Posts Tagged ‘finance’

This post shall be really short. My book review showed up in The New Indian Express. A first.

No satire, (un)fortunately!

 

 

(Un)customary Warning: This is a parody of a rather boring real-life event. Negative interest rates; a topic high on Repulsive Quotient. Mumbo-jumbo is kept down to a minimum, however, and one hopes the brief waddle through an arcane world turns out to be an enjoyable ride.

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Johnny Simple was flummoxed and a trifle grumpy. The reason behind his grumpiness was his government. Simple didn’t really harbour views on the quality, or the sanity, of his government (‘I couldn’t care less’), but in the sleepy surroundings of his home, his mind was astir. An investment that he had made – out of his own free will – was giving him ample cause for bemoaning.

He had chosen the safety of his trustworthy government’s Bonds, had made an investment for a return, waited…but on maturity, something seemed amiss. Simple had naively thought his government would return his principal and then something extra, on his investment. But his government seemed to have charged him for the privilege of investing with it. He learnt the true meaning of ‘return’. To air his misgivings, he sought out a friend, Complexius, and learnt a bit about himself and human behaviour. Complexius quickly got down to dealing with complexities.

For centuries, people thought a country’s government was the safest of safe places to park one’s capital. It was simple. You invested in a country’s government bond, the government provided interim happiness (interest on the bond), and one got one’s investment back at the end of it all. This was when countries around the world were paragons of strength.

Like a body that wilts under the tentacles of cancer, countries were now consumed by Debt. A pale shadow of their strong former selves, countries were scampering to resuscitate one another. The world had changed.

Bank deposit rates had gone Negative.

Ailing countries proclaimed that considering their financial ill-health, their citizens would now have to pay them for the privilege of safe-guarding their savings. A few paused and thought, deteriorating financial health ought to lead to ever higher interest rates as compensation. What in the heavens was happening here? This minority, however, was superseded by a vast majority that deemed it rational to turn over their savings to near-default governments, that were now mavens of shakiness and scrambling in the race for life-support.

Risk-free return was now replaced by returns-free risk.

But humans, bless their rational souls, continued ‘investing’ blissfully in their rationality.

Some thought of taking this a step further.

Earlier, everyone desired more money and growing paper wealth. The rules had changed. Holding Paper Currency was now anathema. There would now be a mad desire to lose money. People would be paid to whisk money off their hands, instead of whisking it off others’ hands, as used to happen earlier.

Soon perpetrators realised that heading to an Ivy League was a great way of launching their lose-money careers. The degrees cost a bomb, and it was seen that Ivy League experience in blowing money served as a tremendous adornment in one’s CV.

This led to a happy situation, where smart fellows (with Ivy League backings) now spent their waking hours conjuring up ways to lose money. Investors brandished their capacity for generating the highest rates of return earlier, in order to garner investors. Now, everyone proudly brandished their capacity to lose other people’s money. It was observed that the ones with a long and established track record of losing money, often in scintillatingly novel ways, seemed to enjoy great demand.

Banks, which earlier were vilified by the larger public, suddenly assumed a God-like persona. Many thought no one would know how to lose money better than those with a centuries-old history of practising the fine art. Banks did not disappoint. Complex derivative transactions, which earlier were onstensibly aimed at reducing risk of loss, were now in vogue; with the sole purpose of finding complex ways of increasing risk of loss.

Governments across the world, well, were already in the game before most others.

This culture spilled over to the social sphere, threatening the very fabric of society by questioning age-old customs. The historical roles of the pilferer and the ‘pilfered’ swapped. Thieves, existing and aspirants, took umbrage to this unwanted development. They remonstrated that their identities were being snatched away forcibly and blamed lose-money Capitalism for this conspiracy.

The culture of education underwent a change too. Oodles of moolah was now spent in providing young humans with an that had little value. The institutions soon had a problem, they were generating massive amounts of money without enough outlets for losing it. So they turned to paying parents to send their kids to school. This circle of bliss, paradoxically, left everyone unhappy. Employment went through the roof, as everyone scrambled to lose money. Governments found that they had little to do, leaving them grumpy. There was no money in being a politician.

Eating also witnessed some queer developments. Farmers now fell over one another to pay consumers to buy food. Gradually, most resorted to not producing any food at all. Food was a source of headache for these producers, so they weeded out the cause. Humankind did not take to this kindly.

