The second half of 2008 will be long remembered as the period when the world's financial systems came close to collapse.
The reasons for this series of events are not yet clear and it may take both the passage of time and the efforts of historians before any real light can be shone on the subject. What is clear, however, is it is only the injection of tax payers' money which has saved the majority of financial institutions.
It is worth noting that financial institutions take much the same line as politicians; when times are good it is due to their valiant efforts, but when times are bad, it is always circumstances way beyond their control.
In the financial crisis of 2008, we even saw the invention of a new language to explain these “unprecedented” events. We had the term “toxic debt”, which replaced the terms “bad debt” or “reckless lending to people who were unlikely to pay it back”. It makes it sound as though it was accidental and the banks were somehow the victims of something awful. We also had “credit crunch” which sounds much more “technical” and prevented the financial industry from saying “we ran out of money to lend legitimate businesses because we had lent it to people who were unable to repay it”.
In reality, a simple glance at financial history reveals that bad times always follow a period of long growth, particularly when such growth has been founded on the apparent belief that prices can continue to rise unchecked. The greater the level of assuredness that the market is strong, the heavier the fall that comes later.
The majority of people realise that the price of shares, houses or indeed anything cannot continue to rise unchecked. Neither can the accumulation of debt. For some reason it is only the financial industry that makes this mistake, very frequently and periodically, on a catastrophic scale. The South Sea Island bubble in 1720 involved a lot of otherwise successful and sensible people spending ever increasing amounts to buy shares in the mistaken belief that they could never fall in price, only to lose it all in spectacular fashion when the bubble finally burst. The Wall Street Crash of 1929 also had a dramatic impact, which was felt on a much wider front and led to considerable hardship in the USA and Europe, perhaps even contributing to the circumstances which led to World War Two.
It is notable that the majority of professionals in the finance industry consistently put their heads in the sand prior to any form of crash. There is always “one more deal to be done” just before the market drops. Instead of taking the view that their customers’ money should be used with caution, they encourage them to trade, because this is the source of their commission and their bonuses. People within the industry who start to warn of the calamity to come are not treated very well by their colleagues, who bombard them with statistics to prove that the trend is on the up and up.
It seems that catastrophic drops in the market are more likely to occur when people in the financial services industry become pre-occupied with making money for themselves rather than protecting the long term interests of their Clients.
A small number of people in the industry seem to know this. There is an apocryphal story told by Fred Schweb Junior who recalled that during a tour of New York, a guide pointed at the ships in the harbour and said “These are the bankers and brokers’ yachts”.
A naïve visitor asked “Where are the customers’ yachts?”
Fred Schweb had come out of the financial industry and went on to write the book “Where are the Customers’ Yachts?” which, in 1955, described in great detail and great humour how the banks and financial system act as a herd; with greed and self importance, ultimately damaging their Clients’ interests.
Fred Schweb’s book is not a rant about the failings of the finance industry. It is fair and balanced; he makes the point that the customer is often wrong too:
“Remember the life assurance guy; first he was a major nuisance, then he became loathsome, then he pushed a policy down your throat. Then a decade or two later you view your policy fondly and congratulate yourself on being such a responsible citizen and family man.”
In one of the most powerful sections of his book he raises one fundamental question which encapsulates why people should be cautious when they hear the advice of their financial advisers and commentators.
“Probably no reader has ever been so rude as to enquire of a professional writer on financial matters why the writer, who clearly knows so much about money, is not rich”.
The same might be asked about brokers. If they are so sure about their advice, why do they not take it themselves and invest all of their assets into the same stocks as they advise their Clients; indeed, why do they not divest themselves of Clients and become full time investors?
Finally, Fred Schweb unveils the reason that so much mystique and jargon has evolved in the finance industry:
“The notion that the financial future is not predictable is just too unpleasant to be given any room at all in the Wall Streeter’s consciousness. But we expect a child to grow up in time and learn what is reality as opposed to what is only his hopes”.
If it is true that the financial future is not predictable, then why would the financial industry spend so much time and effort on charting, statistics and forecasting? Is it because they truly believe in it or is it necessary to create a pseudo-science that convinces their Clients to continue to invest more recklessly than they might if they thought that a market fall was just around the corner.
This theme is taken up by Nassim Nicholas Taleb in his 2007 book “The Black Swan”
“When you put an Excel spreadsheet into computer literate hands, you get a sales projection effortlessly extending ad infinitum! Once on a page on a computer screen or a PowerPoint presentation, the projection takes on a life of its own, losing its vagueness and abstraction and becoming what philosophers call reified, invested with concreteness; it takes on a new life as a tangible object”.
Nassim Nicholas Taleb first achieved notoriety when he wrote a piece in his book “Fooled by Randomness” about the possibility of a plane crashing into his office building. The book was published the week before the tragic events in New York on 11 September 2001. He says:
“So I was naturally asked to show how I predicted the event. I didn’t predict it – it was a chance occurrence. I am not playing oracle!”
He develops the theme that you simply cannot use past data to predict the future. In one of his most powerful examples he says:
“Those who believe in the unconditional benefits of past experience should consider this pearl of wisdom allegedly voiced by a famous ship’s captain:
But in all my experience, I have never been in any accident of any sort worth speaking about. I have seen but one vessel in distress in all my years at sea. I never saw a wreck and have never been wrecked nor was I ever in any predicament that threatened to end in disaster of any sort.”
These words were from Captain E.J. Smith in 1907 and five years later he was the Captain on the RMS Titanic.
When financial disasters occur, it appears that the members of the financial industry are the last people to see it coming; they have just received a super-bonus from the previous period. When the bad times arrive, they will not “lose” money. They will merely forego the next bonus. This is a very different position from the fate of their customers.
Perhaps the finance industry should reconsider what it considers to be success. Is it merely extracting the maximum financial benefit from the customer, regardless of the benefits that they receive?
Our advice to the industry goes to the heart of one of the basics of business. “No business was ever harmed by looking after its customers”.