Archive for the ‘Financial Markets/ Finance’ Category

Is the banking industry undergoing a change or a transformation?

February 17, 2017

A nice speech by Mr Frank Elderson, Executive Director of the Netherlands Bank.

He nicely mixes the consulting/strategy talk with that of central banking:

Now, the banking industry is facing several challenges. Fintech is rising, consumer trust is damaged and Basel 3.5 is on the horizon. Then there is doubt about the future of Europe, growing criticism of globalisation and uncertainty about the geopolitical landscape. Meanwhile, the world is trying to achieve the Sustainable Development Goals and implement the Paris Agreement.  

Banks will have to adapt – perhaps contribute – to this and the question is how. What is an appropriate business model or strategy? And what is the best form for the key functions that banks perform, such as safeguarding money, providing loans, and determining risk and return? Or is there a future in which non-banking entities perform banking functions?

In discussing these questions, perhaps it’s worthwhile to distinguish between change and transformation. To me, change implies an increase or decrease over time of something while its nature remains constant. Money was first metal, then paper and now digital, but it’s still money. And today’s stock exchanges are in essence quite similar to those established centuries ago.

Transformation is different. It implies something essential changes and a new order emerges. A caterpillar transforming into a butterfly. A child transforming into an adult. Philips, as Hans de Jong so eloquently described it, transformed from a consumer tech company into a health tech one. Transformation takes time, vision and the courage to take tough decisions. And it is anything but easy to genuinely transform an organisation’s culture.

Having said that I wonder: is the banking industry changing or transforming? Perhaps both? I am sure this is something we can debate at our tables later on. For now, I would like to stress that transformation is not just an inspiring concept, but also a practical and operational process. People and organisations have a capacity to transform that can be nurtured. In today’s turbulent environment, banks would do well to evaluate this capacity. It could mean the difference between relevance and irrelevance.

Sums up the issue quite neatly indeed.

He then points to some lessons from the central bank on their work on pension funds:

DNB has conducted research into the capacity of pension funds to transform and we found several things I am sure apply to other industries.

For example, we found that leadership is key. Specifically, individual leaders with the capacity to identify changes in the landscape, develop best-case and worst-case scenarios and create a compelling vision. Also leaders who are able to develop a strategy around this vision and then execute it. The leadership team is of importance, too.

There needs to be openness, trust and diversity in terms of personalities and competences. We also found that pension funds need to be appropriately equipped.

They need to be agile, have an up-to-date IT infrastructure, have sufficient budget and task the right people with the transformation process. And pension funds need to have their house in order. For unless everything runs smoothly, the organisation will focus its attention on managing the present rather than designing the future.

Finally, we found that pension funds need to be proactive. If they wait until the environment forces them to change, they are at risk. Instead, they should proactively adapt. Some pension funds began to transition from a defined benefit to a defined contribution system years ago and they are now in a good shape. Those who haven’t, are struggling to adjust to changing realities. So transformation is a process that can be managed. But the process needs to lead to something. Transformation is a means, not an end. So what is or should be the end result of a bank or the whole banking industry transforming?

He says organisations should have a well-defined purpose (vision/mission?) and work towards their purpose. Netherlands central bank purpose is financial stability (as monetary function in hands of ECB):

De Nederlandsche Bank believes in the value of having a purpose and we cherish ours. We are in this world to contribute to the sustainable welfare of the Netherlands by promoting financial stability. Through this, we also contribute to the realisation of the Sustainable Development Goals. This inspires us and guides us in relating to our stakeholders. And it seems we are not alone in this. Last December, the Dutch Banking Association published a report in which it explored how banks can contribute to the Sustainable Development Goals. I wholeheartedly encourage such explorations.

Many issues simplified..

Central Banks are served by club of elite PhD economists and suffers from groupstink…

February 10, 2017

A former Dallas Fed employee has written a stinker of a book accusing Federal Reserve (applies to most central banks) for all kinds of things. The book is titled as: Fed Up:  An Insider’s Take on Why the Federal Reserve is Bad for America.

The WSJ article provides a glimpse:

(more…)

Predicting human behaviour is legal, predicting machines is not?

February 9, 2017

Prof JR Varma of IIMA has a food for thought post.

He points to casinos saying they look for whatever possible ways to predict human behaviour and make you gamble more and more (and lose). However, any person who looks to predict these machines and play the game is deemed as illegal. Why?

