... and Marx bothers!

(Blog n°8)

  

Ethic is now in the core of the discussions, of the reflections and of the classes about finance. Ethic must be distinguished from the concept of moral. The latter is a set of rules corresponding to an idea of what is good. Ethic is more complex, less dogmatic. It refers to the argumentative reflection held to reach a good action in the framework of defined circumstances. More simply, the concept of moral refers to a general rule, ethic refers to the personal behavior that takes the concrete events into account. (For those who are interested in that subject, the philosophical debate between E. Kant & B. Constant on the right to lie is a very captivating topic, Kant would favorize the morale and Constant the ethic.)

Considering that nowadays finance needs to be studied with an ethical prism, perhaps would it be possible to conceive a system where moral is in the center of the financial system. This would imply to follow absolute rules, without considering the circumstances. Of course, in the current capitalist system, it sounds unreal. Nevertheless, a system based on the prosecution of a good act under any circumstances should be put into question, because it means that there is no constant law, so no real idea of what is good in such a whole.

Here comes Marx. The person who imagined a world of harmony. The documentary Masters of Money: Marx, with its so objective eye, began to describe Marx’s ideas as dangerous. Indeed, they are dangerous for a system, because Marx preaches the establishment of public property of the means of production. This would be the fundamental law of the Marxist economic morale.

However, the most important aspect of Marx’s theories is not purely economic. Indeed, and therefore is Marx both an economist and a philosophe, his theories focus not only on the economy but also on the society. Moreover, he conceives society through economy. The final goal of Marx’s is das Ende der Geschichte (the end of the history). A state where only proletarians remain, where every human are equals.

Since the middle of the ninetieth century, the basis of the idea of democracy is the center of a debate. The liberalist side argues that to own the power, people only must be free, so they can establish their own individual success. Conversely, the socialist side claims that only a perfect equality between people allow them to rule together. With this debate about the essence of democracy, it is also a debate on what creates the happiness of a society that is proceeded. This opposition degenerated in a confrontation of ideologies during the cold war, until one of the (Leninist-) socialist side collapsed.

Still, the question of the possibility of a free society without any kind of equality is asked. In the UK, in France and in Germany, this problematic finds an answer in the place of the state. A compromise is agreed making is sort that inequality is tolerated under the strict condition of solidarity; the state acting as a regulator in this process. Besides, French motto (Liberty, equality, fraternity) and German motto (Unity and justice and freedom) are directly linked to this idea of compromise allowed by the solidarity between people. This phenomenon is seen by the economist J. Schumpeter as a degradation of pure capitalism facing its own contradictions and evolving to an implementation of providence states.

Explaining society through economy (method called Economism, called into question by J. Schumpeter) allows a clearer view on what can be proposed to solve a so complex debate. True balance cannot be established within one only system because dogmatism does not allow to any healthy and durable situation. In economy, private property and market economy seem to be essential for the dynamism and the growth of a system (according to J. Schumpeter agreeing with F. Hayek), however it becomes unfair, inequitable if not controlled by an entity established by the whole stakeholders of that system, which should correspond to the idea of state in a democratic society.

Lehmans' bothers...

(Blog n°7)

  

As presented in the documentary The last days of Lehman Brothers, common people hate bankers. The narrator tries to find a reason for that. He speaks about success, money, but finally cannot find an answer relevant enough. At first, because all those answers are right, and the reputation of arrogance and mediocrity can also be added on the list of those people’s defaults. At least, on the list established by the common sense.

The characters presented by this documentary-fiction do not contrast with that vision. Only, they introduce new aspects of this world. Strategy, such as presented by the “rescue” of Merrill Lynch by Bank of America, but most and foremost, lie. Lie and cheating funded the final bankruptcy of Lehman Brothers. By using debt repurchase agreement, LB hided his financial situation and blinded the market. When the actual gearing appeared, the market purely destroyed the share price of the organization.

