Entering Financial District - Proceed with Caution, Moral Hazards Ahead

Why is it that the tail end of every “this time is different” experience in financial markets looks the same?

The events looked quite different in the beginning: in one case, the focus is on technology. In another, it may be energy, sometimes it is housing or even race horses, and now it may be gold, according to pundits and George Soros.

The only common theme in the beginning is that a certain group of economists identify something as being worth more in the future than in the present, and that therefore smart people will buy early and losers will come late to the party, if ever.

We know from the past financial bubbles that the devil takes the hindmost. Coming late to these parties has a greater price than missing out on the best hors d'oeuvres or vintage wine, and many late-comers leave these parties with less than when they arrived, like the restaurants in South Korea where people take each others’ shoes.

During the “morning after” people writing and investigating the situation tend to focus on the unique features of the melt-down, which often involve the personalities in the center of the crisis; Milken, Boesky, Lay, Fuld, Blankfein and Rajaratnam are just a few of the latest.

We are treated to pictures of the spoils of their “actions”, our eyes change from green to red as we see their gigantic homes, yachts, trophy mates, etc. As we look at these behaviours and their consequences, we truly want to believe that these are flawed individuals that did things that we would never do ourselves. However, the facts show something else. If you put someone in an environment where they are viewed as being unique, it is only a matter of time until they view themselves this way, and begin to believe that their rules are different, the past if filled with examples and studies that prove this with little doubt.

When this sense of entitlement becomes malignant in a Fortune 500 company, a large financial firm or a government agency, we all find ourselves at risk. As these “special” people get more and more arrogant and less and less empathetic, they forget that there is a world outside the bubble that was built by the people they are swindling.

This arrogance is sometimes harmless. Larry Ellison builds boats with budgets larger than half of world’s countries’ GDP and Jack Welch writes self-aggrandising books while dumping his wife of many years for a young blond his daughter’s age. We know these things happen, and they don’t matter to us because the only people that these sociopaths harm are those closest to them.

While fascinating and repugnant, these examples of egotism run amok are not the Moral Hazards society needs to worry about. The problem that really matters is that through de-regulation bankers have managed to shift from models of risk management to a philosophy of “Gambling on Resurrection,” as McKensie and White called it in their 1995 paper. What these authors found was that after being freed by Reagan’s policies in the 1980‘s, banks began to choose riskier asset portfolios that paid out higher profits and bonuses. This seemed all fine and good, until these methods wracked markets so violently that government bailouts were the only answer, then the envy turned to anger.

Since they were still banks (or like Goldman Sachs in the recent crisis, a bank when it is convenient), when the huge losses happened they fell upon the depositors, or the FDIC that insured them. For all of the brilliance that is claimed on Wall Street it is clear to see that the deals that have trashed the world’s economies for the last several years are nothing more than a series of that old game of “Head’s I win, Tail’s you lose.”

The problem is that effective marketing by the banks through the corporate media outlets and politicians of both parties has convinced people that the banks have more concern over their well being than does the government, while all this obfuscation results in is the creation of high risk portfolios filled with taxpayer money.

So what is a country, or in the case of this crisis, the world, to do? The folks in the know have designed a financial system that is designed to generate huge profits for no detectable work or skills. The elite schools of economics appear to be working like prisons, turning out trained criminals that are more hardened to the outcomes of their actions, and with no empathy for those they destroy.

The answer is in transparency and limits, both anathema to people in power, and history has shown over and over that there is no way we can be trusted in situations where the only one who can see us is God. In Goldman Sach’s case, Lloyd Blankfein was famously and incredibly quoted as claiming that they were doing “God’s Work.” Perhaps this was because he was paid like a god, and not an employee of a public company.

So if God can’t help then we have to help ourselves. The answers aren’t nearly as hard as they have been made out to be by our Armani wearing friends on Wall Street and in Washington D.C. What we need to do as a society is to demand having a local bank representation and a consumer panel made up of a rotating and hard to bribe group of people, who are responsible for vetting and explaining financial instruments before they are permitted to be sold to any investors. There needs to be a clear alignment with risk and reward that pulls the thread all of the way through to the individual and their assets. And, there needs to be shareholder approval of pay packages in the C suites of public companies.

The bankers will cringe and 50 per cent of Americans will view this as socialism, because they aren’t able to understand that capitalism is not a license to steal, they have just been brought up in a country where it seems that way.

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