(more…)

How storytelling drives finance and economics…

February 6, 2017

Brendan Markey-Towler who is an Industry Research Fellow at The University of Queensland has a nice piece.

He says whatever the model and its logic, finally it is the story which leads people to invest in markets:

In his recent presidential address to the American Economic Association, Nobel Laureate Bob Shiller drew attention to the importance of narratives in economics and, particularly, in financial markets. This corroborates some recent research by the author and colleagues at the University of Queensland into the psychology of economic behaviour.

When we tell ourselves stories, we link up a number of different events into a coherent whole. In financial markets and across the economy as a whole, these stories not only affect expectations but are expectations. And expectations shape behaviour.

Our research shows that the more simple a story, the more it extends and agrees with preconceptions, the more persuasive it is. A good story becomes embedded in investors’ minds; the story becomes the expectation.

If a narrative embedded in the mind of an investor tells a positive story about, for instance, profitability, they will act on it. A positive story results in good news in the financial markets.

It is a pity that this building of narrative was once a major strength of economists. This is how they captured the imagination at the first place. Now it is all hopelessly lost.

Reviving PIMCO..

January 31, 2017

Nice Story of how Jackie Hunt is trying to revive PIMCO. PIMCO saw a shocking decline post exit of its star Bill Gross. Now the fund is slowly trying to come up once again:

(more…)

Betting on Nordic rain pays better than your average Hedge Fund

January 27, 2017

Jesper Starn of Bloomberg has a nice piece showing how Nordic electricity utilities gave better returns than hedge funds last year.

(more…)

Hedge-fund managers are buying air strips in New Zealand in case…

January 24, 2017

An interview of Rob Johndon, President of INET.

He says one indicator to look for is the elite anxiety which is rising . As a result, the top elites in US are buying private spaces in New Zealand and private planes to fly there:

(more…)

Legislating Instability: Adam Smith, Free Banking, and the Financial Crisis of 1772

January 20, 2017

This is the title of a book by Prof Tyler Goodspeed. A brief of the book is here.

The failure of Ayr Bank in 1772 was a turning point in financial history. It led to change in thinking of Adma Smith who till then favored banking free of government regulation. Thus, this event continues to inspire financial historians who look for different viewpoints to explain the crisis.

Prof Hugh Rockoff reviews the book and sums up:

(more…)

Financiers of Victorian England would marvel at our nativity about markets and economics

January 19, 2017

An old post written in Oct 2016 but really fascinating.

Andrew Odlyzko, Professor of Mathematics (?!) and an interdisciplinary researcher writes about Victorian Finance:

(more…)

What I learned from Warren Buffett and Charlie Munger?

January 19, 2017

Shane Parrish tries to answer the question.

We make a big deal of skills of investors and financiers but deep down it boils down to basic human qualities.

(more…)

How culture shapes conversations about money, financial abuses and respectful relationships…

January 17, 2017

This is a part of economics/finance which is least studied but is important. Who controls financial purses (the male or female) in a household and why? Most of the time why is related to the cultural practices.

Prof Supriya Singh (Sociology in RMIT University) shares her recent research with a colleague on the topic. She looks at two cultures in Australia – Anglo Celtic and Indians:

(more…)

Will Brexit change history of financial centres?

January 5, 2017

There is just so much of financial history here.

Earlier talks of financial centre moving from London were dismissed. But now talks seem to be picking up pace and steam.

Paris is meeting London based bankers to shift base to French capital:

(more…)

British bank branch network decimated with move to mobile…

December 15, 2016

Chris Skinner points to a report which shows nearly 1000 bank branches (10% of total branch network) have closed down in 2 years. Reason? People have moved to mobile banking:

Building on yesterday’s news, the consumer research organisation Which? just released a report with a whole bunch of stats on UK bank branch closures.  Over 1,000 branches have closed in the last two years, with HSBC being most aggressive, shutting over 27% of their network.

A total of 1,046 branches – equivalent to 11%  of the total UK bank branch network – closed between January 2015 and January 2017, with rural areas affected the worst.  As the map below shows, it’s particularly bad if you’re in Scotland, Wales, Devon and Cornwall.