This kind of behavior is perhaps why we, as student in finance, have a class dedicated to the understanding of companies’ annual reports… with an emphasis on impression management. The saddest is certainly that this is maybe one of the most relevant observation about finance world: as every business, money business is based on appearance and fool’s games.

For the market at least (considering a long-term point of view). However as said in the documentary, this financial crisis leaded to an economic, a political and a social crisis. Economic because it initiated a global recession. Political because a huge questioning about the financial structure and the role of the states has been raised. Social because millions of people lose their jobs during the recession. What happened in Iceland is perhaps one of the most impressive effects of that crisis.

In Latin the word fortuna has a meaning related to the idea of luck. During the crisis, when shareholders were losing their fortunes, people all around the world were losing their luck, and what was once the center of their lives. This only because a lack of ethic from some people.

Here is the center of the subject, in every crisis the lack of ethic of some people is pointed out. During the Tulipomania, the Great Depression, the Subprime crisis, the system found culprits. Finding them is easy, avoid the apparition of new ones is more difficult. It requires a questioning concerning the whole system, more rules, more verifications, more trials, more scandals.

However, one thing can be noticed. Just an idea, an historical data. Technically, bankers and financiers are merchants. Very simply, merchants were people buying goods where there were inexpensive and selling them where there were expensive. Imagine the caravans crossing deserts and forests, climbing mountains to move tons of materials from a place to another. They were people whose work was to make money by creating nothing, so considered as abject. Ironically, these merchants still do not produce anything but have the power to create and destroy value in a flash.

Dividends VS Life? (Part 2)

(Blog n°6)

  

Capitalism is defined by the private property of production means. In terms of fundamental economic, the capital is what is used to produce goods. This capital should be bought by the capitalist to allow him a property on the said capital. The goal of that ownership is to create value from raw materials by transforming them into finished or intermediate products. This value may have two uses: re-investment in new capital (in fundamental economic sense) or it can be kept by the capitalist as a personal revenue.

Roughly, these lines constitute a brief description of the functioning of an Idealtyp company. It tries to define its goals by considering the way it works from a financial point of view. Therefore, the principal aim of a company is to make money. Problematic: a company does not produce only money, at least not permanently. This statement would imply that on a short term point a view, a firm does not need to create wealth to exist. So, the criterion of value creation is not the only one that can define a firm.

Fundamentally, the most basic aspect of a company is that it has an activity. It could be goods production or services dispense, but any a firm is basically an organization that has a more or less profitable activity. Introducing the idea of activity in the conceptual definition of a firm implies to consider the people having an influence on that activity: the stakeholders. Suppliers, customers, governments, competitors… these entities must be considered when establishing a company strategy.

To keep the Whirlpool example taken in the previous part of that post, the employees in that case are important stakeholders, perhaps the most important ones. Firstly (and obviously), because they are the base of the company’s activities and production. Secondly, because they are ambassadors of the brand, of what they produce. By their employment, they are loyal to the company, especially if this loyalty in encouraged by the firm’s culture. Thirdly (finally and most importantly) they based their entire life on the company. A human life is also maid that if the foundations of it are removed, it collapses and has then nothing to lose, and people having nothing to lose is one of the worse publicity for a company.

This is why a company is not a place where goods are produced to make money, this is why dividends have a link with relocation of a factory. Of course, it is not relevant to implicate dividends in a human resources problem. However, the leader of an organization must consider all the influences of such a decision. The position held by the company at this moment is delicate and should take into account all the implications that it could have with any of the stakeholders, especially those able to have an influence on the image of the organization. The main idea here is that diplomacy and balance are in the very core of strategic and financial decisions. These can influence not only the fields of their applications but also the large scale of the whole company.

The Minion of Wall Street

(Blog n°5)

Even if the schedule imposes a slightly divergence in the planned subject, this blog will not lose its core subject: trying to understand the relationship between the human society and the financial society. The wolf of Wall Street by Martin Scorsese is really a perfect support to illustrate this relationship.

