A memory from my last trip to India

I lay on my bed in the warm humid Kolkata weather, gazing lazily at the clock on the wall. It's an old clock, perhaps twenty years old, runs on a single AA battery. It hung on the wall in our home in Bokaro, or was it Durgapur? It brought back memories...

My father had a childlike enthusiasm about some things. When the clock was still new, he would compare the time on the clock with that on TV before the news on Doordarshan - India's primary TV channel. This was before cable. Some days the clock showed near perfect time, other days it was a little off. I remember the day my father noticed that due to the influence of gravity, the second hand progressed much faster from 0 to 15 seconds past the minute, and considerably slower from 45 to 60 seconds. The clock was not in error! It was perfect! Well... ignoring gravity anyway... There was this look of triumph in his eyes.

My brother recently sent me some old family photos. The one above is from 1990...ish. We were not rich, not poor either. We hardly had any savings but I did not know that as a child and it did not bother me. We were happy. Now, I am probably worth several times what my father was worth at the end of his life. But I miss the simple happiness. In many ways, I have less than I had then. I need to find my way back.

Charles Ponzi, Bernard Madoff and the exponential function

The Ponzi scheme is a fraudulent investment scheme named after Charles Ponzi. The idea is simple. Investors are promised fabulous returns on money. A few investors cautiously bring in small change, and the money is returned with interest as promised. Reassured, these investors bring in larger amounts. Other investors join them. People ask questions on how the money can grow so fast. Answers range from gold and diamonds mines in Africa to philanthropic donors who crave anonymity. In reality, there is no investment. Money from new investors is paid to old investors, while the organizers of the scheme help themselves to some of it. As long as the returns are coming, few questions are asked. People who ask too many questions are even censured by others who have invested money in the scheme, and are reveling in their imaginary returns.

Ponzi schemes tend to be short-lived, with a few exceptions. One important exception may be Bernard Madoff, and we will get to him. In order to thrive, a Ponzi scheme requires a growing inflow of new investment, and to get this inflow, the returns have to be be large enough to induce greed. Charles Ponzi, for example, promised to double money in 90 days. At that rate, money grows to 16 times in a year, and 4000 times in 3 years - exponential growth. To be truthful, all investment at fixed interest rate grows exponentially. Money kept in a bank at 7% interest would double in 10 years, 16 times in 40 years and 4000 times in 120 years. Exponential growth is the norm. What is not normal is the fabulous rate promised by the Ponzi scheme. I suspect that a lot of Ponzi schemers lack an appreciation of the exponential function. Anyway, if Ponzi's scheme were to go on for three years, an investor who brought in a thousand dollars on the first day would be entitled to four million in three years. So long as the investor does not demand his money, all is well. But chances are that the investor of a thousand dollars, now thinking himself a rich millionaire, would want to spend a modest few hundred thousand of his millions. At this point, paying the investor becomes a challenge because inflow of investment money can never keep up with the rapid exponential growth of accounts payable. The game winds up.

It is not hard to see that the longevity of a Ponzi scheme is inversely related to the promised rate of return, but the rate of return must noticeably exceed that obtainable through legitimate sources so as to attract new investors. In this regard, Bernard Madoff took the game to the next level. His returns were consistent, and always better than the market, but not like Charles Ponzi's. His scheme lasted over a decade in the complete absence of investments, and swallowed over 50 billion dollars. His story carries a bold warning: A smart enough Ponzi schemer may get away with a lifetime of fraud. Madoff had no investment whatsoever. A combination of a mediocre investment scheme with fraudulent accounting that shows consistent returns could last many decades. The idea is similar to what Enron and other firms charged with accounting fraud did. Somehow, productive and deceptive activities tend not to co-exist harmoniously over time, which is a great blessing for investors. Still, it pays to be cautious.

There is only one effective antidote to the Ponzi bug - transparency. Never put money into an investment that hides information, whatever the excuse may be. Madoff hid information for decades claiming that his techniques were proprietary trade secrets - sounds legitimate, but no reason is legitimate enough. Another partially effective cure is diversification. There is something pitiful about people who lament the loss of their life's savings in a Ponzi scheme. It is as if they have failed to evolve in a fundamental manner. Not only were they naive or greedy or both, they never understood the eggs and baskets principle either. The law can and should punish predators, but it is impossible to protect those who willingly set themselves up as prey.

Associating with the wise

When I was in tenth grade, I read the English translation of a small episode from the Indian Epic 'Mahabharat'. The God of Justice was quizzing his son. One of the questions he asked was :
'How does a man gain wisdom?'
The answer was :
'By associating with the wise'.

Reading a book enables one to associate with the author, a person wise enough to write a book. Reading is useful. My father would take me to a children's library and read to me when I was too young to read. Then I started reading, developed a love for it, and read story books for many hours each day as a child and as a teenager.

With age came focus. I did not read stories much more. I read things that would help me to achieve a goal - academic or otherwise. Whatever the subject, a book has probably been written on it.

Not all books are created equal. Some books are a lot better than others. They are written by wiser people. In the old days, when I went to a library or a bookstore, there was no alternative to judging a book by its cover, the author's reputation (if you knew the author), and from reading a few lines. One of the things I love about the Internet is that it has made the flow of information and opinions so easy. These days, I never buy or read a book before checking its reviews. Associating with the wisest has never been easier. And this is important, especially in fields where the world has very few real experts, and a lot of wagging tongues. This reminds me of the following experience:

I have purchased several books on finance from Amazon. Whenever I go to the website, it recommends other books along those lines, and I spend some time reading reviews of the recommended books. When the book 'Reminiscences of a Stock Operator ' was recommended, I was curious because the book has excellent reviews. It's a book on trading, or speculating, something I generally refrain from doing. But hey, reading a review cannot hurt.

The book is a biography of Jesse Livermore, a famed trader, or speculator. The reviewers heaped praise on the trading 'commandments' that the book offers, rules that any trader can repeat. Commandments such as -No stock is too high to buy or too low to sell. The book was crowned the grandfather of all books on trading, containing wisdom transferred from mothers to daughters(??) and winners to losers(!!). A sturdy foundation on which to build a successful trading career. WoW!

Another review spilled a few beans. Livermore made and lost millions throughout his life. He was worth 100 million after the 1929 crash and bankrupt by 1934. He ended up committing suicide in a bathroom.

(a moment of shocked silence)

God bless his soul. Clearly not my idea of associating with the wise...