HSBC claim they can be this aggressive because footfall has reduced by 40% in their branch network as more and more people are online.  However, 20 million people don’t use online services and many of these people are in the areas where the most aggressive closures are taking place, as in rural villages with limited access to broadband services.

Tut, tut.  The British Bankers Association are updating their guidelines about how banks close branches.  Meanwhile, as can be seen, most rural users are moving towards mobile banking.

This is interesting. 1000 branches in 2 years is a big number (needs to be verified). One would also be interested in the job losses due to closure of so many branches.

I hope Indian authorities are looking/aware of this aspect as well while making rapid strides against everything digital.

The Swiss private bankers should be a model for bankers everywhere (and the lost Indian ones)…

November 30, 2016

Mention Swiss banking and we either have the image of them as hiding wealth of uber rich across the world or the UBses of the world. But the region also has a much lower profile and glamorous set of bankers called Swiss Private bankers.  They are these century old bankers which have held the principles of banking for a long time.

Marcia Christoff-Kurapovna writes about these bankers:

The strong showing in banking stocks may show some optimism following the presidential election victory of Donald Trump. But, a healthy future for US banking will only take root if that industry comes to terms with the original purpose for which banking was intended — wealth management. As such, the great American bank in generations to come will not be of the calamitous Wells Fargo or Bank of America type — or even Facebook’s Electronic Money Institution license or Google’s Mobile Wallet. The most solid banks will be remakes of that timeless classic, the Swiss private banker. It is this “back to the future” philosophy of banking, already prevalent in some of the past decade’s best performing and least known banks in the US, that must become predominant if that sector is to remain resilient……

The focus instead must be on the cultivation of localized, community-centered but nationally ambitious banks that one rarely reads about amid the stories of pointless bail-outs, fake-account scandals, ZIRP, and robo-trading. Superbly managed and often family-owned, these banks profited throughout the post-crisis period, enduring regulatory mayhem, Fed mission-creep, and the rise of ‘alternative banking” fintech and mobile-app technologies. They did it by sticking to sound fiscal fundamentals and never underestimating the “psychological” preference on the part of the public for sturdy institutions whose owners or managers are members or descendants of that founding banking family itself. Though PriceWaterhouseCoopers gloomily predicted that traditional banking would not survive beyond 2025, it is precisely highly successful banks like Beal Bank of Dallas, Texas, or the 100 year-old Bank of Fayette County in Tennessee, that will be the only banks to survive the next decades and beyond.

These Private Bankers are not Private banks:

To understand the real next-generation banking, let us look to the forefather role model that embodies the very best of ultra-traditional banking principles: Switzerland’s national legend, the unlimited liability banquier.No American bank, including the two examples mentioned above, follow this ‘severe’ Swiss model. Still, such Geneva, Zürich, and Basel-based aristocratic workhorses in the art of wealth management and no-frills (not even on-line) banking are the kinds of institutions where money still means gold and Ms. Yellen’s machinations an amusing, yet comfortably distant, American curiosity.

First off, a nuance of definition. The expression is “Swiss private banker,” and not “private bank,” or “private banking.” This first refers to a very specific institution, defined by 1934 Swiss law and, as an expression (“Swiss private banker”), is a registered trademark. These are not UBS- or Credit Suisse-type banks (which are, for all intents and purposes, American banks), nor simply lesser-known tax-evasion vehicles shrouded in glamorous secrecy. Instead, the term refers to a narrowly defined privileged few “houses,” often centuries old and almost always still family owned, that, by law, must adhere to unheard-of (on these shores) personal liability among their partners and high reserve requirements, among other standards. Indeed, in the last three years alone, the number of these banks has dwindled from twelve to six, as pressures from the global economic crisis forced several of them into limited liability companies. 

They are in a class of their own, synonymous with unbounded responsibility. The six remaining are: Baumann et Cie.; Bordier et Cie.; E. Gutzwiller et Cie; Mouge d’Algue et Cie; Rahn & Bodner; and Reichmuth & Co. “Private bankers” as these are: (1) exclusively organized in the legal form of a partnership or limited partnership; (2) run by partners who are usually family descendants of the banks’ founders; (3) invest their own capital in their banks and maintain high cash reserve ratios; (4) defined by a special private-banker status that is dependent upon the presence within management of one or several partners with unlimited liability for investment obligations. This last is their greatest distinction. Other Swiss banks offer wealth management services but their maximum liability is confined to equity capital. With private bankers, liability is not solely limited to the company equity, but partners are additionally liable with their private assets.

