A Greek Tragedy or There’s a Sucker Born Every Minute

Is legal the same as ethical? Is following the letter of the law the same as being guided by the spirit of the law?

What has me asking these related questions is the latest news emerging from the melt down of the Greek economy (as well the economies of Spain, Portugal, Italy and Ireland) that could have a devastating effect upon the euro. Greece borrowed like a drunken sailor in the late 1990’s and early 2000’s. This orgy of borrowing has placed it in an extremely treacherous debt laden crisis. It has now come to light that Goldman Sachs, the subject of my January 14 blog, aided the Greek government in its destructive efforts to suck itself down the debt drain by arranging financing through derivatives known as swaps which imploded along with so many other derivative based financial schemes in 2007-2008. While these financial arrangements were legal within the context of financial arrangements of the time (2001), Goldman Sachs structured these derivatives for the Greek government in such a way that in effect they masked the true extent of how much the Greeks were borrowing.

Well, so what? What does this have to do with ethics? The transactions between the Greek government and Goldman Sachs were legal. The problem is Goldman Sachs violated one of the so called sacred ethical principles of the financial services industry. That principle is transparency. What is now happening because of Goldman Sachs’ actions (it advised and then partnered with the Greek government using swaps to raise money while hiding its real debts) is that it has greatly, if not terminally, handicapped the Greek government in its efforts to deal with its debt crisis. Greece is having difficulty in attracting investors to help it out of its self induced debt crisis because no investor can be sure that the government balance sheets are telling the truth or are there more of these Goldman Sach-like investments waiting to explode and further plunge the Greek economy into deeper economic crisis and consequently losing the investments of any investors who are lured into investing in Greece. In hindsight, a senior Goldman Sachs executive, Gerald Corrigan, recently stated before a British parliamentary committee that, while there was nothing inappropriate done by Goldman Sachs (read Goldman Sachs followed the letter of the law), “the standards of transparency could have been and probably should have been higher” (read Goldman Sachs violated the spirit of the law to collect its reportedly $300 million (US) in fees). What is chilling is the language used by Mr. Corrigan. Even after the experience of our world-wide economic meltdown, caused in no small part by the really irresponsible trading practices of investment firms like Goldman Sachs, Mr. Corrigan doesn’t say his firm should have been transparent in its actions, he says they ‘could’ have and they ‘probably’ should have. Like, kinda sorry everyone and maybe next time we will, ya know. Just trust us, we know what were doing here, bucko.

Why does a firm like Goldman Sachs, one of the very best at what it does, filled with the brightest people from the most prestigious MBA programs in the world, constantly shoot itself and its reputation through its very questionable actions? Could it be that by following the letter of the law but constantly ignoring the spirit of the law, its profits first and those profits more than make up for the public humiliation of being recognized as sleazy snake oil sales people (my apologies to any snake oil sales people who are offended by being lumped in with such company)?  Could it be that while the firm is publicly chastised for its greedy behaviour  the individuals within the firm who engineered this behaviour and profited handsomely from this very questionable behaviour remain anonymous while they collect their bonuses?  There is little or no personal accountability for this irresponsible and often destructive behaviour but the financial rewards are, as the younger generation says, awesome.  After leading the world economies to the brink of disaster in 2008, Wall Street is paying itself a reported $20 billion dollars in bonuses for 2009. Ca-ching goes the cash register. Ethics to the back of the bus.

