A recent report by Max Abelson contains some choice statements by a couple of former Lehman executives:
There are two ways to react to the biblically proportioned report that Lehman Brothers’ bankruptcy examiner released last Friday... The first is to lose faith in man...
The second reaction is to shrug... Two former senior Lehman executives did just that this week, telling The Observer that the examiner’s autopsy... was simply not a big deal... “It’s just not that big of an event... They just want to be mad and don’t know what they’re talking about and want to be outraged...”
“When I read this, I giggle a little bit. Because $50 billion is a shitload of money, but in the grand scheme of things... $50 billion is a drop in the ocean.”
The former managing director in London said that Repo 105 was an open secret there, if it was a secret at all. “Yeah, yeah, yeah. In Europe, people just generically talk about it. It’s funny, for nonprofessionals, you can try to make it a smoking gun,” the source said, “I’m like, whatever.”
The only people who would worry about using an old trick to reduce leverage from 13.9 to 12.1, the second executive said, are “yappers who don’t know anything.”
Stacy-Marie Ishmael at FT Alphaville is rendered speechless by this. Felix Salmon, however, is not lost for words:
[It’s] important not to lose sight of the fact that what we’re seeing here is a corporate failing to an even greater degree than it is an individual one, and that it infects investment banks generally, not just Lehman Brothers. These shops deliberately go out to hire psychopaths, and then they fire the ones who go soft, while promoting the most aggressive assholes, keeping a few smooth-talking client-relationship types on hand to preserve some semblance of a respectable public face.
I prefer to think in terms of preferences over risk and reward rather than psychological pathologies, but behind the strong language his point still stands: human behavior differs substantially across career paths because of selection both into and within occupations. This is what I was trying to get at in an earlier post in which I argued that behavioral economics, despite its many successes, was going to be of limited use in understanding the determinants of financial instability:
[Regularities] identified in controlled laboratory experiments with standard subject pools have limited application to environments in which the distribution of behavioral propensities is both endogenous and psychologically rare. This is the case in financial markets, which are subject to selection at a number of levels. Those who enter the profession are unlikely to be psychologically typical, and market conditions determine which behavioral propensities survive and thrive at any point in historical time.
This calls for an ecological approach to understanding financial market behavior, focused on behavioral heterogeneity and selection pressures. The argument is not by any means new; it is a critical component of Minsky's financial instability hypothesis, and has been articulated recently in the following terms by Macroeconomic Resilience:
If we assume that there is a sufficient diversity of balance-sheet strategies being followed by various bank CEOs, those... who follow the... strategy of high leverage and assets with severely negatively skewed payoffs will be “selected” by their shareholders over other competing CEOs... cheap leverage afforded by the creditor guarantee means that this strategy can be levered up to achieve extremely high rates of return. Even better, the assets will most likely not suffer any loss in the extended stable period before a financial crisis. The principal, in this case the bank shareholder, will most likely mistake the returns to be genuine alpha rather than the severe blowup risk trade it truly represents.
Selection of strategies necessarily implies selection of people, since individuals are not infinitely flexible with respect to the range of behavior that they can exhibit. Hence any incentive structure will elevate certain types of individuals at the expense of others. As Felix notes, this is "something that regulatory reform can’t even come close to addressing, unless it deals head-on with the question of compensation."