Humility, integrity, or greed? - The Honest Truth By Ajit Dayal
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Investing in India - Honest Truth by Ajit Dayal
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3 NOVEMBER 2008

Greed is good, said the respected gentleman, it is what drives our industry. It is what drives the economy. We had excessive greed. We don’t need to eliminate it. We need to control it.

Our business is so complex, said the head of a large financial company, we have hundreds of people making bets and decisions in so many parts of the world that we don’t really know what is going on.

What we did was wrong, said another, but that’s what we had to do or we would lose the business to a competitor.

What we need, I said, is a world with more humility - and a lot less greed.

No one said anything - I had not expected them to.

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A global conversation
It was an interesting conversation.
We have seen what the mixture of greed and finance can do.
Look around you.
Look at your portfolio.
Look at the NAV of any mutual fund.
Look at the high - and look at the low.

The defence of the people I was with was this: the world was greedy, our competitors were greedy, and so what else could we do? Nothing.

We became greedy, too.

Sure, they did.
I don’t really know the people I was with but from their titles I figured that at least two of them must have cleaned out (in bonuses and salaries) over USD 10 million a year for the past few years.

Making money is not a bad thing.
Making money by knowing you are doing something not so good - but doing the not so good thing "because everyone else is doing it" sounds pretty terrible to me.

But that is the way of the world.
That is the world of finance.

During the technology bubble, analysts with the largest broking companies in the world wrote each other emails from their plush offices in New York: This technology share I am recommending is a bunch of crap, but I will recommend it because by saying "buy" we get obscene salaries and obnoxious bonuses.

One senior research analyst said he wrote knowingly inaccurate views on one company because he wanted admission for his children in a well known school in
Manhattan in New York City.
And we thought Americans did not love their children!

What happened to these greedy people when they were "found out" and taken to the SEC?
The companies they worked for paid USD 1.4 billion in fines.
Rs 5,600 crore in those days.

The companies were allowed to submit a "not an admission of guilt" and then left to go.

My, my - you may say - that is a lot of money. It sure is - by itself.

This is what I wrote on December 21st, 2002:

"The high profile probe into the alleged wrong doings of the 10 largest Wall Street firms has ended with a settlement of US$ 1.4 billion.

A fine, one would think, would be a punishment and an economic incentive not to break any more rules. Well, the table below suggests that breaking rules, being investigated, and then being fined under a settlement with regulators may actually be a good thing.

Table 1: Modern justice - Pay a fine, and then recover it instantly!
Firm Fine Paid (US$ m) Cap, US$ m percentage of the fine paid
SSB (Citibank) 400 3,268 817%
CSFB 200 155 78%
Merrill 200 262 131%
Goldman 110 707 643%
JP Morgan 80 3,225 4031%
Change in Mkt Cap is the day the settlement was announced
This is the wealth created by actions of the market
Only CSFB has to recapture its payment: the others have more
than recovered their payment by an increase in overall wealth

The day the fines were announced in New York (December 20, 2002), the share prices of the fined entities rose sharply and the wealth created by the increase in market cap overshadowed the cash impact of the fine.

The markets have voted that the fines were a lot less than expected and should not take away from the long term economic value of the Wall Street firms.

There could also be a political reality that these firms account for hundreds of thousands of jobs in New York and the tri-state area and any severe punishment to them is a loss of income to the City, a loss of more jobs, and a loss of votes.

Whatever the political or economic compulsions of the settlement, the average investor who got misled by tainted research may not see much of a benefit.

The traders on Wall Street may soon follow a new mantra:

  1. break the law
  2. cheat investors
  3. take a lot of bad press
  4. pay a fine
  5. create wealth, and all is forgiven.

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History repeats its greed
Six years later, look at the names of the firms involved in today’s crises.
Pretty much the same folks.
A different division, though.

Remember my weekend conversation at the start of the article: "Our business is so complex, said the head of a large financial company, we have hundreds of people making bets and decisions in so many parts of the world that we don’t really know what is going on."

Just as when you sit in your car and your driver pays a bribe because he broke some rule - and you look the other way.
Or when your "contractor" who is building your new bathroom arranges for something that is not allowed.

So these companies found a new way to devise a new "greed" and discovered the next scandal.
The one we are in now.
Chances are they will be bailed out again.
There will be some fine, there will be some public demonstration of apology.

