Saturday, 8 January 2011

The problem of having too much money

Of course, there is no such thing as too much money. One man's dream is another man's basic necessity. But then sometimes there are those who don't know what to do with their money. The damn thing is burning a hole in the pocket (or the bank account, or wherever). They've already bought into houses, gold, shares, mutual funds, whatever. Now what ?

They invent instruments like catastrophe bonds. I read about them with my jaw dropping - hadn't known that such esoteric stuff existed. Well compared to other even more esoteric species of investments, this might more resemble "plain vanilla". That only underscores my point.

Insurance companies issue these catastrophe bonds. They carry a higher rate of interest and investors invest in them. The condition is that the investor loses his investment if the catastrophe occurs. So he is essentially betting that the catastrophe does not occur. For the insurance company, this is a form of reinsurance. If the catastrophe occurs, they have to pay out to those they insured, but don't have to pay out to these bond holders. Thus they reduce their risks.

For investors , their attraction is the higher rate of interest, but more importantly diversification of their portfolio. These bonds do not move in tandem with say equity markets or housing markets. They move in tandem to catastrophic events occurring or not occurring. Looks good, but .....

Look at what the investor is betting against. That another Katrina will not hit Florida or Louisiana this year. Or that an earthquake will not happen in Sichuan. Or that there won't be a flood in Bihar. Actually, these are bad examples. The market, at least for the moment, is mostly for disasters in the US. But why on earth would you want to take risks like that ??

I have long been disturbed by the societal implications of what is happening in the financial markets. Because the possibility of riches are huge, the best brains in the world go into finance. They innovate like crazy - compared to what happens there, an Apple or Google are midgets. They take incredible risks in the pursuit of even more money. They conjure up extremely complex and fiendish instruments that very few even understand, let alone operate meaningfully.

Its says something about a society that its greatest minds and greatest achievements are in the field of high finance. I am not convinced that its the most glorious claim to fame. I, for one, will steer clear of catastrophe bonds. Of course, that's merely an academic statement - there's the small problem of not having that kind of money !!

12 comments:

  1. Good one. Catasprophe Bonds!!! Why would anyone want to invest on that? There would be a lot of runners if something like "Political re-catastrophe" bonds were there.We could bet on lot of things that would happen again.
    Ofcourse, if the small problem of having the monies is resolved:-)

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  2. i have a slightly different take on this. instead of one, there would be some 1 million hearts beating that a catastrophe should not occur. probably, the strength of the prayer could actually avert a catostrophe. so we are invoking the power of collective positive vibration to project the world.what you say !!

    I hope you dont threaten to quit blogging if people like me continue to post such stupid comments!!

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  3. @Hema - That's a brilliant idea - political catastrophe bonds ! Lets issue a series ....

    @Sandhya - As always your comment is not only thoughtful but also bring out the warm sided nature of any issue. Unfortunately, human nature, especially in the financial jungle being what it is, these bonds would have derivatives and get traded. Being a zero sum game, there would be as many blighters who would be wishing that the disaster happens.

    I should take a leaf out of your book and stop such morbid thoughts !!

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  4. Anonymous9/1/11

    money money money....must be sunny...its a rich man's world :)...all the things that i cud do...if i had a little money ..its a rich man's world :)

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  5. @Anon - Ha Ha. But then ABBA hadn't heard of catastrophe bonds :):)

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  6. Extending and building on this idea, could all sort of gambling and betting be legalized!

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  7. @zeno - That's what it exactly is. Best it to legalize everything and tax it !

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  8. I decided to wait before doing a back to back controversial post :)
    I agree with you that it is a waste of talent when bright people flock to Wall Street. it is also a recipe for dangerous experimentation. But I don't see why you are so against the cat bonds. Let's look at it as a form of reinsurance for the insurance companies. Many large scale natural disasters can leave many insurance companies bankrupt and that's not good for those facing the calamity. Instead here we have some hedge funds sitting in Chicago willing to take a chance that another Katrina will not happen in far away New Orleans in the next say 5 years. This source of funding is so critical for the insurance company to survive the Katrina should it happen that they are willing to pay a higher interest. Seems like an efficient way to transfer money to disaster areas from people who can take the small hit (assuming their portfolio is well diversified). But this needs to be restricted strictly to natural disasters. Once you bring in man-made disasters - that is perverse and people will stop at nothing...

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  9. Wonderful post and fantastic comments! This space rocks amazingly as ever. I could not write anymore than what all the commenters have already said.

    It was difficult for me to access internet over past few days and I was eager to read your posts. To my pleasant surprise, there is not one but two posts from you. Keep rocking!

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  10. As the Tamizh comedian Vadivelu would howl in his characteristic style, 'Eppadiyellaam irukkaangayyaa' while making a contorted face. Interesting to see how there is an opportunity in anything and everything. Thanks for adding one more phrase to my vocabulary. :)

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  11. @J - Not against cat bonds at all. What I can't understand is why the average investor wants to take on a risk like that ? Reinsurance is more spreading the risk amongst other insurers and insured . Here the risk is being passed to an investor. That sounds much like gambling to me .....

    @Vishal - Humbly, thank you .

    @RamMmm - Ha Ha. Actually comedy and business go along quite well !!!

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