my thoughts.....

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Tuesday, September 16, 2008

The Spy who shagged US, Inc.

A funny line but a serious matter! For the last few days, the global media have been preoccupied with the sudden fall of two Wall Street giants – Merrill Lynch and Lehmann Brothers. It has become 'the talk of the break room' at my workplace. There has been sense of uneasiness – a desperate usage of euphemism for panic here - in every square inch of financial space right now. As a blissful ignorant of the intrinsic details of ongoing mess melodramatically addressed by the global media as “The financial meltdown”, “The change in financial landscape of Wall Street” and “Why the Bull run ended?”, I want to do a quick search on who the spy is.

I recollect an incident in my life that happened almost couple of decades back. My aunt asked the help of my dad – a private financier then - to broker one of her gold jewels and wanted him to invest the money obtained into something that could generate an income for her. My dad went on to broker the jewel with a private pawn broker for a particular interest and lent the money received out of the pawn brokerage to couple of persons for a higher interest. My dad ultimately assumed the responsibility of getting the difference in interest earned to his sister. It is a simple example of the primary business by a typical Investment Bank.

In this case, my dad was comparable to a broker; my aunt was comparable to a banker backed by an asset – the gold jewel; the pawn broker was comparable to an investor investing money on an asset-backed-security; the two persons whom money was lent to were the end borrowers. My dad played a pivotal part here as he‘d assumed the risk involved with both the brokerage and creditworthiness of the borrowers.

Let’s look into the potential risk modes here. What if the value of gold had started plummeting sharply? The pawn broker‘d have got panicked and tried to liquidate the security as soon as possible – it means he should either ask my dad to return the money ASAP or sell the jewel in the market. My dad could not have repaid the money to the pawn broker unless the borrowers had repaid the loan to my dad. The borrowers could not have repaid the loan to my dad unless they had used the loan prudently. If my dad could not repay, the pawn broker would take a loss by selling the jewel at a lower price and my dad would lose the confidence among investors like the pawn broker. If the borrowers could not repay, they would never be able to barrow money from my dad again and my aunt would take a loss. It is very cyclic and everyone would get affected if anything goes wrong here.

Let’s look into risk mitigation strategies here. First of all, the pawn broker should be careful about how much money can be invested on a security - I remember the pawn brokers used not to invest more than half of the value of a jewel in my town. My dad used to be very careful about the brokerage interest - the return on investment for a broker. My aunt chose my dad to do this job as he is after all her brother – that is her confidence on my dad. My dad also used to be very careful about whom he lends money to – being prudent about the creditworthiness of a borrower. If any of these of risk mitigation strategies is not strong enough, the failure is quite imminent. Here, it is only a question of a personal responsibility and business acumen to make sure everything goes right. If this business is done in a much larger scale, something similar to Lehmann Brother’s, whose responsibility and business acumen it should be?

Lehmann Brother's business involves not only thousands of investors, an extraordinarily wide variety of asset-backed securities and a large customer base but also multiple nations across the globe. This is very analogous to the two borrowers buying an asset using the borrowed money and forming another transactional cycle similar to the one explained above and the borrowers from this new cycle also forming another transactional cycle and so on and so forth. It does get complex. does not it?

How could you keep forming this seemingly-endless sub-transactional cycles? You could keep doing as long as a net earning - a difference in interest as in the case explained above - is sustainable. There is obviously a limitation to it, as governed by "Law of diminishing utility". It is very similar to how many coke you can drink at a time or how much juice you can squeeze out of a sugarcane!

Lets just talk about the responsibility part alone as business acumen part is beyond the scope of this blog. Responsibility is as important as business acumen in running any business anywhere. It is very difficult for both to coexist especially in capitalistic economy and more specifically in trying times when companies are struggling to sustain the growth. It is very obvious both can't be taken care of by a single person or entity. This is exactly where a government comes into the picture taking care of the responsibility part while a CEO takes care of the business. You can certainly not expect a CEO of a company like Lehmann Brothers to be as responsible and emotional as my dad was to my aunt. Its is ultimately the responsibility of a country's President, to take care of the responsibility part in running a business. What is our President's response to the ongoing mess in Wall Street? How is he going to explain the giants of wall street crashing like a pack of cards?

In a global economy, a person in arizona defaulting a mortgage payment could lead to a person in chennai losing his/her job. With companies like Lehmann brothers in the business, the cause-and-effect relationship is even more significant as investment banking in a global economy fundamentally builds its business through connecting the epicenters of world economies one over the other in the name of trading asset-backed securities. You can obviously see a high chance of domino effect if anything goes wrong in this framework.

A government has to be as prudent in setting the policies for how a company can do its business as the pawn broker was by only investing less than half the value of a jewel. A government is the ultimate authority in making sure that a company's business solution fits into the fundamental governing laws. It is strongly evident in the ongoing mess that our President played a significant role in pushing things beyond its limits breaking himself the laws of government. He has simply acted as a CEO of US, Inc. but not as a President of United States.

To avoid similar collapses in the future, It is necessary a right candidate rule this country who not only understands the business but also socially responsible; It is also necessary people becomes more aware of the intricacies of economy, more importantly the dynamics of capitalistic economy and most importantly the challenges of global economy for them to elect a right candidate.

BTW, would Michael Moore's next venture be titled 'Washington Powers: The spy who screwed me' glorifying Mr. Bush's extraordinary achievements as a President in the ongoing developments at Wall Street? I am also wondering if Mr. Bush himself would be cast in the movie as he won't have anything to do after his retirement. If happens, would he be cast as a hero or a villain? Well, It does not really matter, does it?!

3 Comments:

  • Hi Mani

    Wonderful article, keep continue

    sujai

    By Blogger S.Sujai Gangatharan, At September 24, 2008 at 6:33 AM  

  • Mani,

    dont you think the big financial giants should be more prudent. Yes they have seen success for the past 20-30 years, but they have weathered the bad markets too, and you know why it was becos of strong principles that they followed.
    I think greed to make quick money made the situation worse. the govt, can oversee the financial makts to a certain levels but its these companies who put these govts there. so go figure.
    Prem.

    By Anonymous Anonymous, At September 30, 2008 at 5:51 AM  

  • Mani,
    I wouldn't blame Bush alone for this fiasco. The whole affair is but a logical conclusion for the mindless free market frenzy from the republicans (of course with democratic complicity). It started with Reagan and hopefully it should end with Bush. But i am not keeping my fingers crossed.

    And yes, Greed too played a big role.
    C Karthikeyan

    This is Thiru's friend.

    By Blogger Karthikeyan, At October 6, 2008 at 10:32 PM  

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