Some Thoughts on Character

Webster’s dictionary defines character as the complex of mental and ethical traits marking and often individualizing a person, group, or nation. As the definition suggests, character is multifaceted. For one, character is cultivated over long periods of time. It is partly formed through one’s biological inheritances and partly through choice.
Character is the embodiment of a person’s moral orientation. It is dependent upon how a person has interpreted his/her values. It is built up, piece by piece, through the decisions we have made over time. It is not innate, we aren’t born with it, rather we create it. But the rub is most of us create our character more or less unconsciously. Character is based upon our core values and how our interpretations of those values influence our behaviour. What is unconscious for most of us is how we have interpreted our values. It takes a lot of self-reflection to understand what our values are and how we have interpreted them. Unfortunately, we live in a society that largely ignores, indeed in many instances actively discourages, self-reflection.
In the development of character, the cultural and physical environments play an enormous role. You can send individuals to ethics seminars that emphasize trust and fiduciary responsibility as the subject material but if the overall environment those individuals work in day to day is one of a cut throat pursuit of profit often at the expense of the clients the individual and the firm have promised to serve, then the environment will heavily influence many of those individuals to act against the well being of the client. While all of us are limited through circumstances, intelligence, self-awareness and environment, we still do make conscious decisions that define who we are. Morally we come to be what we do and not what we say or think.
With moral values it is one thing to “know about” them and another thing to “know” them through the richness of encounters with other people. When we merely know about values, we can become easily detached from their real existential meaning. Abstract intellectual analysis of values allows for distancing oneself from the spirit of the values. Talking about honesty, fairness, fiduciary responsibility and other critical values is not the same as experiencing those same values in encounters with other people. Some investment firms have magnificent value statements and they may even throw in an ethics seminar to highlight those values, but in their actions one can see that the values statement is merely a mist behind which those firms operate like pirates. One can look at the present state of the investment industry where many of the behaviours that created the massive economic meltdown that we are still suffering through are still the operating behaviours of many of those firms whose selfish and stupid actions created the economic mess in the first place. Here is character on display. These firms can speak abstractly about values but their behaviours indicate the values aren’t worth the paper upon which they are written. They flaunt both the letter and the spirit of the values that they present to the public as demonstrations of their true character.
While most individuals in the investment industry (and, to be fair, the general public) are more or less unaware of the values that influence their decisions that create who they are, many financial firms through their actions are consciously demonstrating an awareness of their values and that awareness, sadly, is still mainly selfish and destructive to the society that both created them and sustains them.

Guessonomics

Investing, as it is presently conducted by the investment industry, is a lot like throwing darts at a dart board that is constantly moving in a random manner, not knowing exactly where the board will be but throwing the dart where it is thought the board could be. When you hit the board, you score points; when you miss, you lose. This dart board analogy came to me a short time ago when I had finished reading two related articles. The first was an article that stated RIM’s sales forecast for the current fiscal quarter did not meet analysts’ expectations/forecasts/projections of what they felt RIM should achieve. The second article was an interview in Report on Business magazine with Bill Kanko who is a respected funds manager. Mr. Kanko stated he firmly believed in “the unreliable nature of economic forecasts, especially our own”. Let’s look at this for a moment.
First the big picture in which this forecast is situated, the economy. Now as far as I can make out, no one truly understands how the economy really works. That is why Nobel Prizes are awarded in economics and why we have a plethora of economic theories and investing models which often contradict each other.  Not to mention all those can’t miss economic initiatives or investment opportunities that have been presented to us that, well, missed and missed catastrophically. Not only do we really not understand how the economy functions, the economy also is very susceptible to randomness. That highly insightful saying ‘shit happens’ comes to mind. Wars break out, Mother Nature defies our need for control and unleashes her uncontrollable power to show us where we really stand in the evolutionary pecking order, terrorism, technological glitches like power grid failures or new technologies having negative often unforeseen impact on how we live or do business, pandemics, luck, someone dies unexpectedly, bad timing, unforeseen consequences occurring from poor business decisions, all of these instances, and numerous other instances that a lack of space on this blog preclude me from listing,  have the capacity to disrupt the best planned economic undertakings.
Back to RIM and its forecasts and the forecasts of the analysts who follow RIM. Their projections, then, are based on an economy that can be highly unpredictable or random in its actions. So, projections are made on a firm that operates in an environment, the economy, which is unpredictable. Analysts study a firm’s financial statements, the industry of which the firm is a part, the state of the economy as that relates to the firm, they look at the firm’s management practices and competitive position in the market place, use whatever model they have been trained with to push all this information into and then make a prediction on what they think the firm should do profit-wise primarily in the short term. Firms also go through this same process for themselves to set out their financial expectations in the short term. They make a prediction. In other words, both the analysts and the firm itself come to a best guess at what they think the firm will do. This guess is overlaid upon an economy that is, in the end, unpredictable. Further, these forecasts are taken one more irrational step. These best guesses based on an ultimately unpredictable economy are turned into hard goals by the investment industry against which the firm’s performance is benchmarked. A guess, its dictionary definition being an opinion formed from little or no knowledge (in this case of this unpredictable economy), has now morphed into a hard and fast benchmark that will relate success or failure to the investing world. The guess now has been dressed up as rule approached by the investment industry much like a physicist approaches the law of gravity. In terms of the dart game analogy, the analysts have decided they know where the randomly moving dart board will be in the future. The firm’s share price will depend upon how successful the firm is in achieving this guess-rule – not whether or not it made a profit (the dart hits somewhere on the board) but whether or not it achieved or exceeded the guess (the dart has hit the bulls eye). This random hit or miss in turn has a good possibility of positively or negatively affecting the society you and I live in.
I recently spoke to a financial advisor who told me these predictions tend to be right more often than they are wrong. They hit the dart board more than they miss it. He quoted me a 52/48 right to wrong prediction ratio which is quite scary when you think about it. Even if his ratio is off, lets be really positive here and say it is a 70/30 right to wrong ratio, does this way of managing our economy, let alone our investments, ever take into consideration that just one wrong guess (one miss of the dart board), one “hot” derivative that turns out not to be so hot, such as derivatives based upon sub-prime mortgages, can wipe out the gains of all the right guesses combined? Has anyone ever stopped to think just how crazy our market economy is? Or consider that the less regulated that market is, the more likely it will blow up due to outright greed and fraud of the dart throwers? Further, how crazy are we, that’s you and me, to allow guessonomics to form the basis of our social and economic lives?

