareholders and get back the money it is owed. State control, with a view not to running the bank (a terrifying thought) but to running it down, would allow value to be extracted for taxpayers through the orderly sale of assets. Bankers could take some comfort from the government's ability to pace disposals according to the mood of the markets. And nationalisation would let the state retain any future gains by going slowly—or even entering into a private-sector partnership—in the somewhat unlikely event that credit markets, house prices and Northern Rock's reputation recovered soon.

To be sure, nationalisation would be messy. Shareholders might well sue. The lesson from other crises (France, Mexico, Sweden, Japan and so on) is that emergency state ownership should be brief and at arm's length; Mr Darling might meddle, keeping unprofitable parts of the business open to safeguard jobs in the relatively poor (and Labour-voting) north-east. Nevertheless, nationalisation looks the best choice of a bad lot, for it aligns risks and rewards most closely and keeps control in the hands of those who have most invested. But there should be no illusions that it is anything but a mercy killing.

America's vulnerable economy

Recession in America looks increasingly likely. Can booming emerging markets save the world economy?

IN 1929, days after the stockmarket crash, the Harvard Economic Society reassured its subscribers: “A severe depression is outside the range of probability”. In a survey in March 2001, 95% of American economists said there would not be a recession, even though one had already started. Today, most economists do not forecast a recession in America, but the profession's pitiful forecasting record offers little comfort. Our latest assessment (see article) suggests that the United States may well be heading for recession.

Granted, GDP grew by a robust 3.9%, at an annual rate, in the third quarter. Granted also, revisions may well push this figure up. But that was the past. More timely signs suggest that the economy could stall in this quarter. By early next year, output and jobs could be shrinking. The main cause is the imploding housing market. Experts said that house prices could never fall nationwide. But fall they have, by 5% in the past 12 months. Residential investment has collapsed, but a glut of unsold homes means that prices have much further to drop. Americans' spending is likely to be dented much more by a fall in house prices than it was in 2001 by the stockmarket's collapse. With house prices lower and credit conditions tighter as a result of the subprime crisis, households can no longer borrow against capital gains to support their spending.

Dearer oil is set to squeeze households further (this week's drop in crude prices notwithstanding). Consumer confidence has already fallen sharply. It cannot be long before consumer spending stumbles, which in turn would hurt companies' profits and investment. The weak dollar will boost exports, but at only 12% of GDP, exports are too small to make up for a weakening of consumer spending, which accounts for 70%.

I want to break free

Will an American recession drag the rest of the world down with it? The economies of Europe and Japan rebounded strongly in the third quarter, but look likely to slow down. Although both should be able to keep chugging along, neither is likely to set any great pace. Strengthening currencies will hurt exporters in both places. Europe's own housing hotspots are cooling, and some of its banks have been sideswiped by America's subprime ills.

The best hope that global growth can stay strong lies instead with emerging economies. A decade ago, the thought that so much depended on these crisis-prone places would have been terrifying. Yet thanks largely to economic reforms, their annual growth rate has surged to around 7%. This year they will contribute half of the globe's GDP growth, measured at market exchange rates, over three times as much as America. In the past, emerging economies have often needed bailing out by the rich world. This time they could be the rescuers.

Of course, a recession in America would reduce emerging economies' exports, but they are less vulnerable than they used to be. America's importance as an engine of global growth has been exaggerated. Since 2000 its share of world imports has dropped from 19% to 14%. Its vast current-account deficit has started to shrink, meaning that America is no longer pulling along the rest of the world. Yet growth in emerging economies has quickened, partly thanks to demand at home. In the first half of this year the increase in consumer spending (in actual dollar terms) in China and India added more to global GDP growth than that in America.

Most emerging economies are in healthier shape than ever (see article). They are no longer financially dependent on the rest of the world, but have large foreign-exchange reserves—no less than three-quarters of the global total. Though there are some notable exceptions, most of them have small budget deficits (another change from the past), so they can boost spending to offset weaker exports if need be.

This does not mean emerging economies will grow fast enough to make up for the whole of a fall in America's output. Most of them will slow a bit next year: for instance, China's growth rate may dip to “only” 10%. So global growth will ease—which, after five years at an average of almost 5%, close to its fastest pace ever, it needs to do. But thanks to the vigour of the new titans, it will stay above its 30-year average of 3.5%.

A tale of two prices

The rising importance of the world's new giants will not only boost growth. It will also shift relative prices, notably those of oil and the dollar. And the consequences of this will be less comfortable for developed countries, especially America.

The oil price has risen mainly because of strong demand in emerging economies, which have accounted for as much as four-fifths of the total increase in oil consumption in the past five years. In past American recessions the oil price usually fell. This time it is likely to hold up. That will not only hurt the finances of Western consumers, but may also make the jobs of their central bankers harder, by combining inflationary pressure with economic slowdown.

