Bulls, Bears and Other Beasts Read online

  All this time, unknown to the stock market at large, action was slowly hotting up in the little-known, murky interbank market for government securities. It was a market in which banks – nationalized as well as private sector banks – bought and sold bonds among each other to meet their liquidity requirements and to make profits too. Before long, the reverberations from the developments in the money market – as it was called – would be felt in the stock market.

  The Sensex had been trading between 700 and 850 from January to June 1990, giving little clue as to which end of the range it would break out from. However, starting July, the index broke out of the upper end, and by the close of the month had risen to within sniffing distance of 1,100. Even more strangely, the market rose through August and September, when crude oil prices had begun climbing after Iraq’s invasion of Kuwait. Logically, costlier crude meant a higher import bill for the country and a strain on its already measly foreign exchange reserves, and should have been seen as a negative sign by the markets.

  Harshad’s scale of activity had increased considerably by then, and the big moves in stocks like ACC, Apollo Tyres, Gujarat Ambuja, Tata Tea and SPIC were being attributed entirely to him. It would be some more months before he attained cult status in the stock market and even beyond – on a level that has not been seen since with anybody else on the stock exchange – but he was already well on his way to becoming the first superstar of Dalal Street.

  What many in the stock market did not know was that Harshad had by then risen to become a powerful broker in the money market too. In becoming so, he had broken the stranglehold on the business that established players like the Ajay Kayan-owned Smifs Mackertich, the Hemendra Kothari-controlled DS Purbhoodas and Bhupen Dalal’s CIFCO.

  Harshad had begun his career in the financial market in the early 1980s as a jobber in stocks and had done well enough to acquire a membership on BSE by 1984. Three years later, he ventured into the money market, hoping to replicate his success in the stock market. While one could rise from a lowly jobber to a broker in the stock market, breaking into the money market was a much tougher proposition.

  There is an apocryphal tale about what spurred Harshad to dive into the money market. I heard it from Sharma some years later when we were reminiscing about the old times over a drink. Harshad was at the office of a broker friend. A fairly important money market broker happened to be there too. When this broker got talking about the market, Harshad got a bit curious and asked for elaboration on something. The broker apparently turned to Harshad and told him, ‘This is way beyond your league, you’d better stick to the stock market,’ or something to that effect. That pricked Harshad’s ego, enough to set him aching to prove that he could be as good in the money market as he was in the trading ring on Dalal Street.

  Harshad’s first year as a money market broker was a disaster. It took him almost six months to crack his first deal and that earned him a paltry Rs 5,500 as commission, net of stamp duty. The next six months were nothing to write home about either. Anybody else in his place might have given up and turned his attention back to stocks. But not Harshad, who wanted to prove a point, no matter what.

  Just the previous year, Harshad had nearly defaulted on a trade in SPIC. His rivals, led by Manu Manek, had made a near-foolproof plan to bleed him financially. Harshad had big buy positions in shares of SPIC in his personal capacity as well as on behalf of his clients. A listless Union Budget had soured market sentiment in general, and SPIC was among the major casualties. The stock crashed from Rs 180 to Rs 125 within a couple of trading sessions.

  Suddenly, rumours began doing the rounds that Harshad would default on his pay-in obligation to the stock exchange. If a broker buys shares, he has an obligation to the stock exchange to pay money (pay-in of funds) for the shares on settlement day. If he sells shares, he has to deliver the shares, or make a pay-in of shares to the exchange on settlement day.

  The bears were trying their best to further depress the appetite for SPIC and hammer its price down by unnerving the bulls into liquidating their positions. Had the stock price fallen further, Harshad would have found it difficult to get financiers to carry forward the trade to the next settlement. On the advice of a trusted broker friend, Harshad decided to make the pay-in of funds for SPIC ahead of schedule. He made the pay-in and requested M. R. Mayya, executive director of the BSE, to announce it on the stock exchange notice board. Mayya declined to do that, citing exchange rules. But he assured Harshad that he would confirm the development to anybody who came checking its veracity.