High Frequency Trading

I just read an article that has caused me to stop and reflect. The article was about high frequency traders who, through the considerable power of high speed computers, trade millions of shares in what can be milliseconds. In one of the main forms of high frequency trading, the trader will capitalize on the difference on the price of a particular share that is traded in different markets. For example if a share is trading for $1.00 in New York but for $1.01 in Toronto, the trader will quickly buy large amounts of that share in New York and sell it in Toronto before that gap closes. $0.01 profit on each share of thousands or more shares traded done many times over the course of the day adds up. My concern is what is the point of this form of trading? Most high frequency traders use their own money or their own firm’s money, they don’t have clients in the traditional sense so the only one or ones who profit are the trader and/or the trader’s firm.

Stock markets were originally set up as places where companies could go to sell shares in themselves to investors in order to raise capital so those companies could further grow and develop and through that growth and development create jobs and provide a further base for taxes and, generally, better the economic condition of society as a whole. Today, much of what goes on in the different markets, is not about creating a more robust, stronger society through the improvement of companies looking for investors to help them grow. Now much of the activity in the market place is simply about making a profit for the banks, investment firms, and some investors with little or no regard for building up society through investing in companies to allow them to grow and in so doing make society a better place for us all. For much of our investment industry, it is now about profit for profit’s sake and if society is impoverished through this hunt for profits, well who cares? That’s what investing is all about, eh? The chase for profits with little or no regard for the society that provides the infrastructure for that profit chasing to take place.

The article on high frequency traders high lights this point I’m making. Such trading builds nothing for society as a whole; its sole purpose is profit only for the traders with no care whatsoever that that profit chasing could well have a negative impact in the long run on all of us. One of the problems around high frequency trading is that we don’t know what its long term effect on society (and the market place) will be. Its proponents say it can only do good – high frequency trading, they say, creates more liquidity (anyone can get an order filled quickly at the market price) and lessens the spread between the high price traditional brokers charge clients who want to buy and the low price those same brokers offer clients who want to sell . However, its critics say such trading could have the effect of blowing the markets up much like the more traditional trading in those toxic investments that precipitated the economic meltdown of 2008/2009. It makes me nervous that once again we, the public, are unwittingly riding the tail of an investment dragon that could well have a serious negative impact on our way of life. Where is the due diligence from both the investment industry’s supposed self-regulatory system and our government on how trading in such a risk filled manner is still, even as we are slowly recovering from the last economic disaster created in large part by a failure by all parties in their regulatory responsibilities, allowed to operate when the real consequences of that form of risky trading are not known?