Bring It On!

Both Sides of the Greed Equation

October 2nd, 2008 | by Dr. Forbush |

I have written about greed before, and I am sure that I’ll write about it again. In capitalism the central motivation is the magic belief in self-interest.

I have been told by the loyalists on the right that greed is somehow magic. Greed drives the markets and those markets will be driven by greed to correct themselves. I have argued forever that greed AND information are needed for a market to work properly. However, disclosing information is often contrary to the greed incentive.

Let me try to illustrate this with a recent example. Suppose for a moment that you would like to upgrade your lifestyle and move into a bigger house. Normally this means that you would need to pay a higher price in order to move into that new house. However, when a real estate agent tells a potential buyer that one can afford this new house at a lower monthly payment (albeit temporary) one is easily persuaded into buying a house by using one of these sub-prime mortgages. Many of those tempted by these dangerous loans know about the adjustment of the mortgage interest rate — but that’s three or five years down the road. When people are living month to month, how can they realistically think about three to five years down the road. And, perhaps they are even thinking: “What’s the worst that can happen? I’ll be kicked out of my house and I’ll either find a new low rate loan or I’ll go back to living in the apartment.” Greed in this respect is obviously encouraging people to get what they can for the moment and disregard any future consequences. In this case, most of the information about the consequences of the loan are right there for the home buyers to see, but the worst case scenario is a net gain. They buyers get to live in a nice house for a few years and then they are kicked out into their old situation when the interest rate jumps. The possibility of the house value falling is inconceivable and never mentioned.  In this case greed encourages bad social behavior.

Conventional wisdom has it that one person’s greed is blunted by another person’s greed. If someone is trying get something for nothing they most likely have their hand in someone else’s pocket. That person should be motivated by greed to prevent that hand from removing any property. However, the principle of “time dilation” adds distortion to the picture. The problem is that greed also plays a role on this side of the relationship.

In a loan relationship the person loaning the money is expecting to receive additional money in the form of interest and fees in return for that loan. The motivation to loan money at a low interest rate comes in the form of a promise to get that higher interest rate some time later in the relationship. In other words, the initial rate is the bait used to lure in the prey that will pay higher rates over the majority of the life of the loan.

In this case the greed and patience of those who loan the money are believed to be rewarded when the interest rates readjust. However, those who make the loans are motivated by short-term greed to sell these loans and make the money up front, instead of waiting for the interest rate to adjust. Technically these loans are expected to be repaid — but greed prevents the true risk of these loans from being communicated to the new owners of these loans. Without knowing the true risk one who purchases these loans can not assess the values and will often pay too much for the loans. If the information was there, then the purchasers would pay the proper price, or the loans may never had been made in the first place. The problem is the lack of information transmitted in these relationships.

This current crisis is only the most recent aberration in a system that has lost its moral compass when the regulators cease to regulate. Greed motivates industrial giants to have little disregard for the community around them. Greed motivates secrecy and deception when a troubled company is trying not to let the stockholders find out the truth — the shareowners would jump ship and the stock price would plummet.

The point is greed is a force of self-interest, but we certainly know that self-interest is not always good for the community. Markets may be a mechanism that converts self-interest into community interest — to some limited extent. But the markets do not automatically extend to making community life better, making the environment better, making health care better or even making our culture better. It is true that we work harder for our own self-interest. It is also true that fear of being caught breaking laws is often enough to modify anti-social behavior. But, there are people who have very little fear and they may take huge legal risks in dangerous market situations. And, this same lack of fear may also result in taking serious illegal risks as well. Without serious regulation these people will always take advantage of the system — be it real or perceived.

On the other hand regulation sends a shiver of fear down the spine of most conservatives. They imagine regulations as the “know nothing” government setting out to “fix” the business of the country. It is quite obvious that a government bureaucracy can not do good things on the microscopic level where there are more exceptions than rules. But, government regulations do not have to dictate every action that business wants to take. Government regulations need to protect the honest business person from the dishonesty that greed temps in every person. Why should a businessman remain honest when he sees his fellow businessman rake in the cash because he disregarded the spirit of the law?

Regulations and the enforcement of those regulations are meant to keep the playing field even for all those who participate in the markets. Under that premise regulations and a free market can share the stage. The greed that drives these markets will still exist, but it will be tempered by regulations that will force legal creativity slightly less profit instead of the illegal creativity that allowed people to pillage the ignorant with loans that could not be afforded by those that were just as greedily seeking short term gains and ignoring the long term repercussions.

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