Thursday, March 25, 2010

Misalignment of Interests on Wall Street

I saw an interview on the Daily Show recently where the guest claimed that leading up to the recent credit crisis, people on Wall Street “fooled themselves”. While this may be true, I think the dominant driver was the self-interest of people at the expense of their companies.

To illustrate what I mean, imagine that you play a game each day on your company’s behalf where you toss 4 dice and your company collects a million dollars if they don’t come up all 1s. If they do come up all 1s, your company must pay $5 billion.

The expected payoff of each roll is a $2.86 million loss, a terrible deal for the company. But, what happens if you play anyway? For a few years you make a million dollars for your company each day. All this apparent profit seems wonderful. The company pays you, your colleagues, and management big fat bonuses for generating so much “profit”.

This continues until the fateful day when the worst happens and the company goes bust having to come up with $5 billion. From your point of view, though, this has been wonderful. You’ve collected a lifetime of income in bonuses in a few years and can retire comfortably.

People on Wall Street were blinded to the risks their companies were taking on, but this blindness may have less to do with ignorance than it had to do with greed.


  1. This is a given.

    One must have the highest integrity not to gamble when presented with this option.

    I doubt that the majority have any more than an iota of integrity. Anyone could have seen this coming, but, the gambler's bosses also reaped the benefits of those profits.

    Then they get the biggest Christmas present of all - instead of going broke, they get bailed out to play again.

    This will never end until the incentive disappears.

    That will not happen until Obama ditches Geithner. And that may not be enough.

  2. 23 years after Michael Douglas personified Gordon Gekko, we are seeing, every day, life imitating art.

    Greed is the new religion, closely followed, in second place, by self-interest.

    On one side, government leaders wring their hands decrying (or pretending to decry) the avarice and materialism exhibited by big commerce.

    And yet, on the other side, we watch Dragon's Den, buy tabloids, or chip in for lottery tickets -- all because we are fascinated by, and aspire to, that very money-grubbing lifestyle that we so denounce.

  3. Mark: It will be interesting to see whether the same Wall Street game continues as before. Stopping it is a serious challenge.

    Michael Di Lauro: I suspect that most denouncing of money-grubbing lifestyles is jealousy. I would guess that most people if placed in a position to make obscene amounts of money through highly questionable (but technically legal) means, would take the money.