Thus, their primary duty is to their clients, to their own families, and to their own vested responsibilities — a quaint notion these days, to be sure. They are run by a flat management structure; decision-making chains are short; they do not develop their own products and are therefore not subject to any conflicts of interest in investment advice. Investments must be tradable and liquid at all times; bankers can’t act as brokers and they are not on-line banks. They are not allowed to sell their own instruments, tend not to invest in global real estate, and, as mentioned before, have strict rules on reserves.

India too had these bankers which were called as indigenous bankers. They were called as Shroffs, Multanis, Marwaris, Chettiars and so on. But they have all disappeared from the mainstream banking scene. They were mostly given bad names by the media and experts alike failing to look at how some of them actually excelled in banking for many years and even centuries. Some of them like Chettiars in Madras even used their banking skills  to form joint stock banks like Indian Bank, Indian Overseas Bank, Karur Vysya Bank and Laxmi Vilas Bank and so on.

There was this tiff between the Government/RBI and Indian Private Bankers. The former wanted them to be regulated as per banking regulations which latter refused as they found the regulations highly restrictive and so on. Till the 1970s there were efforts between the two but now we hardly hear about them.

Many mistrust banks, but why you mistrust banks says a lot

November 15, 2016

Erica Vause, Assistant Professor of history at Florida Southern College writes on this dilemma on banking. Banks run on trust but remain on of the mistrusted organisations. Why is this so?

Since the early 19th century, banks have thrived, and are foundational to modern economic life. Yet the ambivalence surrounding them has not dissipated. Over the course of the 19th century, the ideal of the independent property-owner, upheld by the classical republicans, gradually faded. Instead, factory labour became the ideal form of ‘real’ value, beside which finance seemed dubious and fictional. The heroes of many 19th-century novels, such as Elizabeth Gaskell’s North and South (1855) and Anthony Trollope’s The Way We Live Now (1875), preferred the ‘real’ work done in factories to the ‘fictional’ and often dangerous fortunes to be reaped from financial speculation.

Viewed in light of this long history, present-day distrust of banks, so salient since 2008, appear less as novel reactions to our changing times than as the latest chapter in the long-running paradox of trust and credit. On a day-to-day basis, most of us trust banks well enough. We’d prefer to deposit our money in a bank account than, say, stuff it in a mattress. Yet no single capitalist institution compares with the bank in terms of the sheer amount of unease and antipathy it engenders. Polls show that a mere 18 per cent of Americans trusted banks in 2010. The 2015 Edelman Trust Barometer, a yearly survey of attitudes across 27 industrialised nations, indicated that, among major industries, only the media is less trusted than banking and finance.

Suspicion of banks today traverses the political spectrum. Different political viewpoints tend to linger on different aspects of the original critiques of the banks. The Left sees finance as integrally connected with a parasitic elite of largely idle profiteers. Much like the classical republicans of yesterday, they see banks as guilty of fabricating fictitious value and avoiding ‘real’ work. The Right portrays banking as a threat to personal or national sovereignty. They evoke the classical republicans’ anxiety about banking and despotism. In the United States, for example, conservative commentators such as Glenn Beck and Ron Paul have not only charged the Federal Reserve with causing inflations and depressions, but denounced it as an instrument of tyranny. Outside mainstream discourse, conspiracy theories about the banks are often tinged with anti-Semitism. Try searching for ‘banking’ on YouTube. In these conspiracy theories, rumours such as the one about the Rothschilds and Waterloo thrive.

No institution more clearly relies on trust than the bank. That is precisely what makes banks a lightning rod for suspicion. From the time modern banking emerged, it has been the subject of intense misgivings. Many of these suspicions are with us still. How and why one mistrusts banks, however, tells us a lot about the way one sees the world politically.

This is all very interesting aspects of banking and finance.

Given what is going on in India at the moment, it is not difficult to see rise in mistrust in banks.  Earlier they impacted lives of the big and mighty, now they impact life of one and all.

As we move from branch banking to digital banking, worries move from branch looting to account hacking…

November 10, 2016

Banking and its security breakers have a Tom and Jerry relationship. The banks keep looking for new ways to increase security and the breakers keep looking for new ways to break the same.

