Walk around Wall Street and it is almost impossible to find someone who is not educated at an elite tertiary institution. This begs the question, then, why does the economy bursts spectacularly like an over pumped balloon every once in a while? Whilst it is universally accepted that recessions reflect the cyclical nature of the economy, one cannot help but wonder how these men and women who live and breathe the stock market fail to limit their losses time and time again.
Take a step back. Look over recent economic crises and ponder. Take your time. Does anything seem profoundly weird about the system? Surely, after the mistakes of the Great Depression, financial whiz kids and college prodigies will install algorithms that will safeguard the economy from such catastrophes. Think again. Do we not learn from our mistakes?
The Asian financial crisis of 1997, the dot-com bubble burst of the early 2000s and the subprime mortgage crisis of 2008 are perfect examples of economic disasters that illustrate our incompetence. Consequently, another train of thought arises: are these supposed professionals misinformed in the market they created? Or, are they as Michael Lewis comments in his bestseller The Big Short , simply getting rich by ‘making dumb decisions’? If you think that this seems overly cynical, just pause and take a deep breath. You will not like the next part.
Greed and fear are two characteristics that have and will always be the demise of mankind. Even the most honourable and saintly of stockbrokers who try to live by the codes of dignity fall prey to greed’s omnipresence. Put it this way. If you were given the dreaded (you may see it in a more positive way) question that the University of Michigan’s Dr Dylan Selterman posed his students with, which option would you choose? In the question, he asked students to select whether they wanted two points or six points added onto their final paper grades. However, if more than 10% chose the six points option, nobody got the bonus. In simple terms, the sudden plummets in markets are caused by too many investors taking the 6 points- a classic example of what economists call the ‘tragedy of the commons’. Of course, there are numerous contributing factors, but almost all of them point to the same basic culprit -greed. Give man an inch and he will want a mile.
There are two types of fear. One is the fear of losing out and being left behind; the other is the fear of impending doom that is expected to come. Unfortunately, speculators are not superhuman. They too are susceptible to the emotions that numbers and facts seek to counteract. In his breakthrough title Liar’s Poker Lewis aptly depicts the fear of being an outcaste in the workforce. During his time at Salomon Brothers, a pioneering investment corporation, he described his colleagues as intellectuals who went against their gut, instincts and rational thought as they were ‘scared of looking foolish’ and ‘feared solitude’.
In the 80s, Salomon Brothers was the investment firm that every fresh graduate sought employment from. Like being a member of the Cool Club in high school, you wanted to work for Salomon’s mortgage department. With Lewis Ranieri (an initial backroom clerk at the firm who later became the firm’s vice chairman) creating the mortgage bond market, Salomon Brothers emerged from the mid-tier pantheon of firms to distinguish itself as the firm that every investment banker had to practise his or her trade in. Its mortgage department had an air of arrogance and invincibility in their stride as any slight opposition of the department’s trade strategies and portfolio management represented two things-criticism of the very men who created the market and an outright rejection of the “mortgage club”. It was like trying to tell Bill Gates he is bad at software programming and, honestly, who on earth would do that?
It became increasingly clear that Salomon was getting too big for itself. It was over-investing and hyper-expanding into Europe amidst the weak US house market and savings and loan industry in 1990. One would think there were bound to be a handful of alpha-male brokers who foresaw the imminent threat of a downturn. Surely, these supposed logical financial brains had the urge to break free from hierarchy in the face of overwhelming evidence that pointed to imminent financial disaster for the firm. Did anyone do anything? Sadly, no. In the end, Salomon Brothers eventually collapsed in spectacular fashion, crippled by a series of poor years, foolish investing and illegal acquiring of treasury bonds. Overnight, professionals sacrificed their individuality for the comfort of belonging, degrading themselves into ill-fated sheep that followed each other over the cliff.
The other fear is the one that the media is used to, where speculation leads to a panic frenzy in the stock market. The Great Depression of 1929 was fuelled by such emotions as speculators dumped stocks in fear of further losses. This fear stems from a lack of confidence in one’s own judgement and natural instinct, subsequently leading to the inherent need to follow the footsteps of proven investors and ‘media economists’. These earthquake-like movements typically occur as investors jump ship from lucrative high risk investments to low returns but stable investments. Do all of them really think through their actions? Or do they simply abandon ship because the captain jumps?
Of course, there are certainly several outliers that squash the claims that investors are victims of the human condition. Warren Buffett, the heavyweight of the financial world disproves this theory. As a financial icon who thrived on generating wealth during economic disasters, Buffett represents those few individuals who grit their teeth and back themselves in the face of market sentiments, suppressing the natural urge to allow the human condition to overpower his rational thought. But there is a catch, do all of us have what it takes to be Buffett? Maybe we can, or perhaps it is too hard. The point is, it can be done.
The path for us seems terribly bleak if the blame of economic tragedies is reduced to these inherent flaws of mankind. After all, these very same qualities ensured that we progressed from cavemen to modern day humans, from organisms to thinkers. As Gordon Gekko, Michael Douglas’ iconic character in the 1987 movie hit Wall Street said, ‘greed clarifies and cuts through to the essence of evolutionary spirit’. The burning desire to always achieve more rather than enough dictated our advances, while the fear of being overpowered by predators and harsh circumstances culminated in the creation of society and communities, something we take for granted. These double-edged characteristics define humanity and our markets. However, unless we tame the enigmatic greed and master our emotions, we can never master the economy.