  The move helped, but only to the extent that the bears backed off from hammering SPIC shares further. But it was not a clean win for Harshad, who had to stretch himself to pay the funds ahead of schedule. Some of his clients were cooperative and paid up, but there were others who refused. The net result was that Harshad’s firm had to absorb a good part of the losses arising from the steep fall in the stock price of SPIC.

  In 1987, when Harshad first tried to gain a foothold in the cloistered club of money market brokers, there was not much action in the market. Banks had to keep almost half of their deposits aside to meet the Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR) norms set by the Reserve Bank of India (RBI).

  CRR, which helps RBI control the money flow in the system, is the proportion of deposits that banks must deposit with RBI. A CRR of 4 per cent would mean that for every Rs 100 of their deposits, banks must deposit Rs 4 with RBI. The banks did not earn any interest on CRR. SLR is that portion of their funds that banks have to compulsorily invest in government securities (bonds issued by the government). SLR investments earn interest, but the interest is much lower than the interest banks charge their corporate borrowers. Today CRR is 4 per cent and SLR 21.5 per cent (total: 25.5 per cent). Back then, the two ratios added up to nearly 50 per cent.

  What this meant was that banks could only lend Rs 50 out of the Rs 100 they received as deposits. This reduced their ability to earn decent profits. Whenever CRR and SLR limits were raised, some banks had to borrow cash or securities to maintain compliance. Some banks realized that planned purchase of bonds to fetch optimum yields was a good way to boost earnings. But for most banks, buying and selling of bonds was done mostly to meet regulatory requirements.

  To get around the stringent CRR/SLR rules, banks came up with a ‘buyback’ or ‘ready forward’ arrangement. Bank A, which needed cash, would sell some of the securities in its portfolio to Bank B, and a few days later buy back those securities at a slightly higher price. This difference was, in fact, the interest that Bank A was paying Bank B for the short-term loan. For Bank B, the difference in the buying and selling price was the interest it charged for lending the money for those few days.

  There also existed a call money market in which banks, mutual funds and corporations could borrow funds from each other for short durations. But RBI had capped the interest rate chargeable in this market at 10 per cent. As a result, banks were not keen to lend in the call market, the rates they were charging through ready forward deals being much higher.

  As the number of ready forward deals increased, so did the use of an instrument called bank receipt (BR). When Bank A sold securities to Bank B, often the securities – which were held in physical form, and not electronically – could not immediately be delivered to the buyer. So Bank A would issue a BR to Bank B that was valid until the time the securities were physically delivered to Bank B. Once the securities were delivered, the BR would expire. A BR was valid for 90 days or until delivery of the securities it represented, whichever was earlier. At least, that was the way it was meant to be under the rules for BRs.

  Before long, BRs began to be misused on a large scale. In many transactions, the physical securities never changed hands; only the BRs did. Issue of BRs was meant to be an ‘exceptional method’ of delivery of securities under special circumstances. But soon it became the norm.

  Banks started issuing BRs against BRs, which was forbidden. This meant tha
t Bank B could trade the BR it was handed by Bank A with a third bank, as though it already had delivery of the underlying securities. The third bank in turn would trade that BR with a fourth bank, as though it now owned the securities.

  If Bank A, for whatever reason, were to default on delivery of the securities, there would be a series of defaults along the chain. It was also very much possible that Bank A never had the underlying securities to back the BR it had issued to Bank B. It probably issued the BR thinking it would reverse the transaction before the 90-day validity period for BRs. Bank A would then not have to deliver the physical securities at all to Bank B. What it would not have bargained for was Bank B trading that BR with another bank.

  And that was exactly what happened. Some banks started issuing BRs that had no underlying securities. They were confident that the purchasing banks would not bother to ascertain the selling banks’ ability to deliver the securities. Cooperative banks like Bank of Karad and Metropolitan Co-operative Bank, which eventually went bust, issued securities that were ‘worth’ many times the value of the banks’ entire investment portfolio.