This article argues how one third of accounts of a British small bank have been hacked recently. It also highlights how the issues are not limited to small banks but for larger entities as well:

We’ve seen some pretty strong attacks on banks cyberdefences in the past year. Three major incidents in the SWIFT network; 50 at the Federal Reserve; problems at the Bank of England and many other central banks; a major incident at the Danish payment processorNETS; and big banks like HSBC and JPMorgan have all been affected.

Admittedly, most of these are DDoS – Distributed Denial of Service – attacks, which bring down websites but not banks, yet that’s just the tip of the iceberg.  After all, it used to be that thieves would rob bank branches as that’s where the money was; now, they rob bank servers because that’s where the money is.

These incidents of cybercrime are often unnoticed however, as banks are loathe to go publish and say they were hacked … but one did just that this week.  Tesco Bank.  A hacker got into the bank and compromised 40,000 of their 136,000 accounts.   That’s a third.  Of those compromised, the bank originally thought that 20,000 had been hacked with money taken, bvut it turns out it is 9,000 who lost £2.5 million ($3.2 million).   Even so, the bank had to shut down their internet banking service to all customers for several days, whilst they sorted out the mess, and suspended all online debit card and contactless card transactions.

That is seriously worrying for a bank’s reputation.  They’ve promised to reimburse all customers who were impacted, but to openly say they were hacked is not good for the image.

He says one solution is for the banking industry to cooperate and evolve more robust cybersecurity standards.

But the jerrys will soon figure whatever Tom (or Toms) does and rob the cheese.  This hacking will be a huge concern going ahead across banking. Basically it is the age old relation which is not changing. The medium is changing from robbing branches to hacking accounts on a digital platform.

The history of student loans goes back to the Middle Ages

November 10, 2016

Superb piece by Jenny Adams, Associate Professor of English at University of Massachusetts Amherst.

He points how people could take student loans bu givings books as collateral:

Prompted by my own anxiety about educational debt, an anxiety that intensified several years ago with the birth of my own prospective college students, I have been researching the long history of educational loans in order to get a better context for the current student debt crisis. With student loan growth rates spiraling out of control, it behooves us to think through the ways other time periods and cultures have monetized, funded or not funded student labor. 

The history of student loans starts with the establishment of institutions of higher learning in medieval Europe from the late 11th century.

The University of Bologna, considered the first official university, was quickly followed by the University of Paris, Oxford University and Cambridge University. All of these places offered degrees to young men, training them for positions in the Catholic Church and, later, in government.

At first, scholars who needed money did not differ from other borrowers: everyone took loans from the same lenders. But in 1240, Robert Grosseteste, the bishop of Lincoln, used Oxford University money to launch the first documented student loan system. He named it St. Frideswide’s Chest.

St. Frideswide’s Chest was literally a chest. Bound by two different locks, with each key held by a different college magister, or faculty member, it resided at St. Frideswide’s Priory, a religious house in central Oxford, amid the city’s colleges, academic halls and student apartments.

To get a loan from St. Frideswide’s, a borrower had to be a scholar of modest means – and likely took an oath for proving so. He also had to have something of value to deposit in the chest as collateral. From the pledge notes I’ve seen in roughly 100 manuscripts and descriptions of manuscripts, it’s clear that scholars hocked everything from silver spoons to gold plates.

But the most commonly collateralized items were books. Not fancy, illuminated books. Just textbooks. In the late Middle Ages, this included works by Aristotle, the Bible, law codes and medical tracts. Here’s a link to a manuscript at Balliol College that was used as collateral. The lines on the final page record two loans taken out by a scholar, Thomas Chace, in 1423 and 1424. The Merton College manuscript (pictured) contains eight pledge notes from the same century.

Then advent of printing machine made books cheaper and books no more worked as collateral.

Overtime loans were given on future incomes and not collaterals:

Yet even before this, the loan system had started to decline. Although the arrival of the printing press in the late 15th century didn’t have an immediate effect on manuscript production, it would eventually make books cheap and thus no longer worth collateralizing. Even in the chests’ final century of use, the use of gold plate and jewelry was increasing and by 1500 had surpassed the use of books.

Around the same time, bankers began to make loans on the premise of future returns rather than in exchange for real property. The shift toward anticipated future earnings soon came with the England’s 1624 legalization of interest-bearing loans, which pushed even more people into this model of lending.

