The Threat to Our Financial System Is Alive and Well



Day-to-day, most of us think of pride and excessive self-confidence when we hear that word. And when it comes to financial executives, that's a fitting definition.

But with its roots in the Greek "hybris," the word has a much more violent, aggressive lineage. It was considered hubristic, for instance, when the wealthy Meidias publicly slapped the robed orator Demosthenes. Hubris was at play when suitors descended on Odysseus' house in Homer's The Odyssey. And in Rhetoric, Aristotle wrote:

Hubris consists of doing and saying things that cause shame to the victim ... simply for the pleasure of it ... Young men and the rich are hubristic because they think they are better than other people.

Perhaps historian Thomas Martin put it best when he defined it as "aggressive arrogance." It was because hubris was such a high-order offense that gods like Zeus were known to save their harshest reprisals for such offenders.

With the failure of MF Global (OTC: MFGLQ), we're left with yet another major financial company that was leveraged to the hilt, took on risks that it didn't have the balance sheet for, and found itself buried by the market when its weakness was revealed. The ink is barely dry on the accounts from the financial crisis in 2008 and yet here we are again watching the all-too-familiar scene of a pedal-to-the-metal financial company going down in flames. MF Global's demise could be a picture illustrating the word "hubris" in the dictionary.

Don't know
Nassim Taleb, the author of Fooled by Randomness and The Black Swan, has been harshly critical of financial executives for their fundamental ignorance of risk. When I first started reading him, I thought he was being unfair or exaggerating to make a point.

The financial crisis taught me otherwise.

Looking back, when Goldman Sachs (NYS: GS) CFO David Viniar referred to 25-standard-deviation events occurring several days in a row -- which as likely as "a real black swan fly[ing] out of Mr. Viniar's posterior," in the words of fellow Fool Seth Jayson -- it's easy to see that the rot of overconfidence in mathematical models of risk is endemic at the highest levels of the industry.

Plato identified the problem over 2,000 years ago in Meno. These "lucky fools" don't know what they don't know. Lacking a holistic approach to risk, they are convinced it has been conquered by mathematics. The problem is "aggressive ignorance" as much as it is "aggressive arrogance," because it has very costly consequences -- particularly when you are playing with other people's money.

In the case of MF Global, leverage, liquidity risk, and financing risk conspired to bring the house down (bets were financed by short-term borrowings that vanished once the firm lost its investment-grade credit rating). This is the very same configuration of risks that annihilated Bear Stearns (before being acquired by JPMorgan Chase (NYS: JPM) ) and Lehman Brothers in 2008. That CEO Jon Corzine and other MF Global executives seemingly didn't learn anything from these recent failures is jaw-dropping.

Don't care
As much as it's a problem that Wall Street executives seem ignorant to some of the risks they're taking, it's likewise a problem that, for many of them, the prospect of failure isn't particularly threatening.

Some people argue that the rewards of working in the financial services industry are simply consistent with the level of risk associated with the job. There is a grain of truth to that -- job security is lower than in many other industries. However, what is your true level of personal risk when you earn enough money in a single year to be able to retire?

The former CEO of Bank of America (NYS: BAC) , Ken Lewis, retired on a cushion of dynastic wealth shortly after his firm averted failure thanks only to the support of the taxpayer. Morgan Stanley's (NYS: MS) John Mack couldn't have been too worried about going broke -- in 2006, he was handed total compensation north of $37 million. And as for Corzine at MF Global, he was given nearly $3 million in cash compensation in 2011 (plus more than $11 million in MF Global options), but that pales in comparison to his already-considerable wealth accumulated during his days running Goldman Sachs.

And if pre-existing personal wealth isn't enough, experience suggests that the greater the magnitude and profile of their failure, the easier it is for top executives to find alternative, highly lucrative positions. The former CEO of Lehman Brothers, Dick Fuld, had no trouble finding gainful employment post-bankruptcy. Citigroup's (NYS: C) crisis-era CFO found a cushy new spot at B of A that paid her $6 million in 2010. Heck, even Brian Hunter, the disgraced trader who blew up hedge fund Amaranth, managed to find new opportunities after Amaranth folded.

As for Corzine, even though he has officially left MF Global, he is still an operating partner at the private equity fund led by Goldman alum J. Christopher Flowers -- he just wasn't collecting a salary from there while running MF Global. And while the MF Global bankruptcy will no doubt be a black mark on his record, as a former CEO of Goldman Sachs, U.S. senator, and governor of New Jersey, there will no doubt be businesses lining up around the block willing to pay him big bucks as an "advisor."

It's all still there
In the wake of the catastrophic financial crisis of 2008 and 2009, there are those that want to us to believe that the answer lies with the market.

"Regulations?" they cry. "Bah! Executives will be sufficiently chastened by seeing what happens when they screw up. What we need are fewer regulations and more trust in the market."

Not if Jon Corzine and MF Global have anything to say about that. We were lucky this time around. MF Global was small enough that its failure was easily digested by the market. And it happened as an isolated failure.

But the hubris, ignorance, and lack of serious personal downside that fueled much of the idiocy leading up to the crisis can be seen in spades in the implosion of MF Global. Regulators have clamped down on the big financial players in the wake of the crisis, so those executives are playing it very safe right now. But make no mistake about it -- in this high-octane industry with trillions on the table, the ingredients for the next crisis are all still as prevalent as ever.

At the time thisarticle was published Fool contributor Matt Koppenheffer owns shares of Bank of America, but does not have a financial interest in any of the companies mentioned. Fool contributor Alex Dumortier doesn't own shares of any of the companies mentioned. The Motley Fool owns shares of Bank of America, Citigroup, and JPMorgan Chase. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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