Riots began, queerly due to the negative prices for essential food commodities, and then thanks to food scarcity. Food scarcity, however, led to a death spiral of ever lower prices now. Things were not turning out well.

Riots soon morphed into skirmishes, which then morphed into regional squibbles, which then morphed into nationwide agitation, which then morphed into international conflict. Ending in obliteration.

Complexius’ exposition left Simple with a heavy head.

He had never thought losing money would lead to such unhappiness and collective disaster.

Apple was unhappy. Despite giving the world a slew of droolable products and doing its bit to improve quality of human life, there seemed to a growing chorus of voices against the technology industry. Stung by what it thought were unfair allegations, Apple came to believe that this wave of vilification was perpetrated by the Finance industry.

After years of being castigated publicly, Finance had fallen in the eyes of the world. Apple thought that in a bid to redeem its deteriorating image, Finance was inappropriately employing tools of new-age technology – its own products, Facebook, Twitter – to spread the Word. Something had to be done before matters got out of hand.

Apple had nearly $100 billion in cash in its bank. On desultory evening walks, it frequently scratched its half-bitten head for avenues to put this money to work. During one such errand, Apple bumped into Facebook. After hastily exchanging pleasantries, an evidently excited Facebook filled Apple in on its upcoming share offering. Would Apple be interested?

A plan took shape in Apple‘s smart head. It seemed the perfect idea. So designed that all parties involved would walk away with a smile. And, Finance would be dealt a striking blow. As Finance was using Technology to spread its word, Apple decided to employ complex Finance to exact revenge. It felt that the best strike against Finance would be to employ speculation for immediate gains, at the expense of folks who took the opposite side in the proposition. Finance would then be blamed.

Apple suggested that it would be interested in taking Facebook‘s entire share issue on offer. Facebook gloated but it didn’t appear to express much gratitude.

Facebook was looking to raise $10 billion. Apple would spend $10 billion acquiring this stake, a fraction of its $100 billion cash hoard. Things seemed simple so far. But motivated by considerations of vengeance, it decided to unleash complex instruments of Finance. Apple thought of Exchangeable Bonds*.

* Exchangeable Bonds are debt instruments that pay a coupon/interest, and give bondholders the option of converting the bonds into shares of a company nominated by the issuer. Apple, in this case, would be the issuer.

Apple would then make an offering of Exchangeable Bonds for $14 billion. Further, it would offer holders the right to convert their Exchangeable Bond into shares of the hot Facebook. Facebook‘s happiness grew some more on hearing this. Apple investing in Facebook would further fuel euphoria. Besotted by the prospect of its IPO, Facebook did not pause to appreciate Apple’s ingenuity in this innocuous offer. For the Exchangeable bondholders, this would be an indirect way of getting their hands on Facebook‘s shares, which would otherwise be difficult to obtain given the euphoria. Moreover, Apple would pay them (interest payment) to have the right of owning Facebook shares!

Apple felt this would be a coup. Scores of eager beavers wanted a piece of Facebook‘s IPO. Euphoria was so high that no price was deemed too high for Facebook’s shares. The shares would sky-rocket, when they began trading. As shares soared, Apple would let its exchangeable bondholders have their Facebook shares. Meanwhile, it would have discovered a way of making $4 billion without investing a dime ($10 billion spent on Facebook, offset by $14 billion received from its Exchangeable Bond). The money made could be fuelled to creating new products that would sell on (more) euphoria.

To execute these transactions, they would engage every known investment banking company on the planet. Always warm to the prospect of making doubloons, no investment bank would spurn their proposal.

Apple would be happy. Facebook would be happier, and Apple’s shareholders would be the happiest. An alluring prospect, indeed.

The strategy played out as planned. To a point.

…then everything began going awry.

The numerous Likers on Facebook grew tired and spent less and less time on it. Its shares tanked.

Apple’s ingenious transaction was predicated on Facebook‘s shares rising in value. When the share price fell, Apple was in a hole. Its $10 billion investment in Facebook‘s shares went underwater; and it had to pay interest on its Exchangeable Bond plus the $14 billion principal when it fell due.

Apple had orchestrated a euphoric strike on Finance but was promptly consumed by it. As revenge overcame reason, Apple failed to consider the consequences if things went wrong. Finance provided a means of laying off this risk, but in an atmosphere of euphoria, prudence died a quiet death.