With their loan chests gone, students again became just like other borrowers. And just like other borrowers, they, too, could end up the notorious debtors’ prisons that began to swell with inmates as early as the 17th century.

Student loans arrived in the United States in the mid-19th century. Like the medieval loan chests at Oxford, these loans started through a singular university, in this case Harvard, which administered them.  This localized system changed in the mid-20th century with the creation by the Department of Education in 1965 of federally guaranteed student loans made by private lenders and available to students across the country.

Students were once again put into a special category. But in this case, this meant they could now collateralize their estimated future incomes (without even knowing what those incomes might be) in order to obtain a degree.

No one is suggesting to go back to middle ages. But we should think why educ has become so expensive? Moreover educ is jeopardizing the very future it is expected to brighten:

I would never advocate a return to the Middle Ages. Yet as we consider the current morass of educational debt, we need to think harder about historical precedent.

True, medieval universities excluded many groups – religious minorities, feudal villeins (a commoner legally tied to a feudal lord in the Middle Ages) and women were barred from entry. Yet poor young men with talent had a chance. Fees were not high. Patrons helped out. And if one needed money, one might be able to pledge a book – not a future.

Fascinating.

India was once the hub of education for not just scholars in India but outside as well. How were students financed back then? I am sure some form of student loan existed even back then. It could be pretty thriving one as well..

How Yale runs its endowment fund?

November 9, 2016

There are two things to  endowment fund run by US universities. One is their huge size which is more than size of GDP of several countries. Two, most of the business schools in these univs would be teaching the utility of passive or indexing fund management. So ideally all these funds should be just invested in some index fund as their own Profs would say. But the univ does the opposite by appointing an active fund manager to do the job!

Here is a profile of David Swensen, fund manager of Yale endowment fund.

Mr. Swensen’s route to the endowment world was circuitous, though. “My father and my grandfather were both chemistry professors,” he said. After earning a doctorate in economics from Yale in 1980, he considered teaching that subject. But while he was researching bond prices at Salomon Brothers for his Ph.D. dissertation, “they offered me a job,” he said.

Salomon was, of course, a Wall Street bond titan at the time and would eventually help define the go-go 1980s “Barbarians at the Gate” era of leveraged buyouts. All of that was still a few years in the future, though, and anyway, Mr. Swensen said, “I missed Yale so much that I went back to teach one class every semester.”

In 1985, the Yale provost, William C. Brainard, plucked him from Wall Street and asked him to take over the school’s $1 billion endowment.

His acceptance meant an 80 percent pay cut. But Mr. Swensen says he never regretted returning to work for an academic mission. “I am in the fortunate position of making very good money,” he said, for something he loves doing. He made $5.1 million in 2014, the latest numbers available.

From the beginning, he brought in analysts and interns to work on the portfolio. Part of that process soon included the weekly meeting to debate investment ideas. “Seeing that there was a debate, even at the most senior level, taught everyone to have their own view,” Mr. Golden said.

There is something about writing these profiles of a fund manager. They read so pristine and make the person appear as some god or something. They are so similar that they all appear too good to be true. All this lasts till the fund does well. As it makes losses all these adjectives turn into something else…

Mutual Fund SIPs are about psychology and not math (the idea is so similar to a chit fund…)

November 8, 2016

Dhirendra Kumar of Valueresearch usually has great pieces on personal finance and mutual fund matters. The best bit is he always sticks to basics and questions all the jazz which keep coming as hype only to disappear eventually.

In a recent piece, he questions all the noise around Systematic Investment Plans. There are lot of ads showing all the math around SIP:

There are now some six-seven types of SIP available from Indian mutual funds. You can have ‘value-based’ SIPs; SIPs with different periodicities, which claim better returns; SIPs that split monthly instalments into weekly ones; SIPs which claim different dates give better returns; and SIPs that vary your monthly investments according to even more complex formulae.

That’s a lot of choice, and consumer choice is always supposed to be good, right? Well, not quite. I’ll put it bluntly. Having lots of choices in SIPs is an unequivocally bad thing. These choices misguide people as to what the real purpose of SIPs is and how they can succeed at SIP investing.

Worse, they promote the idea that the way to get better returns lies in some newly discovered trick or feature that is available in some SIPs and not in others. This is a bogus idea. The value of an SIP lies in its simplicity.

