Greed isn’t the only game on Wall Street

Anyone who has read the surfeit of books on the meltdown of the financial system will know that the burden of patience chiefly falls on the reader. The authors, whose lives were barely buffeted by the Great Recession, seem infinitely addicted to the notion that lust for short-term profits was the major contributing factor in the lead-up to the 2008 financial crisis.

The reason we know this is because they keep telling us.

Greed is always a popular scapegoat when something goes wrong. We assume it’s inherent in human nature; ubiquitous. It’s embedded far more deeply in the American capitalist system than are the benefits that flow from resisting the temptations of immediate gratification..

However inherent greed may be, lost in the frenetic discussion is the notion that it takes particular incentives to make it burst forth in full glory. These perverse incentives are an essential point that is often overlooked.

On a macro level, are government housing policies flawed for providing incentives to borrow too much to buy a home? Do U.S. tax policies promote short-term investment? Are stock option-based executive compensation schemes promoting a fixation on quarterly earnings?

Let’s consider two simple examples. Suppose you hire me to sell your line of Christmas cards door-to­ door and offer me a lucrative commission on the retail price of all the cards I sell. Do I have an incentive to push the cards that generate the highest profits for you or to push the ones that can generate the highest retail sales volume, even if they’re loss leaders?

You already know the answer to that one. Now, let’s switch places.

Suppose we work on Wall Street and I hire you to sell the glitzy derivative securities our brilliant rocket scientists have packaged up from pools of solid and not-so-solid home mortgages. And your year-end bonus -which can often be the largest part of your compensation – is based on the dollar volume of these securities you’ve sold during the year.

Is this arrangement likely to make you act responsibly, to sell high-priced derivatives backed by not-so­ solid mortgages only to savvy investors who understand the risk that accompanies their higher yields, while focusing on selling less-savvy investors the lower-price derivatives that offer modest yields but are backed by solid mortgages? Or does it reward maximizing your sales volume, pushing the high­ priced derivatives across the board by touting their “fabulous yields” without mentioning the risk?

You know the answer to that one, too.

So when judgment day comes and the value of all those risky  high-priced derivatives collapses, leaving stunned investors holding the bag, are you at fault because you gave in to your inherent greed? Or am I the culprit because I gave you an irresistible incentive to push toxic, high-priced derivatives to all and sundry, never mind the consequences?

Many of you remember Gordon Gekko’s “Greed is Good” speech from Oliver Stone’s 1987 movie, “Wall Street.” Greed is a powerful tool; only the desire for more, more, and more and to get ahead generates economic growth. But there’s a much more articulate and compelling defense of greed in Ayn Rand’s classic libertarian novel, “Atlas Shrugged” in which entrepreneur John Galt insists that greed is the only thing we can really depend on to move society forward.

Or is all this just the old story of Satan conning Faust to sell his soul?

Good intentions alone cannot constrain greed. If government and business fail to provide the right kind  of incentives to channel legitimate self-interest, capitalism is as appealing as letting a pack of rabid dogs loose on the American worker. Until the incentives are changed, the hard truth is that most of you should reach for your wallets.

originally published: April 25, 2015

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