The enfeebled dollar—lately in sight of $1.50 to the euro—would be weaker still without enormous purchases by central banks in emerging economies. This support is now waning. China and others are putting a smaller share of increases in reserves into the American currency. And Asian and Middle Eastern countries with currencies linked to the dollar are facing rising inflation, but falling American interest rates make it harder to tighten their own monetary policy. They may have to let their currencies rise against the sickly greenback, meaning they will need to buy fewer dollars. More important, as international investors wake up to the relative weakening of America's economic power, they will surely question why they hold the bulk of their wealth in dollars. The dollar's decline already amounts to the biggest default in history, having wiped far more off the value of foreigners' assets than any emerging market has ever done.

The vigour of emerging economies is good news for the world economy: for its growth, it has much less need of a strong America. The bad news for America is that this, in turn, may mean that the world also has less need of the dollar.

Fannie Mae's fuzzy math

somebody's cooking again!

The mortgage lender has quietly changed the way it calculates its bad loans -- and it could be camouflaging steep credit losses, writes Fortune's Peter Eavis.

By Peter Eavis, Fortune senior writer

November 14 2007: 1:03 PM EST

(Fortune) -- Investors might want to take a closer look at Fannie Mae's latest earnings report. Lost in the unsurprising news of the mortgage lender's heavy losses was a critical change in the way the company discloses its bad loans -- a move that could mask that credit losses that are rising above levels that the company predicted just three months ago.

Without the change in disclosure, an important yardstick for credit losses that Fannie Mae (Charts) provides to investors would have looked much worse than it did in financials filed last week.

Fannie Mae's potentially misleading disclosure comes at a crucial time for the company. Fannie Mae was severely penalized last year for overstating earnings and for a lack of oversight. As part of its punishment, the amount of home loans that Fannie Mae can make was limited.

But now influential members of Congress, including Senator Charles Schumer, want Fannie Mae's watchdog, the Office of Federal Housing Enterprise Oversight (OFHEO), to temporarily lift the portfolio limits on the company and its rival Freddie Mac. Legislators want both lenders to buy more subprime mortgages to help stave off foreclosures.

Fannie Mae already holds a substantial amount of risky mortgages in its $2.4 trillion mortgage book -- and the recent shift in how it discloses a much-watched credit yardstick disguises just how quickly bad loans may be rising.

If that's the case, Fannie Mae will face a new barrage of questions about its bookkeeping.

Fannie Mae controller David Hisey responds that the change in how its loss numbers were presented makes them "more transparent, not misleading."

How the Wall Street money machine broke down

But Fannie Mae's numbers effectively make its credit look better than it is.

It all comes down to what's known as the credit loss ratio -- a measure that Fannie Mae has consistently provided to investors to help them assess the credit quality of its mortgages. The credit loss ratio expresses bad loan losses as a percentage of Fannie Mae's loans.

In August, Fannie Mae predicted its credit loss ratio would be 0.04-0.06 of a percentage point for all of 2007. (Wall Street generally refers to percentages in basis points, which each equal one hundredth of a percentage point. In Fannie Mae's terminology, then, its 2007 loss ratio estimate is four to six basis points.)

A range of four to six basis points may not sound like a big deal for an institution involved in mortgages, but for Fannie Mae it is the norm.

What matters is if Fannie Mae goes above that range. And Fannie Mae appears to have already done that this year. But its disclosure change makes that worrying development very hard to see.

Here's why: Last week, as part of its earnings report, Fannie Mae revealed that the company had changed the way it calculates the credit loss ratio. Under the new method, Fannie Mae's annualized credit loss ratio was just 4 basis points in the first nine months of the year.

At first glance, four basis points looks to be at the low-end of Fannie Mae's full-year forecast. Problem is, because the company is using a new methodology, the previous estimate no longer makes sense to use.

So what would have happened if the company had compared apples to apples -- and stuck with the old method of calculating its loss ratio?

Under the previous method, Fannie Mae would have been well outside of its range. The company would have reported an annualized loss ratio of 7.5 basis points in the first nine months of this year.

Uh-oh. It's Enron all over again

What exactly caused the change -- and how did it lead to a reduction in the credit loss ratio?

In its third quarter financial statements, Fannie Mae started to break out credit losses taken to fulfill an accounting treatment called SOP 03-3, which the company said it adopted at the start of 2005.

These SOP 03-3 losses were previously included in its credit loss ratio calculation, but Fannie Mae last week removed them from that calculation, causing its loss ratio to look much lower.

The company said it made the change to add transparency to its loss numbers and to show a more cash-based reflection of credit losses.

In a statement, Fannie Mae spokesman Brian Faith said that the forecast of four to six basis points was "predicated on our estimation of what our realized losses would be for the year."

What does realized losses mean? When asked that, Faith referred to Fannie Mae's most recent quarterly filing. There, realized losses appear to be defined as losses calculated under the new method. In other words, Faith appears to be suggesting that the 2007 forecast was always based on the new method of calculation.

Why is that hard to believe? When the company issued that range in August, it expressed all its published credit loss ratios under the old method. And on an August conference call, when discussing the full-year range of four to six basis points, Fannie Mae executives did not mention any change in calculation of the ratio.

