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When trading frightens. — S. Muralidhar

The picture is still hazy after a series of avalanches in the Indian bourses, and investors repeatedly found the ground slipping away. Who would forget how, only days ago, the charts were awash with red before brokers could mutter their prayers in full, and how the breakers fell in place to freeze the pain so the plunge could stay still for what looked endless. It happened… “On Friday, October 17, a ‘run’ on the Knickerbocker was under way, and doze ns of depositors clamoured at the trust company’s doors to claim their funds…Wall Street was gripped by a paroxysm of fear. In the coming days, money would become scarce, banks would fail, the stock market would plummet, and the city of New York itself would reach the precipice of bankruptcy…”

Both the date and the description may seem eerily close, though not the day and the setting, but this is a snatch from the prologue to ‘The Panic of 1907’ by Robert F. Bruner and Sean D. Carr ( www.darden.edu). Having seen the volatility of the markets, you’d agree with the statement, ‘These are troublous times,’ a quote of Charles T. Barney of Knickerbocker Trust Company dating back to October 21, 1907, that adorns the start of the prologue.

“Why do market crashes and banking panics happen?” the authors ask, and present the common answers, which fall into two opposite schools of thought. “At one extreme, we find explanations that are highly detailed and idiosyncratic to a particular event — often comprised of a hodge-podge of period-specific causes. At the other extreme are conclusions that might be broadly described as ‘one big idea’: A sole cause large enough to cover a multitude of sins.” Popular examples of ‘big idea’ are reasons such as lack of liquidity and greed.

Steering clear of the extremes, the authors dissect the ‘perfect storm’ that blew through the financial system in 1907 and identify seven elements that converge to cause financial crisis. The first is ‘system-like architecture’. The very existence of a system means that trouble can travel, explain Bruner and Carr. “The difficulties of one financial intermediary can spread to others.” Also, as the system grows in complexity, “it is difficult for all participants in the financial system to be well informed — this is called ‘information asymmetry’.”

The other six elements are: Buoyant growth, inadequate safety buffers, adverse leadership, real economic shock, behavioural aberrations such as fear and greed, and failure of collective action.

Since “rationality assumes that prices today reasonably reflect an expectation of prices tomorrow and that markets are efficient in impounding news into asset prices,” an emotional market ‘panic’ challenges fundamental economic assumptions about the rationality of economic decision markers, the authors note. “On balance, large markets in standard assets appear to be rational on average and over time,” they add. “But crashes and panics are the exceptions to such ‘average’ assumptions. To suspend the assumption of rationality admits the possibility of a great deal of bizarre behaviour.”

Timely read.

The incestuous coupling of wealth and power poses ‘the deadliest threat to democracy,’ cautions Al Gore in ‘The Assault on Reason’ ( www.landmarkonthenet.com ). When money and deception corrupt the reasoning process, and counterfeit usurps power, a significant portion of the citizenry loses confidence in the integrity of governance, and democracy goes bankrupt, Gore describes graphically.

“No critical mass of opposition can form among individuals who are isolated from one another, looking through one-way mirrors in soundproof rooms, shouting if they wish but still unheard. If enough citizens cease to participate in its process, democracy dies.”

In a chapter titled ‘the politics of wealth’, Gore traces the origin of the word ‘corruption’ to Latin ‘corruptus’, meaning ‘to break or to destroy’. Corruption destroys and breaks that trust, which is absolutely essential for the delicate alchemy at the heart of representative democracy, he interprets.

“It matters not if the private enrichment is with cash or with its equivalent in influence, prestige, status, or power; the harm is done by the fraudulent substitution of wealth for reason in the determination of how the power is used.”

Another chapter, in the book by the author of An Inconvenient Truth, is ‘convenient untruths’, where he uses the analogy of computer to explain a bit of politics. Totalitarian regimes are like a central processor dictating all commands, while representative democracies rely on ‘massive parallelism’ and ‘distributed intelligence’. The latter can work well only if the individuals involved have the ‘freedom to obtain information that flows unimpeded throughout the system’.

Alas, “the role information plays in our democracy has been profoundly transformed with the new dominance of television over the printing press,” laments Gore.

Too shrill to ignore.

Elementary economics tells you how ‘marginal return’ for a poor entrepreneur can be higher than it is for a rich entrepreneur. Yet, capital doesn’t naturally flow to the poor. “Instead of investing more money in New York, London, and Tokyo, wise investors should direct their funds toward India, Kenya, Bolivia, and other low-income countries where capital is relatively scarce. Money should move from North to South, not out of altruism but in pursuit of profit,” write Beatriz Armendariz and Jonathan Morduch in ‘The Economics of Microfinance’ ( www.phindia.com ). They cite the findings of Nobel laureate Robert Lucas Jr that, based on estimates of marginal returns to capital, borrowers in India should be willing to pay 58 times as much for capital as borrowers in the US.

The sad truth, and a common one, is that investments are more likely to flow from poor to rich countries, or that “large corporations have a far easier time obtaining financing from banks than self-employed cobblers and flower sellers”.

The authors crack the paradox to find that “the important factors are the bank’s incomplete information about poor borrowers and the poor borrowers’ lack of collateral to offer as security to banks.”

For generations, poverty has thus reproduced poverty, and one way of breaking the vicious circle is microfinance, “by reducing transaction costs and overcoming information problems,” the book argues.

Worth a detailed study.

How to create more wealth for shareholders? Redesign the organisation, say Lowell L. Bryan and Claudia I. Joyce in ‘Mobilizing Minds’ ( www.tatamcgrawhill.com ). “Most companies today were designed for the twentieth century. By remaking them to mobilise the mind power of their twenty-first-century workforces, these companies will be able to tap into the presently underutilised talents, knowledge, relationships, and skills of their employees,” the authors propound.

“The modern, ‘thinking’ company should be a fluid and fast-moving creature, in which its workers discover knowledge and exchange it with their peers, collaborating with others to create value,” they describe.

“The problem, however, is that most of today’s large companies fall well short of creating conditions that maximise the productivity of their thinking, problem-solving, self-directed people.”

D. MURALI

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