The 1987 film classic, Wall Street, is seen as one of the quintessential representations of the wrongs that are brought about by money. Gordon Gekko, a Wall Street "fat cat,” exclaims at the annual shareholders meeting of Teldar Paper that greed is a wonderful quality of human behavior:
In the field of psychology, greed is expressed as excessive urge to acquire material wealth and possessions beyond the need of the individual, especially when this accumulation of possession denies others legitimate needs or access to those or other resources. In this way, greed generates satisfaction.
The economy is known for its cyclical nature, meaning that there is constant change between market growth and recession. Eventually over lengthy periods of time, major recessions arise and are denoted as “depressions, ” which typically require extended periods of time for the economy to recover to an acceptable baseline. Greed, in particular, is a human trait responsible for dramatically exacerbating economic recessions, primarily because it takes the form of abusing financial investments that will fail when used improperly. As illustrated with the Great Depression of the late 1920’s and early 30’s, investors realized they could purchase stock on “margin,” or 10 percent of the stock’s value, and never pay off the entire investment until they liquidated their stock assets. This made investors highly leveraged, meaning that any slight economic downturn would exponentially harm the wealth of investors and firms as they would lose their large investments and then owe the additional 90 percent of the stock value. And it did. With the recent depression in 2008, companies realized they could abuse an insurance product for defaulting home mortgages. When these sub-prime mortgages defaulted, there were far too many insuring products that could not be paid out to their associated claimants, and as a result the economy collapsed. Both of these situations occurred primarily because of greed. Exploitation of financial products during profitable economic conditions provides an opportunity for massive profits, but also creates an opening for leveraged firms to take dramatic losses in the event of an unforeseen economic downturn cycle. While normal want and desire for wealth is healthy for economic prosperity and competition, the obsessive nature of greed exaggerates these qualities to the point in which judgment is distorted. Avarice acts as a pertinent negative manipulating factor of economic cycles, and because it is difficult to quantify and regulate, will consistently adversely damage the wellbeing of investors and the economy alike.
In the depression originating in 2008, blatant greed is witnessed in various situations, all of which were responsible in culminating collapse of the housing market and United States economy. The issue originated primarily from the housing market. Banks such as Lehman Brothers decided to issue loans to homeowners that did not fit their stringent lending policies. Banks did this primarily because the could group these sub-prime mortgages into pools called collateralized mortgage obligations, or CMOs, that had a few highly rated mortgages, but were primarily consisting of sub-prime mortgages. Credit rating agencies such Moody’s Investors Service, Standard & Poor’s, and Fitch Ratings would evaluate financial products such as CMOs, CDOs, and mortgage-backed securities on the ability that a company can repay their investors without the potential of defaulting and neglecting payments. Most companies issuing products such as CMOs were financially successful and had a great deal of excess capital, meaning that they were given high credit ratings while the mortgage pools they were selling may have actually had high probabilities of defaulting. This can happen because credit rating agencies focus on the company as opposed to the products offered.
Rating organizations such as Moody’s, S&P, and Fitch are one of the major players responsible for allowing greed to take control of their company actions. A large criticism of these organizations is that they sometimes have limited insight into how structured debt products can affect a company’s cash flows, meaning they did not completely comprehend the products of companies they were rating. Another denunciation of credit rating agencies is that they are paid to issue ratings by companies. As a result, such companies expect good credit ratings for their business; otherwise they will seek out competitors, making it challenging to establish “honest ratings” for investors to use and analyze. There lies the possibility for conflicts of interest. Credit rating agencies will offer higher credit ratings as this will boost sales and increase market capitalization if debt-issuing firms believe they will receive high ratings. While this allows for companies such as Moody’s to become extremely profitable, the downside is that investors are unknowingly taking greater risk when investing in a company’s securities. Thus the greed for dominating profits can affect the judgment and reputations of credit rating agencies that apparently will receive payment in order to issue high levels of credit worthiness.
In addition to credit rating agencies, the banks responsible for allowing sub-prime lending to occur decided it was more appropriate to issue riskier loans in order to attain greater profits. After all, there is the expectation and pressure for companies to produce significant results over short periods of time, all while “complying with a myriad of rules and regulations.” The opportunity that existed for banks issuing sub-prime loans was that the housing market was expected to continue to grow. If people defaulted on their sub-prime loans, banks could take the house as collateral and sell it for a profit. A win-win scenario as long as the price of homes continues to increase. Managing officers of these banks illustrated excessive want, even greed, through their distorted judgment to initially issue large quantities of sub-prime loans, and later through grouping them into CMOs and passing these financial products with mortgages that were at a higher risk of defaulting on to other investors. Thus an insatiable appetite for more money translates to selling high-risk investments under the guise of exhibiting respectable company credit ratings.