Management acknowledges that credit losses are mounting. During an analyst call last week, Fannie Mae CEO Daniel Mudd warned that the company's loss ratio could rise to eight to 10 basis points in 2008, due to a worsening housing market. It's not clear whether that forecast is based on the old or new methodology.

The company may already be exceeding that 2008 guidance. Based on the old methodology for calculating the loss ratio for the third-quarter alone, the company's annualized loss ratio is already at 14 basis points.

If so, Fannie Mae's mounting losses are disturbing.

So what could a soaring loss ratio mean for Fannie Mae? Consider these numbers: At Sept. 30, Fannie Mae had exposure to $74 billion of loans with a FICO credit score below 620. Loans scored below 620 are generally classified as subprime. In addition, Fannie Mae has exposure to $196 billion of Alt-A mortgages, home loans for which the borrower doesn't have to submit complete documentation for basic criteria like income.

At the same time, Fannie Mae has only $40 billion of capital.

Worst-case, credit losses from high-risk loans like subprime and Alt-A could eat away at that capital and leave the mortgage giant on an extremely weak financial footing.

RUNNING FAST: Technology in India and China

India's billion-strong population cuts both ways. Whenever an Indian demographic appears as a numerator, the resulting number looks big. But whenever its population is in the denominator, the number looks small. It is like looking at the same phenomenon from opposite ends of a telescope. As of now, India matters more to technology than technology does to India.

TOWARDS the end of the 11th century, while tardy Europeans kept time with sundials, Su Sung of China completed his masterpiece: a water clock of great intricacy and accuracy. Standing almost 12 metres (40 feet) tall, Su's “Cosmic Engine” wavered, it is said, by only a few minutes in every 24 hours. From twin tanks filled by servants, a steady flow of water was cupped and spilled by a series of buckets mounted on a wheel. The rotation of the wheel turned the clock, as well as an astronomical sphere and globe that charted the movement of the sun, moon and planets. Drums beat 100 times a day; bells chimed every two hours. A replica, painstakingly built with contemporary methods, now turns in Taiwan's National Museum of Natural Science.

Clockmaking was only one scientific endeavour in which China and India comfortably led the world before the 15th century. China outstripped Europe in its understanding of hydraulics, ironsmelting and shipbuilding. Its machines for ginning cotton, spinning ramie and throwing silk seemed to lack only a flying shuttle and a drawbar to match the 18th-century contraptions that launched Britain's Industrial Revolution. Clean your teeth with a toothbrush, rebuff the rain with a collapsible umbrella, turn a playing card, light a match, write, pay—or even wipe your behind—with paper, and you register a debt to China's powers of invention.

India's genius, then as now, was in software not hardware. Its ancient civilisations ushered in a “mathematical revolution” from the fifth century, when Aryabhata devised something like the decimal system. In the seventh century Brahmagupta explained that a number multiplied by zero was zero. By the 15th century, Madhava had calculated pi to more than ten decimal places.

After the 15th century, however, the technological clock stopped in both countries, even as it accelerated in Europe. This peculiar loss of momentum, noted Joseph Needham, a great historian of Chinese science, takes some explaining. Why, he asked, did the science of Galileo emerge “in Pisa but not in Patna or Peking”?

In his book “The Lever of Riches”, Joel Mokyr settles on a simple explanation for China's technological stagnation: the country's imperial state lost interest. Its purposes were better served by continuity than by progress, and there was no rival source of power and patronage to pick up the threads it dropped. Roddam Narasimha of India's National Institute of Advanced Studies reaches a similar conclusion for India. “Up to the 18th century, the East in general was strong and prosperous, the status quo was comfortable, and there was no great internal pressure to change the global order,” he writes.

That diffidence no longer hampers either state. Both China and India are now restless with technological ambition. China's government does not have the luxury of choosing between progress and stability; it cannot enjoy social peace without economic advance. For the past 30 years it has tried to turn the clock forward. By 2015 its research scientists and engineers may outnumber those of any other country. By 2020 it aims to spend a bigger share of its GDP on research and development (R&D) than the European Union.

India, for its part, surveys the future with uncharacteristic optimism. Its technological confidence has grown immeasurably thanks to the success of its software and IT firms. The heirs to Aryabhata and Brahmagupta, India's digital ambassadors have won acclaim for their mastery of ones as well as zeros.

But even as India's technological powers make a splash in the world, they stir only the surface of its own vast society. India produces more engineering graduates than America. But it has only 24 personal computers for every 1,000 people, and fewer than three broadband connections. India's billion-strong population cuts both ways. Whenever an Indian demographic appears as a numerator, the resulting number looks big. But whenever its population is in the denominator, the number looks small. It is like looking at the same phenomenon from opposite ends of a telescope. As of now, India matters more to technology than technology does to India.

