Moral Hazard

Greed is good.

Once upon a time this was an assertion and a truth. Today it is a question – is greed really and truly good? Can capitalism survive if this is an unanswerable question? Or to put another way, how can capitalism survive if we cannot show that greed is indeed good?

I finally watched the second Wall Street movie, having avoided it for some time because all the reviews said it was trite, uninteresting, predictable and boring. Predictable, and because of that, somewhat boring, yes, but trite and uninteresting no. Indeed, there were some gem-like lines that deserve re-statement and reflection.

We remember the great line is the first Wall Street movie – Greed is good. Greed really will make the world go around; it is the lubricant that spurs action and because everyone knows the game, there is a certain “honesty” to the system.

Fast forward to the banking-generated “recession” of 2009 and the near collapse of the world’s financial structure. Released from jail, but not repentent, Gordon Ghekko, asks, Is Greed good? Money he says is “a bitch that never sleeps” and, in addition to never sleeping, she is an intensely jealous mistress. What GG, and the screenwriter, might not know is that the female metaphor was the language eighteenth century observers of financial matters used to describe and understand the volatility of capitalism. Fortune was a fickle women; you had to woo and seduce her to win her favour. But her favour was capricious; she could not be trusted. Even with over 200 years of observation, study and analysis, we are reduced in 2011 to reviving this metaphor as the best way to understand a financial system whose volatility continues to elude – and terrorize – us.

What we need to do, as Mr. Ghekko and other real-life observers assert, is to restore confidence. And the best way to restore confidence would appear to assert two possibilities. The first is that no one is responsible. This is not to say that there aren’t institutions that are responsible (for example, the rating agencies). It is to say that no inidividuals are responsible.

The second is to identify the presence of a “moral hazard” and say that it can be contained through better regulation. But let’s be clear; moral hazard does not imply individual responsibility. It means that there is uneven, or asymmetric, information that to be minimized, needs better regulation.

This can then explain how it was that Citigroup held a $40 billion position on sub-prime mortgages, but the CEO at the time, Chuck Prince, claims he was not responsible for the disastrous outcomes because he did not know about this position. As reported by The Financial Crisis Inquiry Report, the “defence” was that that was a small position on a corporate balance sheet of $2 trillion. So small and yet so large.

And as Abby Joseph Cohen, one of the most respected, and famous, market analysts and a partner at Goldman Sachs, explains the crisis:

There was a very unfortunate confluence, bad decisions made by many different entities. (NY Times Magazine)

So lots of people making similarly bad choices and decisions, creating a horrendous financial crisis that had deep impacts on how people around the world are able to live their lives, is a way to absolve individuals from responsibility?

Is the market place an arena of herd-like humans who believe unquestioningly in the commands from the front as to shich is the optimal way to march? And then we learn that there is really no one at the front of the line – only institutions who again act in unquestioning ways? If the world is then determined by endless looping of herd decisions, it would appear that we have abandoned individual responsibility. The “market” replaces God in the ageless query – if an entity (read God or the market) is omnisicent and omnipotent what happens to free will.

Moral hazard means that individuals are shielded from accountability and responsibility. Because of something called “information asymmetry” – where one member of a transaction knows something the other does not – victims have had to bear the consequences of the moral hazard. There is a reason that the buyer can’t “beware” because they are ill or un-informed; it is the responsibility of the seller to inform.

If we believe in free will – and I believe we do – then we need to take responsibility for the decisions we individually as well as collectively make. When the analyst assesses the value of a stock, or an investor pitches the value of his project, or a banker sells the new financial product, we need all to know we are responsible for those decisions. Otherwise we are operating in a world entirely bereft of real human connection and accountability.

It is the absence of human trust that is the real problem revealed by the actions of the “market”. The absence of trust only makes it harder for the market to operate efficiently. More potently, it dismantles the glue that binds people into families and communities. We give permission for a world where no one has the back of anyone else.

But moral hazard and the call for new regulation is the responses we need and want. And all that we have been given. The alternative is to say that the system is fundamentally flawed or that human beings, because they created the system, need new rules of engagement. And what would that option look like? Most of the time it appears we are too terrified to even contemplate the question.

So we soldier on. Without mass anger, or mass exodus from the financila institutions we have come to know. We continue as before, out of habit and fear; it is no longer out of belief or trust.