Sunday, October 21, 2007
Contract types and Financial Cycles.
Weekends, like war, are filled with long stretches of the mundane and brief moments of the unexpected. That said, there are few moments of fun as well. Like this blog entry about arranged marriage that I stumbled upon. In her own charming way, she writes about the razor’s edge that arranged marriages can be. The stolidity of this type of marital institution is an historical fact; but perhaps the material conditions in which such a marriage flourished are changing. I don't know. Perhaps, the uneasiness lies in the modern belief that love and marriage can be found within the same institution. If not this marriage, then Hallmark and Cosmpolitan promises you it in the next one. The irony is that I spent this weekend reading about securitization (particularly about asset back commercial paper market) by Vinod Kothari. One of the early remarks he makes is that marriage is one of the oldest relationship contracts, as opposed to innumerable “friendships” that we find in modern society that can be thought of as transactional contracts. The degree of replaceability of buyers-and-sellers of contracts, the sunk costs involved in arriving at a trading decision etc., distinguish such contracts. While for humans I am convinced that ‘relationship contracts’ are better; for financial markets ‘transactional contracts’ have been a stupendous blessing. These market mechanisms allow you and I to buy and sell stocks, participate in the fortunes of publicly traded companies etc., without necessarily being privy to a specific information or part of some restricted group of people. However, the flip side has been that ‘transactional contracts’ (exemplified by the securitization) business has led to innovation, and with innovation comes possibility of excessive profits. Lured by this specter of excessive profit comes easy credit. Soon, entrepreneurs, con-artists and revolutionaries all agree on one sole idea – this time it’s different. Thereafter, human, all too human sentiments follow like clockwork: greed, hype, irresponsibility, disaster and finally despair. Till yet another cycle begins, perpetuates and finally dies out. The best read on the inevitability of such bubbles and busts is still the one by the late J.K. Galbraith.