Collateralized mortgage obligations and mortgage-backed securities are often purchased as future investments by firms in order that they receive mortgage payments as a form of “bond coupon” while the loans are slowly paid off. In order to cover themselves in the possible event that these loans are defaulted on, CMO owners purchased credit default swaps, or CDSs. These financial products act as a form of insurance in the case that a mortgage in not paid. If this event occurs, the CDS provider pays the holder of the CMO with defaulting loans. Most banks and hedge funds would buy CDSs on one hand to cover any potential losses from CMOs, and on the other, issue CDSs to other firms in order to offset costs of the “insurance.” This meant that if banks and hedge funds suffered from mortgage defaults, they would have to pay out money, but at the same time receive money, thus negating any costs and allowing for them to reap any profits gained from the mortgages. In comes AIG.
American International Group, Inc., or AIG, suffered from a blaring issue in that they only sold credit default swaps and never bought any to insure themselves. They treated CDSs as a form of insurance and assumed that the necessity to issue payouts to claimants was rare, and therefore would act as an excellent source of income. By legal regulations, firms are required to maintain a reserve of capital for payouts in the case that someone claims benefits to their “insurance.” AIG issued 440 billion dollars worth of CDSs, which began to raise questions with investors and government regulators, as it was unlikely that they had the ability to follow through in all payouts if they were suddenly required to. Nervousness and questioning caused for credit rating agencies such as Moody’s and S&P to downgrade the credit worthiness of AIG, meaning there was a greater likelihood that the firm could default on their financial obligations like credit default swaps. Further actions such as selling off company capital created an investor panic and stock prices tumbled. As it became more apparent that homeowners were defaulting on their sub-prime mortgages, firms that owned CMOs called for their benefits stated in their CDSs, many of which were owned by AIG. It became readily clear that AIG was incapable of paying off its claims, and therefore entered bankruptcy. Because companies were unable to receive their insuring payouts from AIG credit default swaps, they were forced to liquidate as they were unable to recover from the loss of value in their invested mortgage securities.
AIG’s miscalculation of the risks associated with credit default swaps led them to believe that CDS were a great source for generating profits, so good that they issued 440 billions dollars worth of them. They assumed that there were few dangers in actually reaching a requirement to pay out claims on their CDSs and utilized the inflow of cash as a source for financing their operations, unaware that sub-prime mortgages and a collapse of the housing bubble would translate “little risk” into “pay out large sums of money now.” Had AIG assessed the situation with greater clarity and fought off temptations to abuse a financial product that they did not completely understand the consequences of given a variety of economic conditions, they could still act as a company profitable firm. However, executives allowed for greed to take hold, believing that large profit margins generated through credit default swaps would benefit the value of AIG, and furthermore increase the money they would receive as bonuses.
Capitalism is one of the defining qualities of America and its free market system. Not only does it provide an opportunity for competition to benefit the consumer, it grants people access to earning exorbitant sums of money through hard work and dedication. Capitalism also breeds greed. The ability to make money causes for people to focus more on shifting around goods and receiving a profit, such as with the case of AIG, rather than produce their own tangible goods. Sam Pizzigati, author of Greed and Good, notes
The “glory” the American economy achieved in the 1990s – the gloriously high corporate earnings, the gloriously soaring share prices – did indeed demonstrate “rampant greed,” a greed that drove executives, accountants, bankers, and lawyers to lying and larceny and whatever else it took to keep their personal gravy trains rolling (Pizzigati, 200)
This is applicable to the economy, whether it’s the 1920s or the present time period. Perversions of want and desire evolve into avarice, which will lead to abuses of any possible outlet in order to produce money. With the 2008 financial crisis, this is evident across multiple spectrums, ranging from banking to credit rating agencies, all a result from efforts to keep the “personal gravy trains rolling.”
Unfortunately there is an inability to quantify human emotions. While greed is a factor that has proven to affect the volatility of economic cycles, there is no way to calculate variability for it. There is no way to say, “greed equals this, when an economic situation equals this.” It is stated “people often pay no heed to fine-tuned economic models by doing things that are not rational, are not in their best interest, and are justified not by numbers -- but by emotion.” By these means, there is no foreseeable way to regulate the effects of greed. President Obama has commented numerous times on developing plans to regulate the “fat cats” of Wall Street, but in reality, limiting the ways in which people can take advantage of financial products leads to the development of new ones with less understanding of their benefits and consequences. The federal government is consistently one step behind in their attempts to regulate the inner workings of Wall Street. As a result, greed-driven firms will consistently take advantage of future financial products, placing multiple parties at risk while they reap the profits of their ventures. This is how the market operates. Therefore recession and depression volatility will always be present no matter how extensively economists attempt to model future economic conditions because human emotions and their effects on the economy are incalculable.