…..

An SIP is all about investing a fixed sum regularly in an equity fund, regardless of market conditions. Over the long term, you end up buying more units when the markets are down and fewer when the markets are up. Thus, your average purchase price is much likelier to be lower than what it would have been otherwise. Therefore, when the time comes to redeem your investments, they are very likely to be worth more than what they would have been. That’s all there is. There are no guarantees, and there are certainly no fixed formulae of expected returns. ….

However, there is a bigger reason to invest through an SIP. The real value of an SIP is not in maths but in psychology. SIPs are the simplest way of investing regularly and getting good returns from equity, without having to worry about when to invest and when not to invest and thus often missing out on the best opportunities. When the markets turn discouraging, the general instinct of many investors is to stop investing, either because they are scared or because they are trying to catch the bottom. However, SIP investors – not all but most – tend to continue their SIPs. Soon, when the markets go up, this teaches them the value of not stopping their SIPs in bad markets. Thus begins a virtuous cycle, creating a larger new generation of investors who understand the value of regular investing.

This is so true. It is more about psychology than anything else. Much of finance is around psychology as it moves based on so many expectations driven by behavior of so many people. Math is just an effort to add some sanity to the picture but makes it endlessly complicated.

I was thinking about something else. It is interesting how things in finance are interconnected and keep going in circles. What is the history of these SIPs? How did they start and where did the idea come from?

I ask this as the idea for a SIP is hardly new. The chit funds which are a thousand year old financial mechanism, the idea was same. Contribute small amounts regularly just to develop that saving habit. Just that in a MF the proceeds are invested in some securities and one is given units showing the ownership of the stocks. Overtime, the amount invested grows which one can use later for consumption or other things.

In chit funds, one instead bid for the pool to use it for consumption purposes. The securities markets had not developed back then and people needed money higher than their savings. So, this system was devised. It also avoided problem of collateral.

Just like in a MF the fund manager matters, similarly in a chit fund the foreman mattered (there was no case of women running the funds despite their origination in Malabar which had a matrlineal system). The foreman is responsible to collect the funds periodically and investors have to ensure that he does not run away.

So there are these similarities and there are these differences as well. But the idea of using human psychology and save regularly  is the crux behind both. SIP may look and sound modern but similar thoughts started much earlier.

There are a few of these core ideas which keep coming and going back and given new names. One could impart such ideas while teaching finance than the usual math way.

How Americans learnt about farm credit from Europeans and modified to suit their politics…

November 8, 2016

As most economics and finance professors are at sea with financial history and institutions, scholars from other disciplines are helping us learn.

Sarah Quinn who is a Prof of Sociology at University of Washington has an interesting piece on evolution of American farm credit system. Not surprisingly, much was borrowed from Europe where these developments had started much earlier:

Hoping to learn from other countries’ experiences in organizing finance for agriculture, more than 150 Americans were sent abroad in the summer of 1913 to investigate the minutiae of farm-credit systems in and around Europe.

They were sent as far north as Norway and as far south as Egypt, with Ireland and Russia marking the western and eastern boundaries of the study. They learned of microcredit-like experiments to support small-plot tenant farming in Italy. In France they were told how farm credit embodied democratic ideals. In the Netherlands and Spain, commission members found counterparts who, like the Americans were doing, had looked to other European nations for ways to improve the management of farm credit. Perhaps the most anticipated stop of this trip would be in Germany, whose system of long-term farm credit distribution had achieved world renown.

The key ideas brought home from Europe by commission members more than a century ago still shape today’s U.S. credit policy. The organizing principle of these ideas was the proposition that providing farm credit could be a low-cost and politically palatable form of economic policy through which government could help people help themselves. This paved the way for the Federal Farm Loan Act of 1916, which redesigned the U.S. system from the ground up by creating a new network of government-supported farm credit cooperatives.

This idea of federal credit for agriculture was used for other purposes as well:

The Act was arguably a watershed in the use of credit as a federal policy tool whose impact was felt far beyond the agricultural sector. Before 1916, the national government used credit allocation more sparingly, as a temporary means to support expensive internal developments such as railways. After the Act, there was a continual expansion of programs that bought, sold, issued, guaranteed, or otherwise promoted the flow of credit to specific sectors or groups. In the United States today, one third of privately issued debt is backed by the government, not only through the Fed but also through the $3.4 trillion in loans guaranteed or held through a vast network of federal credit programs (if you include implicit guarantees of financial debt, the amounts are much, much higher). As Marianna Mazzucato and L. Randall Wray have noted, these forms of credit support are a central part of how the federal government participates in the U.S. economy. This proliferation of government credit allocation seems remarkable in light of longstanding political attitudes on government involvement in the economy.