But will they be shut down? Will these giants of greed be banished from doing anything in the field of finance till they take the greed out and have proper control over what they do?

India story
Despite the careful oversight by the RBI, India has its share of excesses.
Take the banks that focused on market share.
They knew that if they grow so large they could not fail.
Because if they are large and if they fail after they have proved their largeness, the entire economy goes down with them.

So a new generation of private sector banks have taken away "market share" from banks like SBI.
In the process, many of those employed in the private sector got rich with good salaries and bonuses.
And they got awards from all the business TV channels for being the "biggest"; "largest", "fastest" or the "greatest".

The SBI loan officers got scolded by its board members for not doing enough to encourage growth and consumption.
Look at the private sector banks, the critics said.

Yes, please do look at them now: they are standing in queue at the RBI waiting to be bailed out by an "easy" money policy.

Can you imagine the local money lender giving more loans because he wants a higher "market share"?
The Shikarpuris of the Sindhi community are basically money lenders. I asked a friend - would your family have ever given a loan to anyone because they wanted a larger market share of the loan business?

But our new age banks - they wanted market share. They knew that the bigger you get - the more "market share" you have - the chances of being rescued by the government and the RBI increases exponentially.

No one rescues the Shikarpuri banker because his loans turn bad. If his business dies, a few local folks get affected. But if you are a large bank, oh boy, you have the government and the RBI backing you.

Get big quick!

And that is the calculation of the greedy. When things are good, they will get their salary and their bonuses.

When things turn bad - they head to the RBI and the government for a bail out.
And they still want their bonuses.
I am not joking.
They actually believe they have done a good job!

Lehman Brothers has filed for bankruptcy. They have lost billions of dollars for many of their clients and investors.
But there is a pool of USD 3 billion waiting to be distributed for bonuses for some of the many divisions in Lehman Brothers.

It was not us, wail the employees of the "good" divisions, it was them.
Yes, this time it was "them".
Last time it was "you" and "your division".

There are chunks of the financial system that are bred on greed. And everyone who is employed by those companies is part of it - they have silently accepted the rewards in the good years.

Whistle-blowers
Professor Jack Behrman taught me a course called "Ethics in Business".
Not very popular with my classmates - now I know why!

Case studies were discussed. An employee finds out that his company is doing something "bad" but if they keep silent - the company will do very well. Presumably everyone will have a job and be happy.

If this "whistle blower" squeals and tells the government or the press, then the company may not survive. People may be out of jobs.

There are families involved here.
There are lives and old parents do be taken care of.
The jobs pay for all these problems.

What would you do?

Would you be the "whistle blower"? Or would you be the conscience keeper?

Would you merrily whistle along with your hands in your pocket ensuring that your salary and bonus is intact?

Until one day, the whole ponzi scheme crumbles under its own weight.
Until one day, millions of bystanders are left shattered.
Clueless as to what happened.

No, my dear colleagues in the world of finance, we don’t need a world of greed. Let’s try and build a world of humility and integrity.

(And please don’t look for global cues: for a change, let’s have a mind of our own!
Happy New Year and much health and happiness to all of you. ?)

Suggested allocation in Quantum Mutual Funds
Quantum Long Term Equity Fund Quantum Gold Fund
(NSE symbol: QGOLDHALF)
Quantum Liquid Fund
Why you
should own it:
An investment for the future and an opportunity to profit from the long term economic growth in India A hedge against a global financial crisis and an "insurance" for your portfolio Cash in hand for any emergency uses but should get better returns than a savings account in a bank
Suggested allocation (New) 46% 12% 42%
Suggested allocation (old) 80% 15% 5%

Disclaimer: Past performance may or may not be sustained in the future. Mutual Fund investments are subject to market risks, fluctuation in NAV's and uncertainty of dividend distributions. Please read offer documents of the relevant schemes carefully before making any investments. Click here for the detailed risk factors and statutory information"

Note: The Honest Truth is authored by Ajit Dayal. Ajit is a Director at Quantum Advisors Pvt Ltd and Quantum Asset Management Company Pvt Ltd.. Views expressed in this article are entirely those of the author and may not be regarded as views of the Quantum Mutual Fund or Quantum Asset Management Company Private Limited.

Mutual Fund Investments are subject to market risks. Please read the offer documents of the respective schemes before making any investments.


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