The Destruction of Trust

Thursday, January 29, 2009

It has been a long time since I posted..apologies.  I have been wondering about the raison d"etre for this blog...: Indian equities, economy and global financial markets. In my meanderings through the Raju saga, and the torrent of frauds that are now percolating through the presses, the premise of the stock market started to become fuzzy and clear, alternately.

It is all rather confusing and very disturbing.

The stock market is not a large (invest and make money or lose money) machine. It is ultimately a price discovery mechanism. Companies can issue shares directly to investors; that is what private equity is all about. The stock market is a secondary market...a buy and sale transaction can occur on an anonymous basis and holders of equity in a company change hands. No problem; private equity has an exit and corporations have an available mechanism for further issuance of equity for expansion purposes.

The key in all this process is PRICE. The secondary market is seen to be a legitimate price discovery mechanism; new shares are issued close to the traded price, M&A activity is with reference to the traded price in the secondary market and Rights issues are usually 95% of the average traded price of the last month or more.

So, we see that the stock market is of prime importance to a functioning global financial market.

Now what happens when this Price Discovery Mechanism is sabotaged?

Let us understand this mechanism first: it is assumed that all available information is incorporated into the traded price of a security...when this is not so, arbritrageurs will step in to take advantage of the situation and the price will self-correct.  Simple and direct.

Information has to be available for this to work...even better, the information should be Correct. Enter the gatekeepers to ensure the information is available AND correct.

  • First we have the management and Board of Directors of the company...well, it seems we have to assume these guys will lean the wrong way when the pressure in on...SAD
  • Second, there are the independent directors of the company...Satyam has put paid to that..of course, Enron and World Com and so many others...had already burned that pillar to the ground.
  • Then we have the auditors of the company books...well, given the number of scandals over the last decade or more, this is no place to hang your hat or form the basis of an investment decision.
  • The Regulators have a very important role...enough said.
  • Then we have that other independent watch dog...the credit rating agencies. I believe whores have more principles and a better moral standing.
I am thus left in complete and total disarray when discussing the stock market...there isn't one...not the one I imagined or learned about or taught. The Price Discovery Mechanism has been destroyed.

The stock market is like Humpty Dumpty. And, Humpty Dumpty is big, fat and has fallen off the wall and BROKEN. And all the "Presidents" men cannot put it all together with a $900 billion stimulus package.

The stock market without a trusted set of gatekeepers is just a Casino...great entertainment, but not a place for investments.

And without a stock market, the global financial market is a non-starter...Hence, The Dilemma.

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3 Post Comments:

Anonymous said...

very true. missed reading your articles...

Kirin said...

in currencies and commodities we trust?

Anonymous said...

Missed u a lot. Please don't stop posting

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