  To make matters worse, some brokers like Harshad Mehta started taking huge positions on their own instead of simply acting as brokers to the buying and selling banks. If Bank A wanted to sell a certain government bond and Bank B wanted to buy it, Harshad, who should ideally only have connected the two and earned a commission, was now big enough to buy the bond from Bank A and sell it to Bank B for a profit.

  Banks were allowed to trade securities only with other banks. But Harshad rewrote the rules of the game when he decided to become a counterparty, and not just a broker, in trades among banks. This would see him strike a deal with Bank A to buy securities at a certain rate, confident that he would be able to offload those to Bank B at a higher rate. Or, he might even short-sell securities to Bank A, hoping to deliver the securities by buying them cheaper from Bank B.

  Actually, it was even more complicated than this, as neither Bank A nor Bank B could directly deal with a broker, according to the rules. Harshad got around this by enlisting the help of Bank C, which would lend its name to the transaction. On paper, it would appear that both Bank A and Bank B were dealing with Bank C, though both banks were aware that they were directly dealing with Harshad.

  The payment cheque would be received in the name of Bank C, which would then immediately credit the funds to Harshad’s account after deducting a fee. Similarly, Bank C would also deliver securities from its portfolio to the buying bank, and receive securities later from the buying broker.

  It was this facility that helped Harshad rapidly scale up the size of his transactions. The jobbing skills he had learnt the hard way in the trading ring of BSE would be put to good use in the money market. Depending on which side of the trade he was on, he would make a security liquid or illiquid to get the best deal for himself. In addition to acting as counterparty, Harshad would also broker trades for banks. On paper he would not be charging banks any brokerage on some of the transactions. But here too, Harshad was benefiting from the wide spread between the rates at which one bank sold and the other bank bought.

  Soon, the banks that Harshad did business for trusted him so unquestioningly that they would credit large sums into his account on his instructions. In theory, they were paying him for the securities he was supposed to buy for them. In practice, Harshad would use the money for his own stock market investments. He would buy huge quantities of his favourite stocks using the money from the banks, sending share prices skyward in the process. He would keep the profits from playing the stocks and pass the funds on to the selling bank, or return the funds to the buying bank, depending on the arrangement. Nobody knows when he hit upon the idea of diverting banks’ funds into the stock market; it began to get talked about only in 1991 when the size of his bets grew very large. In 1990, however, Dalal Street was yet to catch the imagination of the masses, most of whom had only a vague idea about shares and the stock market.

  A couple of months after his generous gesture, Sharma asked me if I wanted to meet Harshad in person. I was very keen, having heard so much about him. A few days later, when we met in the ring, he told me that Harshad was meeting up with a few friends over dinner at the Grasshopper restaurant in Vile Parle that evening.

  ‘Bhai will be happy to have you with us,’ Sharma said.

  I was a little tense about the meeting. I had heard that Harshad was quite voluble, the exact opposite of somebody like me who had trouble making conversation. I worried my reticence would make me appear unimpressive to Harshad.

  Sharma and I went together to the Grasshopper. We were ten minutes late. Harshad was already there with seven others, all of them stock market friends. I knew all of them by name, and I guess they too were aware of my existence. As usual, Sharma was to the point while introducing me.

  He placed his hand on my shoulder and said to Harshad, ‘This is Lalchand, better known as Lala.’

  I managed to mutter a feeble hello to Harshad, but was so awestruck that I involuntarily bowed while greeting him.

  Harshad eyed me for a couple of seconds, and I could sense that he was sizing me up.

  ‘I am Harshad, how do you do, Lala?’ he responded with a warm smile.

  I was a bit taken aback at the humility with which he introduced himself. Of course I knew his name. But then, that was part of Harshad’s charm, and as I would learn later, he had a knack of putting people at ease in his company.

  ‘Arre Sharma, when you mentioned a jobber who loved to finger those robbers, I certainly did not imagine a college kid,’ Harshad said, and turned towards me. ‘You seem to have got the hang of the game early on; that’s important if you are to survive the first couple of years, always the toughest. Reminds me of my initial days in the ring.’

