The Hindu : Greed and market failures

Online edition of India's National Newspaper
Saturday, Aug 03, 2002

Opinion

Opinion - Editorials

Greed and market failures

THE STOCK MARKETS everywhere have been spewing out only bad news in recent weeks. In India, for instance, on Friday last week the markets closed a depressing week at nine-month lows. Both the benchmark indices, the 30-stock BSE Sensex and the NSE's Nifty, closed at their lowest levels since November, with the former closing at 3024 and the latter falling below 1000. By the middle of this week, the Sensex had breached the psychological barrier of 3000. Like on most occasions in recent weeks, the market's decline has been mainly attributable to global developments. They have aggravated the effects of India-specific factors such as the delayed monsoon. The growing connectivity among the financial markets, especially the stock markets in the wake of globalisation, might be more perceived than real at this stage. But to Indian policy makers, especially the new Finance Minister who is trying to generate a feel good factor, the message is clear: the linkages can be ignored only at one's peril.

That is why the whole world including India is glued to the happenings in the U.S. stock markets, whose valuations have been plunging dramatically with each revelation of one spectacular corporate governance failure or the other. The U.S. model of governance has long been acclaimed as the standard which even the well developed West European markets were to emulate. The American accounting systems were supposed to ensure the maximum transparency and from a shareholders' point of view were considered infallible. Even the regulators there, the SEC and those connected with the stock exchanges, had set great store by the American model. Certainly the great boom decade of the 1990s did not belie such unquestioned faith. The way apparently well managed companies kept on bettering their own past performance and seemlessly delivered higher earnings seemed to suggest an end to trade cycles. Part of that belief at least stemmed from the increased faith in the new economy model, which promised an unending boom. The stock markets there, more truly reflective of the economic scenario than in India, responded in a dramatic fashion. Stock market capitalisation in the U.S. grew exponentially, according to one estimate by $12,000 billion in just five years beginning 1995. Such an unprecedented boom created euphoria among the ordinary investors and the senior management of the companies, whose representatives, as subsequent events reveal, have been the biggest beneficiaries by manipulating such devices as stock options.

However, for the U.S. economy and the global financial system, the biggest failing emanating from such uncritical faith in the stock markets was the inability to comprehend, leave alone check, its numerous failings which were effectively hidden by the ballooning stock market indices. Alan Greenspan, the highly regarded chairman of the U.S. Federal Reserve, who had way back in 1995 warned against "irrational exuberance" has now spoken of "infectious greed" as being the prime culprit. Beginning with the Enron debacle and going on to a rapidly expanding list of big American corporate governance failures, it is now obvious that nearly all the stakeholders were afflicted with greed. The investing class is normally the victim. With many share market-based pension funds evaporating, there is a breach of social security as well. Yet, in the days of the bubble the extra large and unreasonable expectations from the market were driven by greed. Just two years ago, ordinary investors believed in everything, not just in what have been considered to be pillars of the capitalist system — Wall Street, world famous investment banks, analysts, accountants. Today they trust nothing. That in the ultimate analysis represents the market's current downfall. It is the restoration of the trust that will be the biggest challenge everywhere.

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