IT’S THE GENES THAT DID IT

How Personality Differences On Wall Street May Have Contributed To The Current Economic Problems

            In a recent New York Times column, economist Paul Krugman suggested that bailing out the investment banking firms was one thing, but bailing out the individuals responsible for the current situation was yet another. He’s absolutely right. With all that’s been said in recent weeks about causes for the mortgage and other fiascos, very little has been said about the bankers themselves, beyond noting that it was bankers what done it. And oh yes, by the way -- a lot of them still got massive severance payments.

            Aha! In the several books I’ve written on investor relations, I noted that people not actually involved in Wall Street tend to lump all financial people in one category. They all deal with money and make more than most people, goes the popular opinion, ergo they must be smart. Not only is it not true – as someone once told me, money is dumb, it doesn’t care who it goes to. There are vast differences in levels of intelligence and personality types for those holding each of the broad variety of financial positions. It’s an old story, of course, that most clients of service industries don’t much understand what the bankers and the professionals really do to work their magic. They’re just interested in results.

            For example, differences may be found between, say, most stock brokers and most investment bankers. Each requires different skills and different personalities. And remember, there are dozens of different jobs in the financial field.

            But I’ve always found that there is a profound difference between the investment banker and the commercial banker. Over the years, I’ve done a great deal with both. And that difference, in both obvious and subtle ways, contributed and continues to contribute to the current economic problems.

            I observed, many years ago, that commercial bankers were apparently born with a risk-averse gene. So controlled were they by that risk averse gene that long after their world had changed, they were still insisting that they were dealing mostly with the depositors’ money. In fact, most of the money they had came from investment and lending income. When I wrote The Prudent Man, the first book on investing under ERISA, I learned that bankers had difficulty grasping the fact that ERISA was the first federal trust law (all other trust law was from the state), and certainly that ERISA was the first trust law that didn’t prescribe the specific instruments in which they were allowed to invest. It took a book, written with the help of about a dozen people, including several who had helped write the law, to explain the difference. In subsequent reporting on ERISA, I learned that for years afterwards, most commercial bankers still didn’t get it.

            In fact, in an article I wrote at the time for a pension fund magazine on preference between commercial banks and investment banks to manage pension funds, I quoted one pension fund manager as noting that, “Banks can’t turn around in the Atlantic ocean.”

            In 1933, in response to banks’ excesses, the SEC promulgated the Glass-Steagall Act, which prohibited commercial banks from functioning in the securities markets. But in the last quarter of the 20^th century, banks, envious of the kind of money that investment bankers were making, pushed hard against Glass-Steagall, and eventually overturned it. That’s when troubles began – and still persist. Commercial bankers thought differently about investment risk than did the investment bankers. Investment departments were established by the banks, only to find them failing. And not only because of the risk factor. The investment bankers were making more money than the bank managers were making. It was a fascinating exercise in envy.

            There were also the differences in the personalities of each group. Bankers are willing to make money more slowly than investment bankers. The investment bankers are more impatient, and their sense of urgency to seize what they perceive to be opportunity readily supersedes a sounder judgment of risk. I wrote back in the 1970s that the perspective of Wall Street ranged all the way from the opening bell of the Stock Exchange to the closing bell the same day. It took the commercial bankers a long time to catch on to how investment bankers work.

            Well, gradually the two groups have learned to accommodate to each other – but only to a limited degree. The lack of perspective allowed both groups to be blinded by greed and to ignore basic business principles. Thus, they didn’t see the danger and potential consequences of turning mortgages into investment instruments, and then granting low interest adjustable rate mortgages to people who could barely afford them. Naturally, they were so short sighted as to be unprepared for a potential rise in interest rates in the future on these promotional, adjustable rate below prime mortgages that were sold to high risk borrowers.

            Surely there’s a personality problem that allows supposedly savvy financial people to be so short sighted. If the commercial bankers contributed to this current crisis, it’s because they understand risk through some fantasy screen – they can see the future only in terms of the past, and still not understand it. The investment bankers, on the other hand, are so comfortable with risk that they’re blinded by the potential gain, and ignore the potential for loss. How else can we understand a Bear-Stearns decline into two bucks a share bankruptcy?

            There’s yet another consideration – or at least a question. In this era in which computers and other technology can quantify risk, how did Bear-Stearns, and possibly several other major investment firms, not see the risk in the mortgage business. If they couldn’t do the arithmetic on paper, they certainly had computers to do it for them. And particularly in the sub-prime business, which was in large degree a gamble on the future of interest rates?

            It’s scary, isn’t it, to know that we trust our money to these geniuses. Krugman is right. Get rid of these shortsighted, risk averse or risk inured financial wizards, and get some really smart people in there.

            Or as the famous philosopher, Yogi Berra, put it, “Ain’t nobody here knows how to play this game?