Sunday, September 28, 2008

Quants, Smith and Artha. Premature announcement of death of capitalism

Quants, Smith and Artha. Premature announcement of death of capitalism

Pramit Pal Chaudhuri should be complimented for a scintillating piece. But he is wrong on many counts. First, he has not counted. He has not explained how a 60-trillion dollar economy can be transformed into a 6000-trillion dollar financial marketplace. Second, he has not thought through the alternatives to capitalism, assuming as he does that capitalism is the greatest thing that has happened to organization of humanity.

Pramit is wrong on both counts.

There is an alternative to both capitalism and communism. That is dharma, integral support systems in a samajam built upon family values.

Greed has to yield place to love and compassion. Fetishism of money has to yield place to primacy of work as worship, of seva to fellow humans as the highest form of worship. This alternative can broadly be called family trust.

Hundreds of examples can be cited for the history of civilization. To cite the most recent ones, just witness the way the Tiruppur hosiery makers are organised and how their jaati became an economic powerhouse.

Pramit will do well to study Kautilya's Arthas'astra. So will the quants -- chamcha-s of the capitalist regimes. Wealth creation is not capitalism's success story. Destruction of wealth has been capitalism's record.

Only wealth formation that is abiding is that resulting from work, from the realization of the fullest potential of every citizen of the world. Quants may give a mathematical kick and win some nobel prizes in economics but are of little value as wealth creators.

The farmers' family who committed suicide as rina mochan (liberation from debt) are the true wealth-creators who were true rebels. They took their lives in defence of dharma, for it is a-dharma to default on debt repayments. They simply became victims of the oppressive financial system built as a house of cards by quants.

Quants of the world, you have nothing to lose but your differential calculus and bogus economic-financial functions far removed from the mother earth's bounties.

Kautilya’s Arthas’astra can be called the science of worldly gains. In the last chapter, Kautilya defines artha: “Artha is the source of livelihood of human beings, in other words, the earth inhabited by men. The science which is the means of attainement and protection of that earth is the Arthas’astra.”

Simply, wealth is the protection of the earth and its bounties. The goals of life, of human existence, in Hindu civilization tradition are: cosmic order (dharma), worldly gain (artha) and enjoyment (kaama). Thus, artha is only one of the three goals of life and cannot be separated from the three goals taken as an integral unit of accomplishment.

Let us look at some specific excerpts which are relevant in the context of the notes on collapsing capitalism-communism duo:

Thus with his organs of sense under his control, he shall keep away from hurting the women and property of others; avoid not only lustfulness, even in dream, but also falsehood, haughtiness, and evil proclivities; and keep away from unrighteous and uneconomical transactions. Not violating righteousness and economy, he shall enjoy his desires. He shall never be devoid of happiness. He may enjoy in an equal degree the three pursuits of life, charity, wealth, and desire, which are inter-dependent upon each other. Any one of these three, when enjoyed to an excess, hurts not only the other two, but also itself. Kautilya holds that wealth and wealth alone is important, inasmuch as charity and desire depend upon wealth for their realisation. Those teachers and ministers who keep him from falling a prey to dangers, and who, by striking the hours of the day as determined by measuring shadows warn him of his careless proceedings even in secret shall invariably be respected. Sovereignty (raajatva) is possible only with assistance. A single wheel can never move. Hence he shall employ ministers and hear their opinion.(Excerpt from Chapter 7. Restraint of the organs of sense; R. Shamasastry’s translation of Kautilya’s Arthas’astra.)

In the happiness of his subjects lies his happiness; in their welfare his welfare; whatever pleases himself he shall not consider as good, but whatever pleases his subjects he shall consider as good. Hence the king shall ever be active and discharge his duties; the root of wealth is activity, and of evil its reverse. In the absence of activity acquisitions present and to come will perish; by activity he can achieve both his desired ends and abundance of wealth.[Thus ends Chapter XIX, The Duties of a King in Book I. Concerning Discipline of the Arthas'astra of Kautilya.]


Adam Smith isn’t dead

Pramit Pal Chaudhuri, Hindustan Times
September 28, 2008

Capitalism does two things well. Creating wealth and making a bad name for itself. The sub-prime crisis and its fallout have meant a lot of the second, not much of the first. However, Adam Smith isn’t dead. Capitalism is just making a poor job of adjusting to a new financial order. And a large part of why it’s tripping is bad governance. Here’s a market-friendly guide:

Sub-prime is a consequence of greedy politics: Sub-prime’s origins lie with the US government. Sub-prime loans were mortgages doled out to people who couldn’t afford them. One variety was ‘stated loans’ where a person just had to declare his income, without proof, and get a cheque.

The largest players in this were the Federal National Mortgage Association, the Federal Home Loan Mortgage Corporation and the State-owned federal home loan banks. The first two alone underwrote 44 per cent of the US sub-prime market in 2004. Better known as Fannie Mae and Freddie Mac, they were private in theory but crony capitalist in fact.