The German system trusted its bureaucrats to deliver. But there was no such system in US. Moreover, it was felt that any such fedeal program if not carefully worded would be met with deep suspicion. This led to another 12 regional Feds to disburse farm credit.

To overcome these objections, proponents of a European-inspired farm credit policy spun it as government helping people help themselves, providing credit support could through farmers’ cooperatives.

The divisive nineteenth century credit politics gave way to a vision of credit as an inoffensive means of economic development, of low cost to the state. Proponents argued that “wise legislation” to lower credit risk could unlock the value of the nation’s land, then estimated by one commentator at $40 billion. It was a huge potential payoff. Later scholars of credit programs would frequently note the same thing about the federal credit programs: compared to direct forms of welfare or other expenditures, credit support is cheap, since it can be implemented by government guarantees, tax expenditures, risk management techniques, and disbursements paid back over time, sometimes with interest.

This logic was built into the structure of the Federal Farm Loan Act of 1916. The centerpiece of the Act was a proposed local version of the German system. The Treasury was authorized to fund 12 reserve banks in order to funnel credit to a network of new farmers’ lending cooperatives. The Department of Agriculture encouraged the formation of these lending cooperatives through a massive education effort. In a nod to American independence, the German system of risk sharing — in which members of the Landschaften were liable up to the full value of their property — was watered down. If the bank itself ran into trouble, American farmers would be liable for only 10% of their loan amount, rather than for the full value of their property. Since, over time, farmers could pay into the system and repay the state, the long-term costs of the program were expected to be low. Tax-exempt bonds would encourage a flow of funds into the reserve banks at the cost of some state revenue, but this was far less expensive than, say, directly subsidizing farmers.

For all that the 12-bank structure mimicked the Federal Reserve Act, the creation of lending cooperatives meant that the FFLA was a far more complicated, experimental, and entrepreneurial design.

Till date, Americans carefully present or word these programs:

In the “Analytical Perspectives” section of the President’s budget, the chapter detailing the $3.4 trillion in loans held or guaranteed by the federal government reveals the diverse political uses of credit. Federal credit has military functions, including Defense Department loans for the purchase, stockpiling, and manufacturing of military materiel, and the Atomic Energy Commission’s use of guarantees to encourage nuclear science. Credit is also a tool of foreign policy: the United States exports food to other nations through USAID. Loans can serve as disaster relief, as both FEMA and the SBA include credit support to assist with natural disasters, and the federal government also provides loans directly to states for this purpose. Credit is also extensively used as part of energy and environmental policy, with geothermal and renewable energy, biorefineries, and synthetic fuels having all benefited from credit support. Tracing its use in housing, David Freund notes that the appeal of credit programs is that they seem like small market corrections rather than consequential state policies. And they have been used to support every major sector of the American economy.

The Analytical Perspectives of the budget wraps the complexities of these programs in the dry academic language of market corrections. “Credit and insurance markets sometimes fail to function smoothly due to market imperfections  … ” The implication is that this massive mobilization of debt and risk absorption by the federal government is best thought of as a technical adjustment to market imperfections, rather than, say, the American version of a developmental state. 

That language, I believe, is the moderate way of thinking about credit articulated during the progressive era, and now tailored for the neoliberal age. Like a nervous wizard, it asks us not to pay attention to the man behind the curtain, and for the most part, Americans comply. And why wouldn’t they? After all, the idea that credit support does not ask us to think hard about the social and political conditions of possibility for market success has been part of the appeal of credit support all along.

Fascinating bit.

Most countries have had a government funding program to help agriculture. One can always argue whether it is efficient or inefficient. But when you are told that Indian govt has no business to be in agri credit and should do as they did in west, one should just laugh off the idea. Agriculture has been politicized worldwide and has enjoyed either direct or indirect/hidden support from govt.

It is just that we are not aware of their histories. As Ha Joon Chang says, the developed world is kicking the ladder for the developing world.