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  • Predictable Surprise: The National Spot Exchange Default

    August 19, 2013

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    A smoker knows that smoking overtime would lead to cancer. However he goes on smoking till one fine day he is diagnosed with cancer. Similarly an alcoholic knows that excessive drinking can cause cirrhosis of the liver but he goes on drinking till he succumbs to the disease. Does it surprise anyone? No because these were predictable surprises. Primary consequences were pleasure and secondary long term consequences were pain.

    Take the case of the tech bust in 2000/2001.

    A predictable surprise: Technology stocks quoting at ridiculous valuations, eye balls replacing earnings, bricks and mortar is dead and the new economy emerging. The inevitable had to happen.

    2008 the global melt down: There were warnings of lax lending standards, evidence of the housing market showing classic hallmarks of a mania and complex derivatives in play. Another predictable surprise.

    Now lets take the case of the current crisis in the National Spot Exchange.

    • A spot exchange offering forward contracts. No regulator to regulate.
    • Interest rate of 14 to 15 % as against the prevailing interest rates of 8%. Can it be sustainable?
    • Brokers lending money without obtaining or verifying requisite security. Is it sound business practice?
    • Brokers enticing clients on the promise of safe and risk free investment. Is it not miss selling?
    • Investors making payment to brokers without obtaining the requisite security. Greed on the part of investors.
    All the facts noted above were for any one to see. Was this not a predictable surprise?

    So the big question is: What prevents us from seeing these predictable surprises? Five major behavioral biases hamper us.
    • Over optimism. Everyone was over optimistic about the exchange and the returns it was generating. No one thought of analyzing the risks associated with such high interest rates.
    • Illusion of control - the belief that we can influence the outcome of uncontrollable events. The exchange, the brokers and the clients suffered from this bias.
    • Self serving bias - interpret information and act in ways that are supportive of our own self interests. The exchange wanted volumes, the brokers wanted business and the clients wanted higher interest rates. Common sense evaded all of them.
    • Instant gratification leading to an overt focus on the short term. All too often we find that consequences that occur at a later date tend to have much less bearing on our choices the further in to the future they fall. "Eat ,drink and be merry for tomorrow we may die".
    • Inattentional blindness: Don’t expect to see what we are not looking for. Brokers and investors got caught up in all the details and the noise and they forgot to keep an eye on the big picture.
    When lots of people are making lots of money, it is unlikely that they will take a step back and point out the obvious flaws in their actions.

    “If something cant go on forever, it won’t.” This is an immensely insightful phrase. If markets seem too good to be true, they probably are. Learning to remember this simple fact would prevent a great deal of angst caused when the party ends.

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