This is a pity. India and China still have more to gain from the adoption and assimilation of technology than from invention per se. Some of their best minds are adding generously to the world's stock of knowledge, but the more urgent task for the countries themselves is to make wider use of know-how that already exists. Indeed, the World Bank has calculated that India could quintuple the size of its economy if it only caught up with itself—that is, if the mediocre firms in its industries closed the gap with the best. Both countries miss out when policies to promote invention, such as China's push for “indigenous” innovation or India's recent patent laws, serve to stymie diffusion.

A year in China, foreign residents say, is like ten years outside. Its clock is already turning rapidly. But the cogs and levers that drive technological progress are as intricate and delicate as Su Sung's mechanism. China's government is in danger of trying to do too much. Its monumental efforts to educate and train have filled the tanks of its innovation engine. Now it is time for it just to let the water flow.

Google Inc: Letter from the Founders

Every year the annual report of Google carries a letter from its founders charting out the Google vision. A good source of data for conspiracy theorists, it makes a good reading on where the information powerhouse is headed (it has moved beyond being just a search giant). Are the founders attempting something like the Buffet Annual letters? Not there yet.



Introduction

There are few things as powerful as human passion. On the Internet, we see it in blogs, videos, and social networks, through many voices with a story to tell, eager to be heard. Over the past year, there have been many developments at Google I would like to share with you – products, partnerships, and milestones. There are many feature lists, statistics, and technical accomplishments behind them. However, what really inspires me are the words of the people whose lives we touch. While in the past Larry and I have taken turns writing this letter, this year I would like to give a voice to these people so you can hear just as I do how Google affects their lives.

Search

Search remains the heart of Google. Every day, millions of people search on Google for information either for themselves or someone close to them - information that can help their careers, their education, or their health. Sometimes it is just a casual curiosity that sends them searching, but at other times, their need for information can be critical – and what they find can even save a life. That is why we work so hard to provide the best possible information for every query, on any topic, in any language, in any country.

I found some minor swelling after feeling minor pain over a couple of days. A Google search brought up several pages with links to articles, all pointing to the same type of cancer… Without Google I would have ignored and possibly forgotten about the incident until it would have been too late. Google also helped me find the doctor who checked me out the very next day, and who organized surgery for the very same day he identified the cancer. It took me a long time to write and express my thanks to all of you who are working there. You are life savers!
- PETER MACKENZIE

Our search must also work well for different levels of expertise. Sometimes it is patients who seek medical information on Google, but other times it is doctors themselves. To go more deeply into technical fields, we have developed Google Scholar™, the most comprehensive search for scholarly work. And we also launched Google Patent Search as well as News archive search, which adds nearly 200 years of newspaper archives to Google News™. In addition, information providers and individuals can now help us improve search within their fields of expertise by creating Custom Search Engines on their own sites that provide more specific search results related to their interests.

Like many people on the Internet, I use Google so many times daily that I hardly remember a time without it… Recently, I had a similar realization while using Google Scholar to search the medical literature. Potentially, Google Scholar can instantly direct you to the most important papers in any field anywhere you can access the Internet, and many of these papers are now available online. I use it at least several times weekly and sometimes daily… A seventy year old woman with neurofibromatosis came to me with severe hypertension. I was initially concerned that she had a pheochromocytoma, which is associated with neurofibromatosis. To look for other associations, I searched [“hypertension and neurofibromatosis”] in Google Scholar, which revealed that renal artery stenosis from vascular neurofibromas was also possible. We looked, and that’s what she had… A second patient was referred to me complaining that he had stopped sweating three months ago. I’d never seen anything like this before. So I searched Google Scholar, which quickly directed me to the literature on acquired idiopathic generalized anhydrosis, a rare neurologic disorder. I sent him to a neurologist for a skin biopsy, and this confirmed the diagnosis.
- JOSHUA SCHWIMMER, MD

“Aren’t ‘X’ billion pages enough? Who needs more search results?” I hear questions like this often. The answer is, “We all do.” When you are looking for something specific, like a particular person or place, comprehensiveness is the difference between finding a long-lost relative or love, and not.

The first time I used Google… I put in my name to see what would come up on me. Imagine my surprise when I found another 3 women who shared my name… one of the other Una McGurks I found on Google is a survivor of the 1998 Omagh bombing, which was just miles from the farm where my father was born and raised on in Tyrone, Northern Ireland. I ended up planning a trip back to Ireland to find the other women with my name… So, I have Google and global awareness to thank for tracking down 3 long lost relatives who share my unusual name.
- UNA MCGURK


I looked up my first love, whom I had not seen nor spoken to in 22 years, via Google. Long story short - we’re getting married… Thanks Google!
- JOSHUA BYRON

Stories like these help us understand just how important it can be for people to have comprehensive search results. In the past year, we have increased our search index size by billions of documents, leveraging continued infrastructure improvements to our indexing system. This has increased capacity and improved refresh time. We also launched Webmaster Central as the place for webmasters to get information about how Google crawls and indexes websites, and to find tools such as Google Sitemaps™ to direct our crawler more efficiently.

