Beware of This Perennial Trigger of a Financial Crisis Lombardi Letter 2018-09-10 11:31:09 greed speculation gordon gekko Wall Street economic crisis adam smith bankers If the overriding cause of the last financial crisis could be distilled into a single-word explanation, it would be "greed." Here's why. Analysis and Predictions,International Markets,News,Stock Market Crash,U.S. Dollar,U.S. Economy,U.S. Politics,World Politics

Beware of This Perennial Trigger of a Financial Crisis

News - By |

Greed May Be the Most Important, if Neglected, Cause of a Financial Crisis

Whenever I think of Gordon Gekko in Wall Street, I reflect on the famous speech about greed and how it describes investor behavior and dynamics. And if the explanation for the last financial crisis could be distilled into a single overriding cause, it would be greed.

In 1987, Oliver Stone released his movie about the market euphoria of the 1980s. The story and the concerns of Wall Street remain relevant today. The most relevant consideration of the film concerns the idea of greed: “Greed is good.”


Stone wanted to present greed in a moral (or immoral, if you prefer) setting. Inadvertently, Stone clearly explained how greed can affect investment decisions in a negative way.

The film helps investors understand how greed works and how it affects market-related decisions.

Ultimately, it shows how greed can become a Frankenstein-like monster, which, if left unhinged, leads individuals to their downfall. At a collective level, then, greed drives markets to a financial crisis.

It Turns Out, Greed Is Not Good

The “greed is good” mantra characterized the 1980s at an individual level.

In the 2000s and after the second-largest financial crisis of the past 100 years, it applies even more now as a veritable philosophy of the markets.

And it’s leading the markets down the path of another, possibly worse, financial crisis now.

Beyond the simplistic arguments that Gekko proffered, greed, as a factor driving investment decisions, has limits.

Seen under the lens of capitalism, greed has stopped working in the interest of a wider societal goal—that is, as a driver of change, innovation, and actual wealth creation.

Indeed, self-interest can set in motion the wealth-generating mechanisms of the market. The quest for personal benefit and utility can often translate or “trickle down” to others.

But modern-day greed, the kind that set off a financial crisis, stems from the fact that today, finance can generate wealth from paper.

In Adam Smith’s day and up to a not-so-distant past—up to the early 1980s and before derivatives—the economy was about producing tangible products and services that spread wealth among many different economic “actors.”

The economy was about Main Street. Finance was, at best, its tool.

Today, Finance Has Become a Goal unto Itself

Finance produces ephemeral wealth for the few. Wall Street no longer serves Main Street and Main Street always suffers more than Wall Street when trouble strikes.

When Wall Street makes a huge mistake—bordering on fraud—it gets a government bailout to the tune of trillions. If Main Street makes a mistake, it shuts down.

And Greed Is the Cause of the Distortion

Greed has always served humans poorly. It’s not one of the seven capital sins by chance.

As the British philosopher Jeremy Bentham stressed, greed is a natural and all-too human instinct. When well managed, it can lead to favorable outcomes for the individual and the community.

Left unchecked, as it is now, it overpowers any good. (Source: “Adam Smith (‘Self Interest’ Meant the Virtue of Prudence) Against Jeremy Bentham and the Economics Profession (‘Self Interest’ Meant the Vice of Greed, Selfishness, and Avarice),” SSRN, December 11, 2017.)

The potentially disastrous situation the real economy finds itself in stems from the very fountain of greed: certain international investment banks, promoting finance for finance’s sake along with a penchant for short-term thinking and really short attention spans.

The banks have encouraged the practice of huge bonuses, which are more often than not awarded without any link to long-term benefits for the clients. The very idea of “service,” or helping customers, has disappeared from the investment banks.

Banks and Bankers Serve Themselves; They Pursue Their Own Greed

And how does this hurt you, dear investor? Greed prompts the big players on Wall Street, already high on the whiff of bonuses and the “How to Spend It” edition of the Financial Times, to detach themselves from reality.

The big money associated with investment banking encourages the kind of greed that benefits the very few and makes markets riskier than they would be otherwise.

The bankers focus on pursuing short-term results and high risk in the realm of finance rather than engaging in longer-term and lower-risk activities in the realm of the real economy.

And therein we find the problem of greed. If investors, you, or I allow ourselves to succumb to pure and unfiltered greed, we will end up taking the kinds of risk we can’t sustain.

Greed is the instinct in the back of our heads constantly telling us to put all our eggs in the risky but potentially high-reward-yielding stock. Greed intertwines with excitement, and we double or triple our exposure to the risky asset.

Instead, a wise investor will try to hedge their bets by diversifying the portfolio and the mix of asset types.

Often, greed becomes blinding and muddles perspectives.

Often the Key to Successful Investment Is to Avoid a Big Mistake

Learning to manage risk and, most of all, greed might be the most valuable lesson for an investor to learn. When you start noticing that greed has beaten your defenses, try to reflect. Take a break and ponder your next moves carefully.

Patience might be a mightier weapon than a tank.

Speculation is the fruit of greed. And speculation differs from investment.

When a trader or a financier—George Soros, for example—speculates, they are willing to take a big risk, perhaps betting a large sum against or for a stock, a commodity, or a currency. Often, the basis of speculation is a contrarian bet, an investment based on an opinion that differs from the dominant position.

Now, when Soros does it, as highly controversial as it may be (as in the case of the Italian lira and British pound in 1992), he can provoke a major market swing.

Still, it must be acknowledged that Soros bets his own assets, or those belonging to a highly exclusive set of clients.

If the bet goes badly, it’s Soros who loses. If it goes well, Soros wins, and the world often reaches the brink of an economic crisis.

Investment bankers, however, bet other people’s assets—the assets of thousands or millions of clients. They have no skin in the game.

Work or Fail, They Still Collect a Fee and Their Salary

That’s what happened in 2008. Several investment banks used the ultimate speculative tool, the derivative, betting in highly improbable assets based on toxic debt.

What could go wrong?

Well, wrong it went. Tens of millions of ordinary people around the world, even those who had never invested a single dollar in their lives, promptly learned the meaning of greed and speculation.

Ultimately, greed is the force that prods some bankers to take unethical risks, triggering the kind of regional financial crisis that quickly escalates into an international economic crisis.

Perhaps the source of unbridled greed is irrationality. Certainly, all individuals have instinctual greed to one extent or another.

The solution, especially when it comes to maintaining a healthy and profitable relationship with the markets, is to remain self-aware and vigilant. When you find yourself dreaming up overly risky investment strategies, you are succumbing to greed.

Most of All, It’s Crucial to Be Aware of the Greed Driving the Market

Phenomena like Bitcoin, Tesla Inc (NASDAQ:TSLA), Snap Inc (NYSE:SNAP), and the protagonists of the tech bubble of the late 1990s are the fruit of pure greed.

Recognize when something is too good to be true and don’t fall into the trap.

Nevertheless, warnings work at the individual level.

The big speculative bubbles of history, from tulips in Holland in the seventeenth century to the tech stocks and subprime mortgage securities a few centuries later, have shown that speculation mixes with the power of crowds.

It takes determination and conviction to avoid falling into the siren-like lure of greed.

Related Articles