Saturday, May 24, 2014

The Farmer and the Viper

The story of the Farmer and the Viper is one of Aesop's fables and goes something like this,

A farmer finds a viper freezing in the snow. Taking pity on the snake, the farmer picks it up and places it inside his coat. The farmer's body heat revives the viper who then immediately bites its would be rescuer.

While there are various endings (and therefore morals) to the story, the one I thought I'd focus on for this post comes from Odo of Cheriton. In this version the dying farmer asks for a simple explanation why the snake would deliver a mortal bite given the farmer's compassion. The snake answers,

 "Did you not know there is enmity and natural antipathy between your kind and mine? Did you not know that a serpent in the bosom, a mouse in a bag and a fire in a barn give their hosts an ill reward?"

As you probably noted in my previous post about the US economy, I have some pretty cynical and sharp views about the financial industry. Ironic I know as I've worked in the industry for over 20 years. To my defense, I wasn't always this skeptical. I started in the business with the same wonderment and awe as every other rookie who was hired on to work at a brokerage firm. No, my cynicism was accumulated over the years, as the shiny veneer peeled away and I got a better understanding of the darker workings industry. Now, let me stop right there and say there are obviously a TON of amazingly brilliant, honest and wonderful people who work in this business. But, there are also a lot of vipers as well and they are threatening our economy (again).


Dr. Robert Hare from the University of British Columbia wrote a book with industrial psychologist Paul Babiak called "Snakes in Suits: When Psychopaths go to Work". The book discusses how psychopaths work (and excel) in the corporate world. An article on MSN referenced Hare and Babiak's work and highlighted that in a very small study of 203 corporate executives, 4% met the criteria to be deemed a 'psychopath' - an interesting number given the average for the general population is about 1%. Moreover, Hare made a very interesting comment in the article specifically about the financial industry  -

"it may even be higher than 10%, on the assumption that psychopathic entrepreneurs and risk-takers tend to gravitate toward financial watering-holes, particularly those that are enormously lucrative and poorly regulated".
Ding Ding Ding.
Okay, not convinced yet?

How about this story from 2011 - "Going Rogue" - that discussed the case against UBS trader Kweku Adoboli who made unauthorized trades that led to losses of about $2.3 billion?

this was the part of the article that stood out to me:  

"According to a new study at the University of St. Gallen seen by SPIEGEL, one contributing factor may be that the stockbrokers' behavior is more reckless and manipulative than that of psychopaths. Researchers at the Swiss reseearch University measured the readiness to cooperate and the egotism of 28 professional traders who took part in computer simulations and intelligence tests. The results, compared with the behavior of psychopaths, exceeded the expectations of the study's co-authors, forensive expert Pascal Sherrer, and Thomas Noll, a lead administrator at the Poschwies prison north of Zurich. "Naturally one can't characterize the traders as deranged," Noll told SPIEGEL, "But for example, they behaved more egotistically and were more willing to take risks than a group of psychopaths who took the same test".Particularly shocking for Noll was the fact that the bankers weren't aiming for higher winnings than their comparison group. Instead they were more interested in achieving a competitive advantage."

This makes a lot of sense when you consider that a psychopath's brain is wired to seek reward at any cost

But are guys like Kweku Adoboli, Jerome Kerviel, Yasuo Hamanaka and Nick Leeson just a few bad apples? Is there really only one or two cockroaches here?

Well maybe, but it could be that they were hired exactly because they were psychopaths. Consider this:

"Functional psychopaths make the best investors"

From the article:

"Functional psychopaths make the best investment decisions because they can't experience emotions such as fear, a study by researchers at Standford Graduate School of Business showed. Fear stops people from taking even logical risks, meaning those who have suffered damage to areas of the brain affecting emotions, and can supress feeling, make better decisions, the report showed. The ability to control emotion helps performance in business and financial markets, the researchers found".

So what am I trying to say here? What is the point of this particular blog entry?

Well, let me lay out my thesis.

1. The financial industry attracts a higher proportion of psychopaths than would be found in the general population.

2. Psychopaths display characteristics that allow them to excel in the industry but they are also tend to pursue reward at any cost, or risk.

3. Given these competitive advantages and successes (see #2) - we can assume that psychopaths would tend to climb the corporate ladder faster than others, and therefore would tend to cluster at the top of an organization.

4. Given the clustering of like minded individuals with common goals (ie pursuing rewards at any cost) the psychopathology would lead to less ethical behavior and heightened risk taking for that company or industry. William Black describes this as "Control Fraud"

5. A Gresham's dynamic compels other competitors to adopt similar tactics until the entire industry is affected.

This I believe played a large part in the lead up to (and fall out of) the Great Financial Crisis of 2008.

But here's the problem. Who did we turn to to help get us OUT of the Financial Crisis?

Wall Street.

Wall Street convinced everyone (just ask Tim Geithner) that it was critical to save them. So we did.

But therein lies the problem - and why I referenced the Farmer and the Viper story above.

Yes - we saved Wall Street, but failed to clear out or even control the activities of the 'psychopaths'. So, it is absolutely naive and unreasonable for us to assume that today they have "seen the light" and are going to change their behavior going forward.

How many times have we, the Farmers - saved Wall Street only to be lethally bitten once they recovered from the cold?

In the last 40 years we've had a Latin American Debt Crisis  in the early 80s, an economic collapse from a credit bubble in Japan in the late 80s, then we had the Savings and Loans situation in the US, LTCM, in 1998 and of course the bubble and 2008/09 global crisis.

Again, I am not saying that 'everyone' in the industry is bad - clearly they aren't. But I can't help but notice some of the excesses of old are starting to creep back into the marketplace..

sub prime is making a comeback

as are PIK-Toggles.. 

I am also seeing a lot of commentary lately given the fine imposed on Credit Suisse - and how it will not end up being a deterrent for future abuses. Credit Suisse got off lightly

It's happening again - and I will say I am worried.

Change will only come when we, the people, demand it. It is our duty to facilitate sweeping changes in the financial industry to once again realign our objectives with our clients.

And we need to do this soon, lest we find ourselves mortally bitten once again and asking "why".

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