Books

A comprehensive search engine is not restricted to the Internet. Much of the highest quality information in the world may be found in tens of millions of books tucked away in libraries and on publishers’ shelves. These books can be tremendous assets - but only if people know that they exist. Google has embarked on a mission to digitize the world’s books and make them discoverable, simply by searching online.

Book publishers benefit from wider distribution of their books. In 2006, we continued to add to our growing book index. We introduced four new partners to the Library Project, including the University of California, considered the largest research and academic library in the world; University Complutense of Madrid; University of Wisconsin-Madison; and the University of Virginia. Our Partner Program grew with new relationships and expanded agreements and now includes more than 10,000 publishers. Book Search is now available in 9 languages, and next year, there will be more.

Today users can search through millions of books to find popular, obscure, and beloved titles on every topic imaginable. Of course, Google Book Search is not just good for readers. Publishers benefit from increased exposure for their books.

At first, we didn’t understand why all of a sudden we were getting a request for this older title. But when we looked at the reports from Google, we saw that it was one of the most-viewed titles over the past 15 days. Best of all, this book is not an exception. Our e-commerce sales have increased 60% across the board.
- GRACE GUINAND, INTER-AMERICAN DEVELOPMENT BANK

This year we also developed a new look and browsing interface for Google Book Search™ that makes it even easier to use. We’re hearing from readers, researchers, and book lovers around the world that they are locating books more quickly and easily than before.

I was idly trying a search on “roads” to see what sort of a literature would turn up for the period of my dissertation research, 1740-1850. I didn’t expect much. I’ve spent the last two years wandering through the Yale, Harvard, and California libraries, the British Library, Britain’s National Archives, and the immense reserves of North American Inter Library Loan reading every book on London, pavement, or travel I could get my hands on. Surprise. In a single idle search I just added twenty extra full-text books to my list…Hallelujah, Google Books.
- JO GULDI, UC BERKELEY

Video

Sometimes text isn’t the best way to communicate or understand an idea. If you are learning about a sport, an art performance, or a mechanical invention, video can be a far more compelling medium. This is one reason 2006 saw such a dramatic growth in the viewing and sharing of online videos. To this end, we have developed Google Video™ to search video, and this year we acquired YouTube™ – an incredibly dynamic and compelling way for people around the world to share their lives and express themselves.

YouTube has the largest online video audience and offers the most entertaining, original content on the Internet – with a community that continues to grow exponentially month after month. YouTube has struck more than 1,000 partnership deals with content providers looking to participate in this growing creative community – including Universal Music Group, CBS, BBC, Sony Music Group, Warner Music Group, the NBA, and The Sundance Channel.

YouTube users are clearly being entertained by the CBS programming they’re watching as evidenced by the sheer number of video views. Professional content seeds YouTube and allows an open dialogue between established media players and a new set of viewers.
- QUINCY SMITH, PRESIDENT, CBS INTERACTIVE

In addition to professional content, user-generated content is central to the YouTube community experience. As more people capture special moments on video, YouTube empowers them to become the broadcasters of tomorrow. YouTube is a cultural phenomenon, winning the hearts and minds of an increasingly broad demographic. It has democratized the entertainment experience and created a new way for people to communicate across the globe. For example, when Leigh Buckley, a wife and mother from New Hampshire, was diagnosed with leukemia, she and her husband Andrew began chronicling her experience and posting the videos to YouTube. They have received an overwhelming response from people not only wishing her well but also organizing bone marrow drives.

Google is about connecting people with information. Online video is a new genre for connection that engages a new generation.

Local

People use Google products to learn not just about the farthest reaches of the universe but about places closer to home. Google Maps™ has become the #1 mapping site across Europe and #2 in the U.S., and now offers detailed street maps in more than 50 countries. We are pleased that so many developers have used our mapping technology as a platform for further innovation, and proud that more than 30,000 websites use our maps API. Local authorities in London now use the Google Maps API to let residents report problems such as road defects and trash on the streets. Google Maps is also available now on mobile devices and plays an integral role in our partnerships with mobile providers. We expect more and better local products to result from our work in the mobile space.

With more than 200 million unique downloads, Google Earth™ users worldwide are venturing out to explore, understand, and share our planet. Google Earth now covers more than half of the world’s population and a third of the land surface in high resolution. We’ve found that one of the first things users do after launching Google Earth is look at their own home from space. Then they quickly discover that Google Earth lets them search and browse a growing web of geospatial content from community storytelling, 3D buildings, location referenced photos and historic maps to Wikipedia articles, United Nations and European Space Agency content, and even photos and stories from National Geographic and videos from Discovery Networks. Furthermore, Google Earth also enables people with limited resources to better understand the world around them.

We used Google technology to prove to the authorities that the land is fertile [so that the Indian government would compensate us at a higher rate in developing an SEZ (Special Economic Zone)].
- ARUN SHIVKAR

Mobile

We were shaken and quite upset [at learning that one of our newborn twins might require a blood transfusion, which is risky for small babies]. Armed with only a cell phone - and a very low battery - I was able to Google [hemoglobin ‘premature infant’] and found a medical journal article claiming that it’s perfectly normal for preemies to have their hemoglobin levels drop to 7 between the first and third months of life, and apparently this is especially true with twins. [I showed the Google results to the doctors, who eventually concurred that the risky transfusion was not, in fact, necessary.]
- HOWARD, GOOGLE MOBILE USER

In many regions, mobile is often a “first screen” device – the primary way users access information.