  I would be lying if I said the remarks did not swell my head. And that’s exactly the effect Harshad must have intended. But it made me all the more tongue-tied, and I did not know what to say.

  But one of Harshad’s friends saved me the trouble by butting into the conversation. Being a Friday, there was a fairly long waiting list of diners. From the look of it, I felt we would have to wait for anywhere between half an hour to an hour.

  ‘. . . that’s why I was saying, Harshadbhai, we should have booked in advance. It is going to be a long wait,’ the friend, Viren, told Harshad.

  ‘But why take the trouble of booking in advance when you can get a table without much difficulty?’ Harshad said.

  I wondered if Harshad had thought he would be recognized by the restaurant staff and promptly ushered to a table. He might be well known in stock market circles, but out here, he was just another patron looking to have a good time over good food.

  ‘If it is so easy, why don’t you get us a table?’ Viren said.

  ‘Are you challenging me?’ Harshad asked.

  ‘Yes.’

  To cut a long story short, Harshad managed to get us a seat without much delay. He did that by posing as a tour operator to the steward at the door allotting the tables. Harshad first told the steward to take good care of a group of twelve in the waiting list (he figured that by peeping into the steward’s notepad). He said they were wealthy diamond merchants from Gujarat and that he had specifically recommended this place to them. A little later, he again walked up to the steward and said he had another group of guests more important that the first group and that they be given priority. I was quite impressed with Harshad’s street smartness, but at the same time I suspected that he would not be averse to pulling off something similar at a bigger level if it helped him get ahead.

  I do not have much recollection of that dinner, except that I chose a seat as far away from Harshad as possible. I was worried that he would pop me some questions on the market, and that I would say something silly in reply.

  Still, he sought me out and asked me something about a company. I was self-conscious, and mumbled something. He heard me out attentively and then asked a counter-question.<
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  ‘True, Lala, but what if you were to look at it in a different way. Assume that . . . ’

  I responded with some more drivel, anxious that he should not question me further because I now had nothing more to say.

  ‘Hmm . . . you may have a point,’ he said, with a thoughtful look, as though I had presented him with an entirely new perspective.

  As we parted after dinner, Harshad put his arm around my shoulder and said, ‘You seem to be an interesting fellow, Lala. Let’s keep in touch.’

  He gave me his visiting card and asked me to ring him whenever I had interesting ideas.

  A couple of weeks after that dinner meeting I started doing trades for Harshad. Sharma was my link to him, and all the orders would be relayed through him. It was mostly to buy shares; sometimes with a price-limit instruction, and at other times being allowed a free hand. I was doing all these deals in my capacity as a jobber and not as a dealer for my firm. Still, a share of the profits went to my firm, under the arrangement I had with the owner.

  The trades were small to begin with, but I guess they were testing me out for efficiency and integrity. Once they were satisfied, the orders slowly started getting bigger and more regular. My commissions were growing steadily, and I was confident that in another couple of years I would be able to realize my dream of owning a house in Ghatkopar.

  7

  Dalal Street Gets a New Big Bull

  The Bharatiya Janata Party withdrew support to the V. P. Singh government in the last week of October after Bihar chief minister Laloo Prasad Yadav had L. K. Advani arrested during his rath yatra in that state. Although the market moved in a contrary direction, gaining a bit, the Sensex crashed the following January as a war in the Gulf appeared imminent after all diplomatic efforts to persuade Iraq to withdraw from Kuwait had failed.

  However, one stock was steadily and mysteriously rising through all these market swings – that of Associated Cement Companies. The sudden fancy for it stemmed from Harshad’s heavy purchases in the stock. I had sourced a sizeable chunk of it myself for him, and knew that he was buying whatever ACC shares he could lay his hands on. The stock had more than doubled over the last six months, and the bears had lost a packet short-selling it on the hunch that it was overvalued.