Greed and fear in the financial world
In a two-part article John Cassar White will look at how two major human motivators have interacted in the recent financial crisis that has affected the lives of millions of people throughout the world. In the first article he concentrates on the interplay of greed and fear among the protagonists in the financial markets themselves, while in the second article he examines how these same motivators affect investor psychology.
The meltdown in financial markets on Monday was a disaster waiting to happen. Merrill Lynch being rescued by Bank of America, and Lehman Brothers filing for bankruptcy represented the tip of the iceberg of toxicity that has been building up in the financial world as a result of gross management fuelled by greed and fear.
Yet for many people, including many so-called professional market watchers, this came as a surprise. While no financial crisis is exactly the same as a previous one, there are undeniable traits of warped human behaviour that ultimately leads to bitter consequences that, among other things, destroy the lives of so many people.
Greed and fear are among the most potent human motivators. Resist reading "good" or "bad" in this statement. Human characteristics can be either good or bad, depending on the situation or use. What may be an asset - healthy propensity to take calculated risk with one's savings - in one situation may prove a liability in another - speculating in the financial markets with money that one cannot afford to lose.
The protagonists of the financial services world have earned a reputation of greed and arrogance that, quite honestly, is quite deserved. Of course, here I am not referring to the rank and file of employees in the financial services who work judiciously to earn an honest living to support themselves and their families.
Many financial institutions are still led by people who know little about the complex products their young whiz kids are putting together to then offload on the market with very good returns. They often take short-term views, mainly driven by the need to maximise their annual bonuses and the need to keep their inflated egos fully satisfied. No wonder many of them have earned for themselves the sarcastic and dubious title of "masters of the universe".
There are of course other economic factors that have brought about this crisis and that cannot honestly be attributed to what I have called warped human behaviour. The booming world economy in the last decade, led by the success of China and India, has created a pool of liquidity that has forced the players in financial markets to under price risk. No one wanted to be left out in taking a share of the seemingly unlimited cheap credit made available by bankers to boost their revenue.
Bankers lowered their guard, ignored the recommendations of their regulators, silenced the voice of conscience that existed among a minority of their own senior officials who were prudently warning about the risk of under-pricing, and plastered over the cracks that were becoming so evident, for the eternal search for the holy grail - higher return to shareholders and ever increasing performance-related bonuses for themselves.
Unfortunately, some of the blame must also be attributed to regulators and rating agencies. Regulators are often a step behind the bankers they regulate in understanding the complexity and the risks of the products that are dumped on the market waiting for investors to take them up.
This leads to pressure building up and eventually causing substantial damage when the inevitable happens. What originally seemed a brilliant and risk-free idea suddenly turns into a time bomb when some fundamental flaw in the logic behind such a product is discovered.
The bonds backed by sub-prime mortgagees are a case in point. Banks offloaded these high risk loans from their balance sheets thinking that by so doing they would be able to free more capital to grant even more loans and earn more profits, rating agencies happily graded these bonds too generously nor realising the inherent risk of lending money to people who could not afford to pay you back. We all know how this vicious circle ended.
But what is even more worrying is how "the masters of the universe" in the financial world tend to react when they realise that their greed has indeed landed them on a slippery slope. Fear takes over and they try to patch over the huge cracks in their balance sheets while at the same time reassure the markets and their clients that their problems are only temporary and caused by others, rather than by themselves.
Eventually they reach a point of no return. Suddenly most people will realise how obvious the consequences of greed are. The king has no clothes on and we wonder how no one realised this long before it became so blatantly obvious. Regulators will rush in the new rules to prevent a similar crisis in future, while at the same time the seeds of the next crisis are being sown because greed and fear will always determine how most of us behave.
Yet for many people, including many so-called professional market watchers, this came as a surprise. While no financial crisis is exactly the same as a previous one, there are undeniable traits of warped human behaviour that ultimately leads to bitter consequences that, among other things, destroy the lives of so many people.
Greed and fear are among the most potent human motivators. Resist reading "good" or "bad" in this statement. Human characteristics can be either good or bad, depending on the situation or use. What may be an asset - healthy propensity to take calculated risk with one's savings - in one situation may prove a liability in another - speculating in the financial markets with money that one cannot afford to lose.
The protagonists of the financial services world have earned a reputation of greed and arrogance that, quite honestly, is quite deserved. Of course, here I am not referring to the rank and file of employees in the financial services who work judiciously to earn an honest living to support themselves and their families.
Many financial institutions are still led by people who know little about the complex products their young whiz kids are putting together to then offload on the market with very good returns. They often take short-term views, mainly driven by the need to maximise their annual bonuses and the need to keep their inflated egos fully satisfied. No wonder many of them have earned for themselves the sarcastic and dubious title of "masters of the universe".
There are of course other economic factors that have brought about this crisis and that cannot honestly be attributed to what I have called warped human behaviour. The booming world economy in the last decade, led by the success of China and India, has created a pool of liquidity that has forced the players in financial markets to under price risk. No one wanted to be left out in taking a share of the seemingly unlimited cheap credit made available by bankers to boost their revenue.
Bankers lowered their guard, ignored the recommendations of their regulators, silenced the voice of conscience that existed among a minority of their own senior officials who were prudently warning about the risk of under-pricing, and plastered over the cracks that were becoming so evident, for the eternal search for the holy grail - higher return to shareholders and ever increasing performance-related bonuses for themselves.
Unfortunately, some of the blame must also be attributed to regulators and rating agencies. Regulators are often a step behind the bankers they regulate in understanding the complexity and the risks of the products that are dumped on the market waiting for investors to take them up.
This leads to pressure building up and eventually causing substantial damage when the inevitable happens. What originally seemed a brilliant and risk-free idea suddenly turns into a time bomb when some fundamental flaw in the logic behind such a product is discovered.
The bonds backed by sub-prime mortgagees are a case in point. Banks offloaded these high risk loans from their balance sheets thinking that by so doing they would be able to free more capital to grant even more loans and earn more profits, rating agencies happily graded these bonds too generously nor realising the inherent risk of lending money to people who could not afford to pay you back. We all know how this vicious circle ended.
But what is even more worrying is how "the masters of the universe" in the financial world tend to react when they realise that their greed has indeed landed them on a slippery slope. Fear takes over and they try to patch over the huge cracks in their balance sheets while at the same time reassure the markets and their clients that their problems are only temporary and caused by others, rather than by themselves.
Eventually they reach a point of no return. Suddenly most people will realise how obvious the consequences of greed are. The king has no clothes on and we wonder how no one realised this long before it became so blatantly obvious. Regulators will rush in the new rules to prevent a similar crisis in future, while at the same time the seeds of the next crisis are being sown because greed and fear will always determine how most of us behave.