Here’s a story that illustrates this global reality:

A Googler was vacationing in Africa recently and happened to be wearing a Google T-shirt. A local approached him, clearly very excited about Google News. Naturally, the Googler asked, “Do you know you can get Google News on your mobile now too?” To which the man replied, “How else would I get it?” Indeed.

We’ve made great strides toward universal accessibility, in no small part because we have forged relationships with some of the most prominent carriers and equipment manufacturers in the world. Motorola, Sony Ericsson, Vodafone, Nokia, Beeline, KDDI, NTT DoCoMo, Bharti Airtel, China Mobile, and Samsung are our partners, and we look forward to growing these relationships.

Our efforts in mobile are helping to drive adoption of the mobile web and create interesting revenue opportunities for our partners, such as the mobile ad pilots that we launched in more than a dozen markets in 2006.

The partnership with Google is making a substantial contribution to the very rapid increase in our customers’ uptake of mobile search. Even more so, the performance of Google’s Mobile Search Ads is greatly exceeding our expectations. We are strongly dedicated to keep developing our world of mobile Internet services through our continuing partnership with Google.
- TADASHI ONODERA, CEO, KDDI

Content, Collaboration, Community

We have worked to expand our offerings that enable users to manage their information – to create content, collaborate on it as a group, and then share it with the world.

Perhaps the most important online collaborative tool is email. Gmail’s introduction in 2004 contributed to a new focus on webmail generally, including a shift from offering storage space in megabytes to gigabytes. Gmail™ has developed substantially, with the introduction of features like Gmail Chat, which brings together email and instant messaging.

I depend on my gmail and gtalk big-time! today, i got a notification that (yipee!) i had new gmail. anyway - it was email promoting a pre-sale for tickets to a huge concert…within seconds, i had checked my gmail, hopped on the ticket buying website, and am now sitting pretty with tickets secured, while the rest of the non-google-users are waiting in a buyers-queue/waiting-room server waiting to purchase… now i have tickets to the hottest show in town for an amazing price, as well as my sister’s birthday present. you’re the BEST!
- EMILY BOUCHARD

For better time management, we offer Google Calendar™ a free online service that we launched this year that makes it easy to keep track of your schedule and share it with friends. Google Calendar fits perfectly with our other online collaboration applications like Gmail and Google Docs & Spreadsheets™ designed for managing and sharing documents. This product combines both ease of use (nothing to install, just use your browser) along with powerful Internet capabilities like collaborative editing, access controls, and content available anywhere you can get to the web.

As I write this right now, other Google employees are editing this document (and making it “flow” - I confess I am difficult to edit).

Products that enable the discovery and sharing of content have become a dynamic force on the Internet. We want to support these activities for all types of information, including photos, documents, and blog content. For example, today we offer Picasa™ photo-organizing software and more recently launched Picasa Web Albums for online photo sharing.

My mother is happy about the ease of using Picasa and finds it a joy working with this service. [She] is not a computer guru, but has learned many ways that Picasa makes photo albums more fun than ever. Color pictures as far back as 1943 are an online testament to how Picasa has now become our family treasure and is bringing our family together. My mother hopes that the whole family will build upon her work and add to a priceless family treasure Picasa has given all of us.
- JAMES HERNANDEZ

Another focus is products that enable users to discover new people and learn more about each other. Orkut™ our experiment with social networking, is now part of the social fabric for the majority of online users in such countries as Brazil and more recently, India.

Finally, in the area of personal publishing for large audiences, we unveiled major updates to Blogger™ and Google Groups™ and introduced Google Page Creator™, which people can use to easily and quickly create professional-looking web pages. Our acquisition of JotSpot, collaborative wiki technology, is another demonstration of our commitment to this space.

Organizations are increasingly sharing these services with all of their users. In 2006, we developed Google Apps for your domain, which includes Gmail, Google Talk™, Google Calendar, Google Docs & Spreadsheets, Page Creator, and the Start Page. Arizona State University (ASU), with 65,000 students, has already implemented Google Apps across the university.

On the day of the announcement [that ASU was adopting Google Apps], students were converting to Gmail for ASU at the rate of 300 an hour… In addition to providing an exciting new service for students… the feat that Google and ASU achieved in the past fortnight displayed a nimbleness that rivals the best of what Silicon Valley can do… The range of technology solutions that Google is putting forward, at the speed and scale that they have proven they can deliver them, is sparking nothing short of a revolution in the IT business…
- ADRIAN SANNIER, CTO, ASU


Advertising

Our goal is to create a single and complete advertising system. Diversity in our advertising and publisher base continues to be central to our business and is important to our long-term success. Advertisers large and small use Google to reach their target audiences easily and get measurable ROI.

