Thursday, February 14, 2008

Herding Cats

John Kay produced an interesting commentary over at the Financial Times earlier this week, in which he tried to explain the current banking crisis by reference to identity politics and group think. His central argument is that bankers got caught up in counterproductive behaviors—like originating toxic CDOs and mortgage-backed securities and flogging them to befuddled widows and orphans—because they wanted and needed to go along with everyone else at their firms and in the industry who were doing the same thing.

Yves Smith, of Naked Capitalism, doesn't quite agree:
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.

Well, at least Yves got it right about bankers' character.

Anyone who has ever had dealings with investment bankers can vouch for the fact that they are a congenitally optimistic bunch. No situation, security, or deal is impossible, overpriced, or unattractive; every client is charming, intelligent, and handsome to boot. This attitude, of course, is a defense mechanism, designed to help the banker cope with the usual state of affairs, in which few if any of these conditions apply. Indeed, if persons attracted to investment banking have an innate fault in this regard it is that they cannot recognize when conditions are so bad as to be irredeemable, and further effort is therefore useless. Recognizing this, and learning to pass the leadership (and workload) for such hopeless cases on to another (usually junior) associate, is a critical career step in the maturation of a senior banker.

It is also true that investment bankers are a remarkably unreflective bunch. They have neither the time nor inclination to ruminate, contemplate, or introspect concerning their clients, deals, or careers. All these the banker takes as given, and it is his sole job to monetize them all to the greatest extent possible for the greatest pecuniary reward possible. Should he fail in this regard, or display an excessively philosophical or contemplative bent, his superiors will look askance and begin to size him up for a wooden box.1 Homo investmentbankibus is not interested in "Why?" He is only concerned with "How," "When," and "How much?"

But these traits do not mean that the average investment banker is particularly susceptible to group think. With the possible exception of the colony organism known as Goldman Sachs—which prides itself on molding its diverse and talented workforce into the kind of uniform, efficient automatons last seen during IBM's heyday in the 1960s—most investment bankers I have known over the years view themselves, to a greater or lesser extent, as rugged individualists. While they may take pride in the institution they work for—if in fact it has a good reputation—they are almost always firmly convinced it is their own talent and genius which explains their personal success. Therefore, the typical investment banker is anything but a yes-man who parrots the party line of his or her organization. He practices his craft according to his own beliefs and ideas, and he suffers direction from his superiors only intermittently, reluctantly, and ungraciously. Not for nothing is managing investment bankers likened to herding cats.

Furthermore, the higher up in the hierarchy a banker gets, the greater the percentage of his or her workday is consumed with open and concealed battle against the other investment bankers at his or her own firm. Much of life for senior bankers and executives consists of claiming credit for good deals and good decisions and avoiding blame for bad ones. This is serious stuff, because you get paid a lot of money for the former and can lose your job over the latter. This, of course, sets you at odds with your supposed partners and colleagues, and the rivalries, feuds, and power struggles within most large investment banks are usually far more pitched and vicious that those between bankers at rival institutions.

For anecdotal proof, I would point you to the recent profile of someone who used to be a banker, before he toddled off to rape and pillage on a larger scale:

As one former Lehman banker describes the firm, “It was survival of the fittest. You produced the business and then you fought over the proceeds. It was every man for himself.” Bruce Wasserstein, then at First Boston, and soon to be regarded as the leading mergers-and-acquisitions banker on Wall Street, said to Eric Gleacher, the head of M. & A. at Lehman, and [Steve] Schwarzman, “I don’t understand why all of you at Lehman Brothers hate each other. I get along with both of you.” To which Schwarzman replied, “If you were at Lehman Brothers, we’d hate you, too.”

(Lehman, by the way, was renowned during Schwarzman's time as one of the nastiest snake pits in the business, composed of bankers with the sharpest knives and the most scars on their backs of any in the industry. But it was only an extreme example of behavior seen all over Wall Street and the City, both then and now.)

No, if there is a type of group think on Wall Street, it is of a particularly simple and unconstraining kind: make money. It's that simple. You make money in investment banking nowadays in two ways: by being an agent, or intermediary, for capital flows among sources and users of capital, and by being a principal, or investing for your own account. In the latter case, you look like any other investor out there, and are subject to the same opportunities and constraints. (Lucrative, but boring.) In the former case, you make money by arranging, executing, and taking a cut of other people's transactions.

Now, if you can find or invent a better way to satisfy your customers' needs—CDOs, credit default swaps, Super-Duper Slice-and-Dice Riskomatic derivatives—you can bet they will beat a path to your door. But the half life of innovation on Wall Street is miniscule, because within a week of putting out a new doohickey six of your competitors have reverse-engineered the dingus and are out flogging it to their clients and yours. Investment bankers do tend to move in a herd, but that is because they are all following the bigger herd of investors with all that lovely money, and it is easier and faster to tinker around the edges of existing technology than to create something really new.

Yves Smith does get something right. There was group think leading up to the current crisis, all right, just not among the investment bankers:

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.2 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).

It was not for the investment bankers to tell their customers that they were wrong to want higher returns and lower risk, even if the two could not be safely combined. It was their job to try and provide those things, because that's what the customers paid them for.

And the customer's always right, no?

1 Yet another reason why, Dear Readers, your Dedicated Correspondent conducts his public philosophizing under the cloak of anonymity. This also explains why I have so few senior investment bankers among my readership. Well, okay, that and the fancy words.
2 "Perps," as in perpetrators, as in everyone knows that those mean old investment bankers were evil devils who literally force fed toxic securities to those poor, innocent institutional investors who had absolutely nothing to do with their own corruption. Thanks, Yves. Consider yourself stricken from the rolls of us perps.

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