To understand how good ideas can evolve into bad ones, the history of genetics provides an insightful illustration.
Mendel’s Garden versus Mendel Booths
Gregor Johann Mendel, the “Father of Modern Genetics,” laid the foundation for understanding heredity. Mendel conducted experiments and devised evidence-based laws on inheritance. His 19th-century Moravian pea-flower garden became home to thousands of meticulously grown plants. After Mendel’s time, however, fanciful ideas on heredity sprouted across the Western world.
Though without scientific merit, these ideas gained popularity and traction. “Mendel booths” and “Better Baby” contests in agricultural fairs became part of a movement for genetic screening. Little by little, public attention shifted from the sublime to the ridiculous. It took well over five decades for these movements and practices to fall out of favor.
Flights of fancy are nothing new in the financial marketplace. Financial crises provide recurring reminders of the clockwork regularity with which ideas can morph into speculative fads. From the tulip mania of the 17th century to the latest innovation-induced subprime failure, the marketplace has stretched concepts to absurd extremes. One useful outcome from these crises, however, is that over time, the regulatory infrastructure has evolved for the better. In any case, it seems that capital by nature lacks the capacity to stop its unwise quest for speculation.
The Indian Experience
How does India fare in dealing with financial crises and speculation? If speculation is defined as investing with a view towards making a quick profit, there is a lot of work at hand. India’s derivative-to-cash turnover ratio is 15, the second highest globally after South Korea, and an alarm bell that has been growing louder over the years.
At the macroeconomic level, for the last quarter century, India has managed to side-step major financial outages. But the economy is changing fast. The flip side of 6% plus real growth is the responsibility to contain any damage. Significant reforms are underway in India, but it isn’t clear that the regulatory capacity to manage risks is growing as fast as the economic growth.
Bank Recapitalization Redux
India’s latest trouble zone has emerged from the credit channel. Bad loans on the books of the country’s public-sector banks account for well above 50% of the banks’ net worth. The government’s $32-billion recapitalization plan, announced last week, is the largest capital infusion of all time. The government has injected capital into the banking system in at least 10 of the last 25 years and is the largest shareholder in India’s troubled public-sector banks. Unless there are efforts to significantly improve governance, cut political interference, and promote sound business practices, the latest recapitalization runs the risk of devolving into yet another wasteful enterprise.
Siddhartha Mukherjee’s The Gene: An Intimate History has a comment on the insights of Charles Darwin: “Freaks become norms, and norms become extinct. Monster by monster, evolution advanced.”
It is not a surprise that financial markets are mimicking nature’s evolutionary progress. The future belongs to those with the capacity to perceive the changing nature of new normals.
Here are some of my readings from last month. I hope you find them interesting. Happy Weekend.
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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.
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