Last year we launched the AdWords™ Starter Edition, a simplified version of AdWords that lets users create an account quickly using a one-page sign-up form.

I was up and running in 15 minutes. For somebody like me who isn’t comfortable with the PC, it was quite a revelation.
- COSMO BUONO, BBPIANO.COM

As more and more users look for local information online, we must continue to improve our ability to attract local advertisers. We have launched local business ads, local coupons, and refined local targeting so businesses can target customers right in their neighborhood. This year we partnered with companies like Intuit, Verizon, and AT&T to help us bring more business information online and convert more small businesses into happy Google customers. Small business is big business.

We have also gone beyond text for brand advertisers. Traditionally, video and other rich formats have been used exclusively by large advertisers because of their higher production costs and higher minimum spending requirements. However, our new clickto-play video ad format can serve ads to both large and small advertisers. In fact, video can be the best way for a small business to communicate its offerings in a genuine and personal way.

Since we started advertising our robotic guitar tuner with Google Click-to-Play Video Ads, not only have we seen a dramatic increase in sales, both in the USA and internationally, we’ve also had lots of inquiries from distributors all over the world who want to carry our product. I don’t know of any other advertising that could have had this kind of impact… Now when people bring us exciting products to market, we know that Google’s video ads can be our strongest new tool to help demonstrate and promote those products nationally or even internationally at a very reasonable cost.
- EVAN SHOFRON, ACTION MARKETING

And we’re helping advertisers of all sizes buy and place offline ads more effectively. In January, we acquired dMarc™ Broadcasting to help develop a radio advertising product and now have more than 900 stations in more than 200 metro markets. In addition, more than 100 advertisers and 70 newspapers have participated in significant tests for print advertising. We believe these offline efforts are key to creating a complete ad system. We continue to roll out new pricing and account tools to help online advertisers better manage their campaigns. Last year the ads team launched Position Preference, which allows advertisers to set controls to have bids automatically adjusted to maintain a desired ad-position range. We also released Preferred CPC in beta, which enables advertisers to bid to an average CPC. To help improve conversions, there is now Web Optimizer for doing multivariate testing on landing pages. And for easier, more robust account management, there is AdWords Editor, a client-based application for making offline changes to AdWords accounts and uploading them later.

Effective advertising is just one component of ROI. Once a customer is on an advertiser’s website, it’s important that they find what they are looking for and complete a transaction. Google Analytics™ allows webmasters to easily monitor and optimize the design of their sites to make them as frictionless for customers as possible.

Every new piece of information we get from Google Analytics gives us 10 new ideas that can help our customers find what they need online. Google Analytics helps us prioritize what to try first, and then track success metrics around each change to make sure our assumptions are correct. Google Analytics is key to continuously improving our site and our customer experience.
- MIKE BOLLAND, DISCOUNT TIRE

Once a customer has decided to make a purchase, completing the purchase swiftly and easily is paramount. Google Checkout™ tremendously simplifies the buying process by enabling you to shop across the web with just your Google login. Checkout has done a great job of increasing conversion and driving leads. Initially launched last summer with just a few stores, it has now reached millions of registered users and signed thousands of merchants, including more than 100 of the top 500 online stores.

We always want to give our customers more choice and more convenience when they shop with us, and Google Checkout gives them both. In addition to the positive customer experience Google Checkout offers, we’ve also been very pleased with the benefits for our business. We’re seeing great results as Checkout helps us acquire new customers every day. We’ve appreciated the increased sales as well as the ability to process transactions for free…
- TIM MCCUE, JOCKEY.COM

Early in Google’s development we realized that great search depended on great content. To that end we created Google AdSense™ for content, which now enables thousands publishers to spend their time developing great material instead of having to sell ads themselves.

We’d tried all sorts of affiliate programs and they amounted to nothing… Without the AdSense program, [our] free service would never have been possible.
- ADSENSE PUBLISHER

Global

I’ve mentioned some of our global efforts earlier, but it’s so important to us that I want to call out a few more facts here. Last year we added 44 domains so that Google is now available in 158 domains and more than 100 languages. Google News is now up to 39 editions, with launches in Hebrew, Arabic, and Russian. Gmail added Hebrew and Arabic to reach 40 total languages.

Google Toolbar™ is now available in 42 languages for Internet Explorer (26 for Firefox) and Desktop™ 4 is in 28 languages. And Google Groups 2 came out of beta and is available in over 40 languages. With international sources comprising 43% of Google’s revenue in 2006, we continue to grow our global monetization efforts. AdWords added several additional language/country interfaces, and now supports more than 40 languages. AdSense for search and AdSense for content both added four new languages bringing their totals to 27 and 23 respectively. We also launched electronic fund transfer payments in 9 more countries and piloted a Western Union payment method in China and Malaysia to further extend payments in local currencies.

