Puzzle Versus Mystery: Who’s To Blame For The Great Recession

Puzzle: Can be solved with more information.  It pivots around lack of information ex: Watergate scandal, whereabouts of Osama bin Laden.

Mystery: Usually all the information, and more, is available to everyone but the mystery can be resolved only when the external parties take the time out – and possess the relevant expertise and the requisite tools – to analyze the information and spot the hidden red flags. A mystery thrives on complexity and no amount of transparency or disclosure burdens on the primary actor will help in cracking it ex: Enron and Satyam failures, financial meltdown of 2008. To quote Malcom Gladwell, who is credited with the above definitions, “It’s almost as if they were saying, ‘We’re doing some really sleazy stuff in footnote 42, and if you want to know more about it, ask us.’ And that’s the thing, (no external party) did.”

In the aftermath of the recent financial crisis where complex financial products blew up and resulted in huge losses to investors, experts and public alike are clamoring for greater transparency from financial institutions. By knowing more about all the risks involved in such products, they believe they’d be in a position to take more well-informed decisions and avoid such problems in the future.

This is a case of treating financial products as a puzzle and attributing what happened to lack of information. Whereas, in reality, they’re more like mysteries. A lot of information is available to us when we decide to buy them. It’s just that we don’t – or can’t – penetrate their fancy packaging to analyze the fineprint or spot the landmines that will inevitably blow up some day in the future. If you want proof, just check how many people can decipher 2/28, ARM, CDO, CDO-squared, CDS, and other fancy financial products mentioned in the post “Is Catch-22 Coming True?” I’d written at the height of the crisis.

Let me take an example from my personal experience to illustrate how financial products are akin to mysteries – not puzzles – and why no amount of additional information is likely to help an average investor.

A few years ago, when I wanted to park some one-time surplus cash, I was on the search of an investment product that called for no more than one or two payments. The MNC bank where I’d held my salary account at the time suggested a Unit Linked Investment Policy (ULIP) from a leading multinational insurance company. While buying this policy, I was assured that I could stop making premium payments after the second year. I was also told that returns from the policy were subject to market fluctuations. Since this was a standard disclaimer, I thought no more about it.

Fast forward to now: The Indian stock market has trebled since I’d bought this product but my portfolio value has barely crossed the sum invested.

pic01_200wWhen I asked the insurer why this was the case, I was told that, since I’d stopped paying premium after the second year, my policy had gone into a so-called “paid-up” mode. When I told them that meant nothing to me, they explained that, as per the terms of the policy, when a policy goes into paid-up mode, the management fees for the entire tenure of the policy (20 years in this case) would be recovered immediately after the second year – which is what put a big dent to my portfolio value.

This came as a rude shock to me and I finally decided to open the Standard Terms & Conditions that had accompanied the policy documents a few years ago. After wading through ten pages of fineprint, I was able to locate a set of clauses (cf. list on the right) that seemed to indicate that, while the insurer could deduct units proportionate to the management fees for the full policy term if the policy went into paid-up mode, they could do so only if the policyholder surrendered the policy and sought premature redemption. Since I was still holding on to the policy, there was no question of the deduction applying in my case. When I pointed out these clauses to the branch staff and call center representatives, they were clueless on how to interpret them despite the fact that their own agreement contained them. They deflected me to some email address. Six months and two reminders later, I still don’t have a reply to my email.

To me, this experience illustrates the following points:

To the extent that the salespersons of the bank and insurer hadn’t explained the possibility of such huge deductions to me and had hidden behind the general disclaimer that linked returns only to market fluctations, they certainly engaged in mis-selling. And in not responding to my recent emails seeking clarification, the insurer is guilty of poor customer service.

However, when it comes to the basic structure of this product (viz. ten pages of terms and conditions) and my decision (viz. to buy it without reading the terms and conditions), this is a mystery and not a puzzle.

One Response to “Puzzle Versus Mystery: Who’s To Blame For The Great Recession”

  1. […] erode capital via entry and exit loads. And, best of all, they weren’t accompanied by reams of fine print. For better or worse, I changed my personal investment strategy at that point although I kept my […]