Under the aegis of providing ‘affordable housing’ — giving home loans to people normal banks wouldn’t touch — the US Congress exempted Fannie Mae and Co. from the regulatory and accounting norms of private banks. In return, these institutions showered political constituencies with dud loans and donated money to campaign coffers.
Because it was correctly believed these hybrid financial institutions could count on an implicit government bailout, they were dubbed ‘government-sponsored enterprises’.

Three-quarters of the $1.3 billion sub-prime loans were handed out by these enterprises. The US government spent $400 billion bailing them out, as opposed to $113 billion for private sector firms who joined in the feeding frenzy. Sub-prime’s rise was socialism masquerading as capitalism and capitalism falling for the disguise.
Wall Street’s financial bust shows markets work: When Lehman Brothers bought up securities backed by dud loans with borrowed money, it decided to load up on risk. Months before the present meltdown, I was told by a senior Federal Reserve Bank official that the market would be better off if stand-alone investment banks like Lehman died — they were gambling on credit cards.

If Lehman had survived and prospered - that would have been market failure. Instead, capitalism put it to the sword. Economists like Joseph Schumpeter adopted nihilism’s description of capitalism as ‘creative destruction’ but argued this was the system’s strength. When firms get greedy and stupid the market wipes them out, making way for more sensible firms. American International Group, as a boring insurance firm, was doubly stupid to have submerged itself in sub-prime and deserved to die. Politics and panic are why the only price it is paying is 11 per cent interest on its $85 billion US government handout.

Yes, it took a long time for supposedly efficient markets to bring down these faulty towers. There was regulatory failure by the US central bank under the once-sainted Alan Greenspan. Gree-nspan, a laissez faire advocate who headed a government regulator, also believed central banks shouldn’t pre-empt asset bubbles, that they should just clean up after they popped.

He should have been warier. Over the past decade or so, the world has become submerged in an enormous tidal wave of dollars, with credit growing nearly a fifth more each year than the real world economy. Capital was abundant, so it became cheap and eventually abused.

Forget sub-prime, this cheap capital has led to speculative bubbles in everything from petrol to platinum. Two years ago, at an Aspen world economy conference, I heard analysts fret that $400 billion worth of the homes being bought in the US were being bought as investments. When, they asked, would someone stop this? The market did. It just took a while because the money flood obscured the reality.

Government regulation is no answer to modern finance: The experience of quasi-government enterprises like Fannie Mae and the US central bank over the past decade shows bureaucrats are as clueless about the financial world as their private sector counterparts.

A simple example are the new-fangled mathematical models being used by both regulators and bankers to calculate the risk in buying and selling things like sub-prime mortgages. The nerds who did quantitative analysis, ‘quants’ in New York parlance, underestimated the sub-prime risk. What they accomplished was to take bad debts, run them through a computer, and then stamp them with ‘AA’ credit ratings. Everyone fell for it, regulators and investors alike, because the stochastic calculus-based financial superstructure was indecipherable. Lehman and the others do not seem to have strayed from the rules, the world of finance had moved beyond the rules.

Not everyone in Wall Street believed in these models. Goldman Sachs didn’t, which is why it survived the panic. Last year, while being quizzed by a Manhattan fund manager on India’s financial sector, I was asked, “Have the MIT quant guys got to India yet?” No He smiled, “Thank god.” I presume he bought Indian bank stock after that.
The other reason the world will have to find ways to let markets be regulated by economics is that bailouts are getting too big for governments. Washington has deep pockets. But Deutsche Bank has liabilities equal to 80 per cent of Germany’s GDP. In case of a meltdown, what would Berlin do?

History won’t declare this the day capitalism died, Perhaps the Day that Lehman Died. Capitalism will go on, not because it is perfect but because no alternative comes close in terms of creating wealth. My guess is historians will look back on what has happened — and the crisis has a few more phases to go — and call it the Day 21st Century Capitalism was Born. Much of what has happened is a consequence of the intersection of two or three developments in the international economic system.
One, already mentioned, was the sheer expansion of capital in the economy. In 1945, only the US generated surplus funds for the world economy. Today, everyone from China to India, Brazil to Bahrain, adds to the global pool. When its capital that’s on tap, no one has the necessary plumbing. This capital flow then joined with an information technology revolution whose intangible impact on finance, one, reduced regulation to guesswork for people like Greenspan and, two, paved the way for quant-based risk assessment. Most quants used a measure known as Value at Risk that drew on historical data. But what if you live in ahistorical times?

Finally, because even regulators are groping with the new financial order, the man on the street is less willing to trust governments to do the right thing. This is crucial because much State intervention in the market is not based on financial logic; it’s just a gut judgement of what is needed to restore public confidence. If Joe Investor believes central bankers don’t know what they’re doing, he will join a vicious cycle of financial panic. If he does so, he will join a virtuous cycle of financial recovery.

Welcome to 21st century capitalism. The ride has just begun.

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