Category: Investing

The 2008 crisis occurred because of too much leveraged risk concentrated in few places. It is easy for an institution with limited liability to fail and take hundreds of jobs with it. This is an open letter to SEBI (Securities and Exchange Board of India), addressing the discouragement of retail participation in the financial markets that it proposes so often.

 

Why do we do things a certain way?

Why do we spread out a country’s debt over a large period of time? Because, a lot of unfeasible liability suddenly starts to look feasible when spread among a lot of people (the taxpayers) over a large amount of time.

Why do we have democracies instead of dictatorships? Because we’ve learned through experience that the power to govern a country should lie with the people of the country and not with a single person. It is easy to corrupt an individual, harder to corrupt an entire population.

When we need to bring trust to a financial transaction, why is the block-chain a feasible alternative to having a third party (bank, escrow, etc.)? Because we know that the consensus of the majority of the population won’t be wrong. If a transaction can be verified by the majority, trust prevails.

These things are done the way they are because there is less risk involved. It is a good idea to ensure that there aren’t a scarce number of entities controlling any kind of decision making. They are susceptible to making a huge mistake and dragging everyone else with them. The consequences of the decisions that lead to the 2008 financial crisis and the consequent bailouts of the american banks and automakers affected every single tax payer in the country even though they had no role in the decision making that lead to this in the first place.

 

We can goof up but you can’t!

Why is it that despite everything mentioned above, the decisions that affect just an individual without any collateral damage to others are a restricted commodity? Securities and Exchange Board of India (SEBI), in the name of risk management, continues to increase lot sizes to restrict retail participation in derivatives. Is this not, instead of distributing the risk, concentrating it in a few hotspots – the institutions? How is this, in any way, reducing the liability of taxpayers if and when something goes catastrophically wrong? How does this, in any way, stop the market from being controlled by a select few when the action itself is empowering the strong and weakening the feeble?

 

Let there be freedom and transparency

Will encouragement of participation by retail investors not be a step towards better financial literacy? It might involve some short term pain while the population gets educated about these instruments. The long term benefits though, far outweigh the short term cons. On top of that, instead of the taxpayer bailing out the institutions, let the individuals have the profits and the losses to themselves. Let the decision makers own their decisions and their consequences.

How about redirecting these efforts towards ensuring transparency in the stock markets to prevent illegitimate transactions from happening. How about letting the market have better instruments that allow investors to come to a consensus about the price of a security. Easier access to derivatives will allow for better price-finding simply owing to the fact that more people will be able to short and hedge, when needed.

 

Empower everyone while reducing risk: Winning while winning

How will a retail client hedge 100 quantity of his stocks in a listed company when the lot size itself is 5000 or 3000? Why will a trader or investor pay a monthly option premium amount equal to the value of his holdings? Why is it that when someone wants to pick up a stock using a cash covered put, he or she cannot do so without committing to an amount 10 times higher than the quantity they actually want? Is it not better to be able to lose small?

A lot of stock exchanges have standard lot sizes for derivative contracts, regardless of what the price of the stock or underlying is. To be a matured market, we need to act like one. It is never a good idea to try to control the actions of people. Let there be financial freedom, let there be transparency, and let there be ownership of one’s actions. Babysitting does not apply to adults.

Read More