The world, once again, pilloried Finance as the Great Evil. Anti-Finance voices added adherents and decibels. The same voices chorused against Facebook and Apple. The latter were blamed for fanning hype and euphoria, leading to widespread distress.

In the Great Battle of Technology and Finance, there was no winner.

Meanwhile, the central protagonists in the drama of euphoria, who were now railing against the above ills, never paused to point a finger at themselves.

In the past century, affluence increased greatly, eager parents could send their future Newtons to big-name schools, which tried furthering education. Schools did a commendable job of schooling folks in tailoring individual actions to suit immediate self-interests but did not teach the art of contemplating the consequences of collective individual efforts. We began believing in the limitless powers of our knowledge. Soon Hubris came knocking and Prudence made a quiet exit.

Not content with building bridges and railroads, man extended ingenuity to other areas. Financial instruments were one such serendipitous invention. Real assets – land, gold, metals – were gradually superseded by paper assets. The benefits of this transition, while real, gradually fostered excesses which began ending disastrously. Attempts at plugging holes only led to creation of new ones. Nobody had/(s) solutions but that does not dissuade us from creating the illusion of finding one.

…and so it is fashionable today to vilify finance as the root cause of our woes. Given this, it is our humble duty to do our bit in furthering this notion. What better way to make a case than engender a crisis?

Yours truly offers a prospect that carries a high probability of culminating in a disaster of gargantuan proportions.

Since gadgets have come to be considered yardsticks of coolness today, we begin with Apple’s battery of products. The launch of the latest iPad was a widely watched event. Even as the price of the latest gizmo was announced, prices of earlier versions of the iPad dropped.

One of the near maxims in the technology world is that a launch of a newer version causes prices of older versions to drop, sometimes precipitously and permanently. The first step would involve creating instruments that derived values from the prices of various versions of the iPad. Once such derivative instruments come into existence, one would buy the instrument that mirrors the latest product (we’ll refer to the derivative instrument as IPD 3, for simplicity) and simultaneously sell the instrument that mirrors the older versions (IPD X).

Crowds, apart from mongrels, are among man’s best friends and should be tapped appropriately. Generally, anything new in the technology world evokes frenzied interest. As flashing the latest gadget seems to have a direct bearing on one’s societal and social media standing, demand for iPad3 would be immense; accompanied by a concomitant decline in demand for older versions. Prices of IPD 3 would increase, while IPD X would fall. The above suggested trade would yield juicy, almost-certain gains. Near risk-free arbitrage.

Fools do in the end what the wise do in the beginning. Once the earliest adopters of this trade make out with handsome gains, the crowd would, as they always do, latch on to the operation. Soon demand for IPD 3, the paper product, would outweigh demand for iPad3, the real product, leading to divergence in prices of the real and paper instruments. The seeds of disaster would begin to sprout…

Demand would then increase to a point where frenzied people would find it difficult to get in on the trade. The concept could then be extended to other competitors. Blackberry and Samsung, for instance. Keen technology watchers would have, no doubt, followed Blackberry’s recent tale of woe with alacrity. Instruments similar to IPD 3 that mirror prices of Blackberry’s slew of products would be created and pumped into the system to satiate demand. Smart folks would, for instance, buy Apple’s paper derivative instruments and simultaneously sell Blackberry’s.

We could utilise another fashion of the present day. Social media. Twitter and Facebook would be helpful in creating Like-able pages and spreading the word. Crowds would be useful here too. As most of us revel in indulging in you-lick-my-back-I-lick-yours activity in the social networking world, the above idea could go viral, till a great number of people joined the juggernaut. Gradually, so many would be dabbling in the trade that nobody would remember the original idea or the mode of execution.

Just to ensure that the crisis would be one of gargantuan proportions, we could introduce another instrument suggested by yours truly earlier. Fortune Default Swap: Hedge Your Misfortunes Away, that is designed to safeguard against attacks of misfortune.

Once enough people line up on one side of a boat, not much is needed to tip the boat over.

Crowds would serve as catalysts that would trigger the disaster. Prices of the real and paper instruments would get so far out of whack that a group of smart early bunnies would look to cash out. All at once. These would be the original boat rockers. Once enough folks rushed for the exit, all at once, the process of crisis creation would be complete. By then, the above instruments would have become so big that they would qualify for too-big-to-fail.

