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Greed, Competition, Investor Expectations: Some Things Social Media Will Never Change


Courtesy Bryan Maleszyk on Flickr

Courtesy Bryan Maleszyk on Flickr

In my previous post, I wrote about the Paul Kedrosky session at Defrag 2008, Around the Horn. It was a free form session in which he queried several panelists on a range of subjects. Lots of good discussions from that.

One topic that got some extended discussion both on the panel and in audience questions was this:

Could social media and better information awareness tools have prevented the financial meltdown?

The basis of the question, in the Defrag context, was that there were signs and data that pointed to the implosion. The argument on the table was that there was a failure of information systems, and of social media, to alert the world to what was happening. And the follow-up: how can we improve this?

You can’t. Don’t even bother.

Because the problem isn’t one of not seeing the warning signs. See Morgan Stanley analyst Mary Meeker’s slides about the various financial ratios at the time of the financial collapse. We were clearly running things in the red zone when you see that data. And the data was there to see.

The problem is that people will never change. They will ignore any system telling them that things might be getting out of hand. Why? Tragedy of the commons.

Financial Meltdown = Tragedy of the Commons

In economics and game theory, there is the notion of the commons dilemma. This is the idea that when there is a common good, people will act upon their own interests in consuming that common good:

  • Person 1: consumes proportional share of large resource
  • Person 2: takes an outsized portion of resource, which by itself doesn’t destroy the resource
  • Person 3: sees Person 2 take larger share, matches that or even increases amount consumed
  • And on and on…

The problem is that as people do this, they are not acting as stewards of the common good. The result is that the common good ends up entirely consumed as each person acted in their own self-interest.

With regard to the financial crisis, what was the common good that was over consumed? Home ownership. The grpahic below is from Mary Meeker’s presentation:

morgan-stanley-home-ownership-timeline

Consider the dotted line on the above graph to be the normal consumption rate for home ownership. From 2000 onward, an increasing number of people purchased their own homes. Turns out, this put a mighty strain on the financial system. A lot of people purchased homes who shouldn’t have.

Now I don’t blame people for wanting homes. But the effect was to drive the prices up incredibly, which caused more desire for home ownership. Home ownership is sustained by a number of factors: steady incomes, mortgage tax breaks, personal financial management, a robust collateralized mortgage market, mortgage insurance, etc. All of those are part of the common resources. They were undermined by too many people partaking in home ownership.

The Banker’s Life

So in the case of home ownership, mortgage bankers ended up destroying the various shared resources that make up the market for home ownership. Each banker acted independently to get as much as he could from the system: loosened lending rules overall, finance build-n-flip construction, push home ownership into markets with lower financial means (a.k.a. sub-prime).

I understand the mentality. Once upon a time, I was an investment banker with Bank of America, in the syndicated loan group. Syndicated loans are like bonds, with the risk spread across many lenders. Here are two examples of how things work in banking.

First, I was part of a deal team trying to win a mandate with HMO company Humana. We were trying to unseat Humana’s incumbent bank, Chase Manhattan. We went in aggressively, with some pretty cut-rate financing terms. Chase did want to lose the deal, and so they went even more aggressively. In the syndicated loan market, you need a bunch of lenders to participate. Which means you need realistic pricing to sell the deal, just like in the bond or stock markets. Turns out, in its effort to keep Humana, Chase went too low in its pricing. They couldn’t syndicate the deal. Chase got caught up in the competition to keep Humana.

Second, at a dinner with the head of our group, the subject of minding the bank’s credit position came up. As in, what was the role of the syndicated loans group in being stewards of the bank’s balance sheet? Should we use our superior market knowledge to alert the credit underwriters about risks we’re seeing, and deals from which we should walk? I was a brash young guy, and provocatively opined that we were all about winning and syndicating deals. We shouldn’t focus on the credit risks, as that was the job elsewhere in the bank. To which the head of the group replied to me, “For the sake of your career, I’m going to pretend I didn’t hear that.” He was right – we really did have a responsibility. But I was reflecting the behaviors I’d seen out there in the market.

I bring up these examples to give you a sense of what it can be like inside banking. There is money splashing around everywhere, and when everything is up-up-up, you really can’t turn off the motivations of people.

Social Media Will Never Change This

What was happening in the mortgage industry was that the motivations were all one way: make the deal! You see your colleague cranking on getting deals done, and getting recognition internally. Your compensation is based on how many mortgages you get done. Competitor banks were reporting higher revenues and earnings. If you don’t match the growth of your peers, Wall Street dings your stock. The real estate market just kept going up, up, up.

Social software wasn’t going to change these dynamics. The current financial crisis is just the latest in a string of such events. And there will be more. It’s just human nature.

Professor Andrew McAfee tweeted a musing about Enterprise 2.0 and the financial collapse. I responded with my own thoughts:

amcafee: Could E2.0 have saved Lehman and Merrill? No. 🙂

bhc3: @amcafee – I used to work in banking. E2.0 would have made the banks better at achieving their growth goals. But those goals hurt the banks.

Social software is a powerful tool for organizations to get better in terms of innovation, productivity and responsiveness. But companies are still run by humans, and we’ll never be rid of that, for both the good and the bad.

*****

See this post on FriendFeed: http://friendfeed.com/search?q=%22Greed%2C+Competition%2C+Investor+Expectations%3A+Some+Things+Social+Media+Will+Never+Change%22&who=everyone

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About Hutch Carpenter
Chief Scientist Revolution Credit

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