Sunday, January 3, 2016

Being Reckless on WallStreet

For some strange reason I was drawn towards finance and market. I took up Economics 101 and Finance 101 as optionals in my undergrad. Thanks to it I could at least attempt to read the Business page of the newspaper instead of directly flipping over as 95% people do.

Twice I attempted to read “Fault Lines” by RBI governor Raghuram Rajan and had to put it down in between. It has to be the toughest book (non-curriculum) I have read (unsuccessfully) till date. The book talks about how Rajan could foresee the 2008 economic crisis before many of his peers and even had the guts to call spade a spade. He was one of the few people to have correctly called the crisis as coming.

Anyways the botched reading attempts didn’t dissuade me. I had already gathered a fair idea about the economic crisis 2008 and its causes from the internet and my 101 classes. Impropriety, no moral compass, government hand-in-glove with the executives in lieu of their funding, no accountability and astronomically high bonuses for the CEOs irrespective of the company’s performance are some of the key reasons that came up on trying to figure the problem. Surprisingly the same reasons came to the fore when I read Liar’s Poker – giving an account of late 1980s i.e. roughly 20 years before 2008. Nothing had changed in those 20 years! While Wall Street did very well to come up with innovative new financial derivatives (CDOs) but everyone turned a blind eye to the unethical, unfair prevalent practices.

I accidentally happened to come across a list of “Movies to Watch” which centered on finance and markets. Quickly I saved it and gradually started ticking off them one by one.

If you watch “Too Big To Fail” - you will realize how blatantly the financial institutions kept aside all caution and rules in the mad race to make more money. It pushed the world on the precipice of a financial collapse and it did. Sadly no one was held accountable for why proper due diligence was skipped. The financial system already had enough checks & balances – but they were rendered useless because those who were supposed to ‘Say No’ didn’t say NO! And one major reason for it is that those in the higher echelons in the finance world (investment banks etc.) were in cahoots with those running the Office or planning to run for the office. On watching the Academy Award winning documentary “The Inside Job” – you will end up shaking your head in disbelief to see as to how come the head of investment bank (to know the name watch the documentary J) who threw all caution to the wind was appointed as an advisor to the US President. And this is after he took home a million dollar cheque even though most of the people around him lost most of their life-savings primarily due to his company’s reckless behavior. No accountability!

However, a non-descript country like Iceland showed the way when it punished the bankers responsible for the financial crisis. It’s a long shot but let’s hope that others follow suit too.

If you think that what happened in 2008 was only the one time all these reasons combined together to create havoc at such a large scale – then you’re wrong.  The most spectacular collapse in the history of Wall Street has to be Enron. All the reasons which precipitated its collapse are exactly the same as 2008. In fact, I should say the other way round – the reasons why 2008 financial crisis occurred were the same as late 1980s and 2001-02. Absolutely no heed was paid to the lessons learnt and we have no reason to believe that this won’t happen again.
Fortune Magazine [2000] - Enron was the most admired then

However, Enron scandal has to be the mother of all accounting and financial scandals – the company fooled the Wall Street analysts, the regulators for 8-10 years – cooked up the numbers, showed profits which were non-existent, hid its debts thanks to Mark-to-Market accounting principle. Its executives took home multi-million dollar salaries and encouraged its 20000 employees to put their savings and retirement funds in Enron stock. They did all this while completely knowing that the Enron stock which was shooting up year after year was standing on thin ice. They even opened up a billion dollar energy plant in Dabhol, India – and there were no cash inflows from it still they propped up the investment as successful to investors.

It is a matter of little satisfaction that the executives were punished but the amount of money people lost, the mental anguish can never be compensated.

I got to know most of this when I watched “Enron: The Smartest Guys in the Room” – again an Academy Award winner and also mentioned on the Movies to Watch list.

Another key standout from it was the California Energy Crisis (2000-01). In the state of California, electricity was deregulated thus it had many players who could price it based on the demand.  A few blackouts occurred in the state of California while it was struggling to supply power and Enron made use of it and used to shut down its power plant which abnormally increased the demand resulting in the increase of electricity prices to 800%. Naturally, the incumbent governor (Gray Davis) was blamed. However, Enron president (Ken Lay) was a close friend of George W. Bush who as the President refused to put a federal cap on the electricity prices. Ken Lay invited Arnold Schwarzenegger for a lunch in May 2001– and by some strange co-incidence Arnold defeated Gray Davis in the polls for the next governor in 2003. Anyways, Enron pocketed billions exploiting Californians misery in 2000-01 while they didn’t earn a penny from most of their other ventures.

This is one of the most glaring examples of how dangerous Capitalism and free markets can be. No wonder we have movement like Occupy Wall Street going on where people are demanding a reduction in the influence of corporations on politics, more balanced distribution of incomemore and better jobs, bank reform (especially to curtail speculative trading by banks)forgiveness of student loan debt, and alleviation of the foreclosure situation.

Although it is unlikely that their demands will be met anytime soon until matters come to a head, but with economic crisis spreading its fangs in Greece, Portugal, Spain and now in Puerto Rico (defaulted on Jan 1, 2016) more and more people will see the crystal clear disparity. Only the top 1% hold most of the wealth (90% and above) in almost all countries – a perfect recipe for unrest, disharmony and all that is anti-social.