At this point, governments would get involved and orchestrate a bailout to save the crowds, so they could indulge in similar activities in the future.

Finance would be vilified.

…and the crowds would live (un)happily ever after.

10,000 words reside in the recesses of my brain, somewhere, yearning to get out and grace the world. Time, as always, is one’s best friend, but one whose company I seldom seem to enjoy for long. The serious (and boring) writing is out on hold to make way for momentary craziness, a fuel that’s necessary for mankind’s survival.

I overheard a girl whining away to a friend in the tube (okay, I eavesdropped. That’s the most productive thing to do when your mouth and brain are inactive). The object of the whining was her apparent misfortune. While she did not elaborate on the causes, I suspect it was love that was the omnipresent protagonist. But we won’t get there. I liked the misfortune bit; as it happened to be the inspiration behind an idea that makes up this post. Needless to add, I dutifully stopped eavesdropping once I set off in my chain of thought…

I thought of the very many people around me who somehow seem oversold on their own misfortune and their neighbour’s good fortune. I include myself in this category. Aggregate this to a sample population and what we have doesn’t appear a zero-sum game. The collective misfortunes seem to be outweigh the good bit several times over. Well, of course something’s amiss somewhere, but then, wth, I’m eyeball deep in my beliefs to worry about zero-sum games with Lady Luck.

What is a Credit Default Swap? Do I digress? Not quite. A Credit Default Swap, or CDS for short, allows a buyer to insure himself against a bond issuer’s default. In simple terms, a CDS buyer makes a series of cash payments to a CDS seller, much like a life insurance contract, in return for a promised juicy payout should a bond issuer default on its debt. To make the idea simpler, a CDS basically protects the buyer against a slew of possible misfortunes that might strike the issuer of a bond over a period of time.

A Fortune Default Swap (FDS) would work similarly. An FDS buyer would make a stream of cash payments to the seller in return for a promised payout in the event of sudden and unannounced misfortune strikes. Misfortune could be defined to include numerous things. When I look around, the number of items that could be included under the misfortune category number in the hundreds, if not more. But this could be handled with some tweaks.

Who could be interested in an FDS? Since I seem to be convinced that my neighbour’s fortunes are perfectly inversely related to my own, I could be interested in an FDS contract. I must add that the inverse relationship seems to hold only for my misfortunes and not for my good ones (there never seems to be enough of the good variety, and there seems to be even less of ill fortune inflicting others).

I would consider buying an FDS and making a stream of payments to a willing seller, in return for a lump sum payout in the event misfortune were to strike….me! I would be the object of misfortune and once I enter into an FDS contract, I would have effectively hedged my misfortunes away! Now, if misfortune were to strike, I would be happy because the FDS payout would protect me. The FDS would turn misfortunes into boons. Once I purchase an FDS, I would look forward to bouts of personal misfortune…the more the merrier.

Since my neighbour seems to view the fortune/misfortune relationship much the same way as me, he would enter into an FDS to protect himself. And given the fortune/misfortune relationship, I would be the seller for this contract. I do so because I believe my misfortunes would outnumber my neighbour’s, leading to greater cash inflows for me over a period. My neighbour, in turn, becomes the seller on the FDS contract that I buy on myself, since he believes……

So we have 2 FDS contracts; one, in which I am the buyer and another, in which I am the seller. Since my neighbour and I would be making a stream of payments to one other, the contracts could be priced such that there’s effectively no net payments to assume the other’s misfortune risk. Now only misfortune-triggered blow-ups would lead to cash flowing from one side to another. I would happily enter into such an arrangement because I’m convinced I would end up with a net cash inflow.

The FDS idea would help me pass on my personal misfortune risk. It would allow me to be fortune neutral. If I was lucky enough to have a run of good fortune, the happiness that I derive from this would dwarf the cash payments I make on my FDS contract. In the event of a run of misfortunes, the cash payouts from the FDS contract would somewhat assuage my busted happiness. The product would have an additional hidden benefit. By monitoring money flows, it would be possible to put the theory of my misfortune/neighbour’s good fortunes to test. The fortune/misfortune relationship could be quantified meaningfully for the first time ever.