Money. Firstly, a tool. Then a resource. Finally, a goal per se.

Money has this incredible power to fascinate humanity. Everybody seem to act as Eli Wallach in The Good the bad and the Ugly, during the anthological scene of the Ecstasy of gold, combing everywhere with crazy eyes, seeking for what we searched during, so many time. Of course, this vision is slightly caricatural in the actual world, nevertheless it would appear strange in the story of J. Belfort, the main character of Scorsese’s movie.

Drugs are equally with money a key element of the craziness of the wolf, until the point where a confusion appears. Money is for him a drug. At this exact moment the question of the possibility of such a behavior is raised: who let a wolf hunt among the lambs? By manipulating humble and unexperimented people to speculate on rubbish securities.

The most questionable aspect here is that M. Belfort sold dangerous stocks to people without any knowledge about what they were buying. The goal in those transactions was to earn money from the commissions, normal indeed. However, such commissions imply to force customers to buy shares, neglecting the risk presented by those shares, even lying on their actual potential. This behavior was never put into question, just because it was profitable for the company and for the broker. Making money without asking how it is maid, speculate on shares, sell them to increase the prices of the one owned by the seller himself, these are the basic financial manipulations described by the movie.

Based on a true story of an existing man. A man without ethic, without scruples, without any consideration for anything but money (and drug and prostitutes). Of course, the place of humanity is relegated in the background. Fundamentally, what is the scariest in that story is not the acts of M. Belfort, but rather the fascination he created. Such a madness needed the intervention of the state, of a superior authority to be stopped.

This statement leads to two major thoughts.

Firstly, and in contrary of the liberal ideas, every market needs a regulation. Indeed, in a long-term point of view, the market would have corrected the too huge difference between the market value of the shares and their actual values, but this would have implied a tremendous lost for all the people misled by the Wolf.

Secondly, the goal of finance is not always the optimization of shareholders wealth. Making easy money by speculating seems to be an excellent goal for the financial activities, this opinion is at least present in the most common mind. This opinion is not only casted by movies and stories like this one, but also by the reality of the financial history: crisis caused by speculative operations.

Dividends VS Life? (Part 1)

(Blog n°4)

  

In France, the unemployment rate reached 9,6% in the first semester 2017 (Institut National de la Statistique et des Etudes Economiques, 2017). Since the unemployment touches even more the unqualified parts of the population, every worker who loses his job will have difficulties to find a new place in the society. Therefore, when a factory closes for whatever reason, workers often organize strikes, afraid to lose their jobs. For example, this happened during the last presidential election: Whirlpool decided to relocate a washer factory from Amiens to Poland.

The relationship between this kind of event and the reflection around finance is determined by the mediatic cover. Indeed, when Whirlpool announced its decision, the press always reminds the turnover of the company and the benefits it made during the year before the relocation (Le Monde, 2017). The goal of this is to point out systematically the fact that a company destroys jobs in France even though it makes good money. Thus, the company is presented as the bad guy and the workers as the common people fighting for their jobs. From the point of view of people losing their revenue source and perhaps a huge part of their life for some of them, this vision is relevant and true: the money earned by the company can and must be used to keep their factory working.

The interest is that in that case ethics and human lives appear to be joggled by the financial history. However, the relevance of the comparison maid by French journalists must be discussed. Indeed, they seem to claim that a company that creates value must use it to keep its factories where there are (in that Whirlpool case at least).

From the company point of view, this relocation has no link with the profit maid or the turnover. Relocating is a cost management decision, not an accounting decision. The profit maid by a company cannot be an argument against such a relocation. Simply because if the organization does not optimize its costs, it will be eliminated in the long run.