Our mobile initiatives, critical to worldwide access, also include these firsts: we integrated mobile search and our first syndicated mobile sponsored links with KDDI, Japan’s second-largest mobile carrier; and we partnered with major mobile carriers and global handset manufacturers such as Vodafone and Telefonica.

We’re also making great strides with our awardwinning machine translation system. We want it to vastly improve the web experience for users everywhere. We improved or added several new language pairs, including English to/from Chinese, Arabic, and Russian; we now have over 20 language pairs.

Google is committed to its investment in markets across the globe, and the advances mentioned above bring us closer to our goal of making Google accessible to people in more languages and in more countries – a goal we will continue to pursue in 2007.

Culture

We have worked hard to create and maintain a compelling environment for Googlers. We’re building a culture rooted in transparency, innovation, and scale. Because we aspire to innovate as much on the people side as we do on the product side, we were honored to top FORTUNE’s “100 Best Companies to Work For” list in our first year of eligibility.

None of what we do would happen without a global employee base. In 2006, we hired 4,994 full-time employees, and for the first time, half of our software engineering hires were outside our Mountain View headquarters, including significant increases in China, Russia, India, Brazil, and Europe. Employees outside the U.S. now make up nearly a third of the company, and many of them moved into new offices this year including Beijing, Trondheim, Istanbul, Tel Aviv, Copenhagen, Vienna, Taipei, Warsaw, Haifa, Moscow, St Petersburg, Sydney, Mumbai, Cairo, and Delhi. Having a presence in all these locations attracts Googlers who want to work where they already live, and contributes to local economies.

We have improved our benefits programs to include such things as more doctors on staff and many new cafes in different locations. We expanded our equity refresh program and introduced our Transferable Stock Options program. We launched a range of development programs including EDGE, which helps grow our engineers into better leaders. And we work hard to infuse Google’s culture and principles into every office around the world, empowering employees to make contributions that help drive Google’s overall success.

Working at Google Kirkland is a fantastic opportunity to get a team together and launch great things. We’ve got the advantages of a small environment that makes it easy to know everyone, coupled with Google culture that keeps us connected with Mountain View so we can work with teams there, rather than as an isolated island. This helps us develop search products like Google Webmaster Central, which is improving search quality and making a big impact for all of Google, not just our office.
- VANESSA FOX, GOOGLE KIRKLAND

These initiatives help us scale by attracting amazingly talented people, and then nurturing them as we preserve what’s special about our culture. Whenever we open new offices, we strive to keep things “Googley.”

The office culture is still relatively intimate, even though we’ve grown 200% since the office opened in September(!). The atmosphere is fun and engaging, and my coworkers are smart, funny and overall great people to be around all day. Even though we’re a much smaller office than our Mountain View counterpart, we continue to have that Googley, welcoming feel.
- STEPHANIE DUCHAINE, GOOGLE ANN ARBOR

Our commitment to our employees is matched by a broader sense of responsibility to our user communities worldwide. Specifically, we recognize that access to information is a powerful tool to help identify and solve problems. We are committed to harnessing our resources to help address pressing global needs.

Sustainability is one example. Last fall we kicked off a project to install 1.6 megawatts of solar photovoltaic panels at our Mountain View campus. This project will be the largest solar installation on any corporate campus in the U.S., and we think it’s one of the largest on any corporate site in the world. The amount of electricity that will be generated is equivalent to powering about 1,000 average California homes. We’ll use that electricity to power several of our Mountain View office facilities, offsetting approximately 30% of our peak electricity consumption for those buildings. Our work in this area has just begun and we hope to do much more in the future.

This past year Google.org, our philanthropic arm, got off the ground by building out a leadership team. Among these new hires was Dr. Larry Brilliant, who joined us in March to serve as the head of Google.org. He is a great leader to help Google.org tackle its threefold mission of global health, global wealth, and the environment. While Google.org is ramping up, our existing philanthropic activities are still going strong. Google Grants puts our advertising program to work for charities and nonprofit organizations that don’t always have equal footing in the traditional advertising business. More than 2,100 organizations in 16 countries have now been accepted to run targeted ads to reach their constituencies around the world.

Our current program is a smoking cessation site testing four Web-based methods to quit smoking. We are very appreciative of your support. Over 190,000 Spanish- and English-speaking users looking for help to stop smoking have clicked on to our site from your ads.
- DR RICARDO F. MUÑOZ, UC-SAN FRANCISCO

Since we first became a grantee, website activity has increased by a dramatic 400% and the number of youth we serve has increased by 20%. Our annual budget has increased 20% due in part to increased donor activity and increased community partnerships – both of which are influenced by our sponsored link positioning on Google.
- BRANDE MARTIN, MY FRIEND’S PLACE

This is just a start. When I write this letter in future years, I am optimistic that I can report significant progress on the global challenges that we hope to address through Google.org’s work.


Thank you

We had a remarkable 2006. None of our achievements would have been possible without our passionate users, strong partnerships, and talented employees. As I read back over this letter, what stands out are the individual experiences of the people who use our products. It is an honor to share these pages with a few of them.


Larry Page


Sergey Brin