No distinction between a small Indian Entrepreneur and Madoff!

I hail from India, and I want to tell my readers how business is conducted in markets in India.
I was seating at my acquaintance shop in textile market of my city, which is supposed to be the manufacturing hub of synthetic fibre in India because of its sheer volume. If you see the functioning of the market you will be amazed to find the length of operating cycles (i.e. No of days of receivables + No of days of Inventory at hand). It ran into months and with the kind of volumes a shopkeeper had, I was wondering how much capital these entrepreneurs might have invested; keeping in mind the low margin on capital employed. My uncle explained me the trade secrets.

Everyone in the markets get credit. And what is important is to honour your commitments on time in order to be operative in the markets. Once you default, then your all doors for credit are closed. But if a trader somehow manages the cycle he can arrange money by selling goods borrowed from another shopkeeper on credit and pay off existing dues. This cycle continues ....The essence is ultimately the bubble is going to burst. The cycle continues as long as there is a greater fool to sell him goods on credit so that everything is in place. The day, trader is unable to find goods on credit; his game will come to an end. And the final person to give credit will be one who will face brunt. And in order to keep confidences going, these traders are very smart; they come in chauffeur driven cars wearing Rolex watches trying to signal their creditors that everything is in place and their money is safe. So the rules are keep cycle going in, and send signals indicating your solvency and profitability. Because market usually sees what you show; it’s very simple to fool markets. !!!!! If somebody can manage to show affluence and somehow keep running the cycle market will tend to believe that the trader is a big shot and doing really good and their money is safe. This will boost their confidence and they will lend more goods on credit with the view of increasing their sales.

Now let us compare this situation to one of the biggest scandals in USA...Madoff is no different to the small entrepreneur I was referring above.

Madoff was one of the most reputable hedge fund managers in US. A hedge fund manager concentrates on absolute returns and has to deliver it even in turbulent times. If the Fund manager is successful then investors will reward him by increasing subscription his fund. One negative point about the hedge fund industry is that they are not under the obligation to report their performance or make disclosures. They might do so on voluntary basis and for fund to fund and it doesn’t apply to entire fund house. So there is presence of survivorship bias, the hedge funds usually overestimate their performance and promote their best funds to collect money from market and do not report performance of their funds which are bleeding and are cash starved.

Madoff was one of these crooks. He used fund inflows to keep the fund afloat and pay off redemptions and show healthy returns of around 12% even in turbulent times. When the wholesale markets were not in tragic stage, the cycle was running. New fund subscriptions were used to pay redemptions and inflate fund earnings and in fact in this case to hide losses. But within past few months, due to credit crisis, investors flows into hedge funds have considerably slowed down and many hedge funds have gone bankrupt; even Alternative Investment Vehicles floated by CitiGroup have gone bankrupt. Now, due to lack of enough capital flows the cycle of floating hats from one head to another couldn’t continue. And now no person was ready to wear the hat....So then finally who had to wear this hat...Mr.Madoff nobody is ready to accept your hat...The fund has gone bankrupt and Madoff has been accused of siphoning more than $50 billion of investors. The impact could be far reaching as many investors, trusts including charities; clients of banks like HSBC etc were invested into these funds. This could further aggravate the ongoing credit crisis. Now the impact will be investors will lose trust in lending their money. This will reduce the investment climate significantly and there will be a global slowdown.

The only difference I see between my entrepreneur and Madoff is each one plays according to his stature and size. The small entrepreneur had exposure of around $200000-500000 while Madoff had exposure of around $50 billion. And in both cases, the people who entered in the chain last were the ones who suffered the most.

Conclusion: - Don’t believe on your eyes. No one can make a quick buck in the markets. If someone gives you information that gold is lying on roads, please don’t be allured and become a prey to it.