John Kay in the Financial Times offers a theory as to how seemingly intelligent people could design and peddle products that would come back to haunt them via massive writedowns and badly dented reputations: it’s the conformity, stupid.
A lot of readers would probably differ; incentives like performance pressure and annual bonus schemes would seem sufficient to explain the short-sightedness of investment bankers. And recall when the firms were partnerships, the aggression in the lower ranks was checked by the owners whose capital was illiquid, which required them to take a longer-term, more deliberate stance. But it is true that the industry favors people who have a can-do attitude and are not prone to introspection, which may make them more susceptible to group-think than most people.
Kay’s observation has some merit, but I think it applies more to the money managers and other investors who bought dubious paper more than it does to the perps. They were surrounded by peers who were buying complicated new products that offered higher returns; being skeptical suggested one was a Luddite, or worse, not up to snuff analytically (not that anyone did much analysis, as we have now learned).
Social psychologist Robert Cialdini, whose classic Influence: The Psychology of Persuasion discusses the power of group assent. Individuals, when confronted with a group that has views they do not share will almost without exception be worn down. Somewhere deep inside, it turns out most of us believe that if everyone thinks differently than we do, we are the ones that are wrong
“So long as the music is playing, you’ve got to keep dancing. We’re still dancing.” Chuck Prince, former chairman and chief executive of Citigroup, was interviewed by this paper only a month before the music stopped. A few weeks later he was out of a job. With these comments, he got to the heart of the banking crisis.
Economists search for rational economic explanations of apparently irrational behaviour. They emphasise skewed incentives and asymmetric information. There is something in these descriptions. But there were financial panics long before there were Wall Street bonuses. There were financial panics long before the invention of limited liability.
Mr Prince’s metaphor is sociological and anthropological not economic. Groups routinely demonstrate behaviour that few if any members would choose to adopt as individuals. Look at teenage gangs, soccer hooligans, religious zealots – or clubbers. Sometimes the group provides a cloak of legitimacy for misbehaviour. The trading floor has a similar effect. You get carried away, explained Jérôme Kerviel, Société Générale’s former trader. The process by which hysterical groups damage themselves and others in assertion of preposterous beliefs is a recurrent theme in human history. We see it in anti-Semitic pogroms or McCarthyite persecution. Before the mysteries of structured credit there were the mysteries of witchcraft; before investment banks used initial public offerings to turn dotcom concepts into billions of dollars alchemists claimed to turn base metals into gold.
Shared values and beliefs create a group identity. No matter that the beliefs may be absurd or the values contemptible: that Salem was not besieged by witches, the US was not threatened by communist infiltration, that greed is not good and that suicide bombers will not be greeted in paradise by 71 virgins. The very improbability of the belief, the unacceptability of the values, reinforces their social function; these factors distinguish the real members of the group from the less committed.
Gangs differentiate themselves by their characteristic beliefs and values. Your performance as a gang member is judged not by rational, objective criteria but by the approbation of your peers. As on the streets, also in the office towers. The people on the floor above fix your bonus and advance your career.
Some beliefs and value systems are more successful than others. The effortless superiority prized at Goldman Sachs seems to have served it well in the subprime crisis. The extreme aggression of Bankers Trust and Credit Suisse First Boston in the 1990s led ultimately to the destruction of these organisations as independent businesses. But always, the beliefs and values that matter are local, not global; subjective, not objective; and to question the prevailing culture is to exclude yourself from the group.
Were the people who presided over the promotion of dotcom stocks liars or fools who believed it themselves? Did the people who said structured credit products were a new and more sophisticated way of managing risk exposures really think this was true? Or had they simply latched on to an academic theory that fitted their self-interest? The analytic mind argues that one or other explanation must be true. But neither need be. Like the politicians who invaded Iraq, executives of major financial services businesses did not reflect on questions to which they did not wish to know the answer.
Sympathise with Mr Prince’s dilemma – although, given the size of his pay-off, do not sympathise for long. If he had decided to pull Citigroup back from its increasingly frenzied trading and lax lending, he would have been deposed – by shareholders desperate for profit, non-executive directors steeped in conventional thinking and, above all, by subordinates hungry for bonuses. The gang leader, despite his apparently unquestioned authority, is frequently the prisoner of the gang members. The man who occupied the chair at Citigroup, ostensibly the most powerful position in the global financial services industry, was in reality the pawn of his own employees. That is what Mr Prince meant when he said that so long as the music plays, you have to dance.