To this can be argued that they could use the profit maid to compensate the loss implemented by the costs of the French factory. Additionally, the use the companies make of their earnings can seem unreal from a worker point of view. For example, Whirlpool paid 294 million of dollars to its shareholders in 2016. Such amounts of money not invested in the company can only anger the humble people losing their jobs. They worked to create this value for the company. But the organization decides to keep the money and to fire them because it is still not enough.

Beyond the dichotomic vision of the different stakeholders in that case, the questions of the core of a company’s goal is raised.

•  Le taux de chômage diminue de 0,4 point au premier trimestre 2017 (2017, May 18) Retrieved from : https://www.insee.fr/fr/statistiques/2851776#consulter
• Tout comprendre à la fermeture de l’usine Whirlpool à Amiens (2017, April 26) Retrieved from : http://www.lemonde.fr/emploi/article/2017/04/26/tout-comprendre-a-la-fermeture-de-l-usine-whirlpool-a-amiens_5118204_1698637.html

The lacking Trust

(Blog n°3)

Because financial exchanges are based on relationship implying the presence of human beings, feelings, intuitions and values, the gravity of such exchanges may be pushed into the background. Indeed, today’s review will focus on the idea that, just like during the 1920s, finance is a game. Of course, any game can be fun, occupy the children during a rainy afternoon, but it is also and most importantly a way, a tool to understand the way the human mind works. Such a knowledge would help to understand the levers of a subject as finance, where psychological actions are the very core of the exchanges. However, before trying to understand the players mind, perhaps should the game be firstly analyzed.

Essentially, the core point of a game is to find an equilibrium, a state where nothing can change. Even if the financial game cannot end, it still can reach a balance. According to V. Pareto (1909), such an equilibrium can only be optimal. Indeed, the players being rational individuals, they can only adopt the most perfect situation. An optimum such as defined by V. Pareto is a situation in which the well-being of one individual cannot be improved without reducing the well-being of the other participants.

This kind of optimum can exist in the financial market (if the shareholder’s wealth is considered as their well-being). Indeed, the Pareto’s optima could be assimilated with the capital market line: an optimal situation in which the profitability of a portfolio cannot be improved without increasing the volatility of the portfolio. This capital market line is a market balance, fixed by the offer and demand law, by the “invisible hand”, so theoretically, it is a Pareto optimum (that follows Pareto’s assumptions).

However, players could be victim of bias. The economist and mathematician J. Nash theorized such a phenomenon in 1950. According to his theory, another equilibrium can be reached in a similar game that the one presented by Pareto. However, this other equilibrium is not an optimal one in the terms determined by Pareto. The most famous example of this kind of situation is the prisoner dilemma. A fictional situation where the lack of trust between two persons is key: because two prisoners accuse each other, they are both condemned to a sentence that could have been reduced if they would have remained quiet. Nevertheless, the game forced them to denounce each other by rewarding such an act. This reward created this lack of trust.

Trust. Again, it is the core point of the whole economic system. Trust in prices, in money, in computers are conditions for the global financial functioning. Therefore, the actors of the market are potential prisoners. A slight doubt can create a situation in which the well-being of the participants is not optimized, in which the objective of an optimal shareholder wealth is missed.

However, all of these theories assume that participants are purely rational. This point remains controversial.

A risky game

(Blog n°2)

Last week's topic covered the first ever financial crisis, the Tulipomania crisis. While its effects were relatively restricted compared to a more recent crisis, it still asked the question of ethic in finance by noticing a gap between the actual value of the shares and their prices on the stock market. Such a gap did also exist during the 1929 American crisis, such as presented by the documentary 1929: The Great Crash. This relatively more recent example leads to ask about the mechanisms that conducted to the collapse of an entire economy.

Nevertheless, more than an economy, it is rather a whole culture that is involved in the financial exchanges at the end of the first World War. Therefore, both cultural and behavioral factors initiate this crisis.

• Firstly, common people are involved in the financial world by the state. Indeed, the US government (as the other belligerent governments) issues “liberty bonds” to raise funds for the war. By buying these bonds, US citizens are using securities for the first time and became quickly used to it.
• Secondly, the post-war situation allows the first consumption boom in the history. People become used to massively buy products and moreover, by credits. “Buy now, pay later” is the norm in terms of buying.
• Finally, the mentalities in Wall street evolve and see in the common people an opportunity to rise fund for the market. This was earlier considered as too risky, but the amounts of money owned by private individuals offer a great advantage to the stock exchange.

So, citizens begin to invest in the stock exchange. They buy shares as they were buying cars or sofas: by credit. A whole financial play culture emerges, based on “buying on margin” exchanges: borrowed money helped people to buy more shares. Fortunes are created, some new financial stars raised, becoming popular because of their stupendous wealth created in a few times.

However, this speculative movements implies an offset between the market prices and the actual values of the issuing companies. The market corrects itself on October 24^th, 1929, the “Black Thursday”. Despite the banks attempts to inject liquidities in the market to stabilize the prices, it finally collapses, leading to the bankruptcy of a huge part of the population.

Furthermore, the shares having been paid with borrowed money, the afraid banks ask the borrowers for cash, alternatively they would sell the shares owned by those people. The shares are sold, the prices collapse, so more shares are sold, leading to a vicious loss of value spiral, to the failure of two thousand banks in the year 1931, and to a major human disaster.

One more time, the analysis of a financial crisis highlights the fundamental link between the market and the rest of the society. The responsibility of this crisis was shared between the bankers, the politics, and the people. All of them suffered from the consequences of the crisis they initiated by their behaviors. Apart from the human and political crisis following this financial one, the biggest challenge remains in the lack trust initiated by such a phenomenon. Therefore, trust  will need a further reflexion.

The costly Tulip

(Blog n°1)

In the beginning of the 17th century, happens what is related as the first history financial crisis: The Tulip mania. Both a fashion effect and speculative investments cause a stupendous increase of the Tulips prices; these flowers become a luxury product within a few years. Regarding the figures that remain from this time, the prices were not reflecting the actual value of these flowers (notwithstanding their incredible beauty). The market validates this recognition by making the prices collapse in the year 1637.

This example illustrates the usual cliché about finance: greedy people exchanging securities for prices based on wind, rumors and assertions such as the global taste of a society for a special type of flowers.

The failures highlighted by this historical event reflect those gangrening the nowadays situation. Are the market prices still related to the actual shares values? The simple fact to be in measure to ask this question implies a possible defect in the global financial organization.  However, the point in this blog will not be to determine if whether or not there is such a difference between market and actual value of securities, simply because a blog is not the good format for such a study. These words are rather going to be focused on the consequences implied by the said phenomenon.

Back to basics: what is finance? It comes from the Latin fine: “end”. So essentially and etymologically, a funding has to deal with time: it can exist only when the whole amount of money is payed back. But if the market and the speculation price a share above its tangible value, there cannot be any repayment of the amount invested. This happened in the previous example of the Tulip mania: the prices collapsed with the demand just at the end of the fashion effect, the flowers owners lost fortunes because of this collapse.

In that case, the trust in a market tending to deviate from the concrete price of goods can be put into question. The market is supposed to help investors and entrepreneurs to meet each other. It is a tool aiming to improve projects realizations, and not to create fake value. This is why the incredible rationally-based and automatically-programmed exchanges can be as performant as possible, anyway they have to be based on human activities or, in other words the most random and chaotic events that could happen. Actually, this chaos needs trust to keep working, expanding and creating value.

Thus, the concrete projects prevail their finance simply because they precede them. However, finance allow the projects to exist. Because of this bilateral strength, trust muss be the base in such in relationship, otherwise the interests would not converge and nothing would be created. So, what is trust? From a human science point of view, it is a feeling including a subjective judgement, determining the base of a reliance relationship. Basically, finance is humanly centered. This is why ethic should be above the exchanges, this is why respect prevail: because Tulip price muss stay stable and relevant.