In the classic 1905 economic treatise The Protestant Ethic and the Spirit of Capitalism, Max Weber provides a compelling argument that capitalism as it emerged in 19th century America and Europe was a direct by-product of a shifting religious view that saw the work ethic as a critical factor for determining “one’s favour in the eyes of God” According to the newly emerging Protestant religions, an individual was religiously compelled to follow a secular vocation with as much zeal as possible. An ancillary to this entreaty though, was that money earned through hard work should not be wasted on luxuries or frivolities, but rather “re-invested” in the further growth of production for the benefit of the broader community. From the beginning of our nation's history, with the Puritan and Protestant work ethics, through to the 1950s, thrift was considered an important virtue, both with regard to the moral fiber of the country and as a support for its continuing economic wellbeing.
While the rise of capitalism is a function of a myriad of complex factors that go far beyond this simple explanation, Weber’s thesis at least helped crystallise thinking as to how men found meaning with their lives. Well into the early 1900s, the dominant view in the Western world was that productive souls built and created for the better of mankind - as well as their own pocketbooks. As such, a career on Wall Street or in the fledging stock-broking firms of Europe ranked about as low on the professional prestige list as was possible. Respectable souls did not engage in either usury or the business of simply making money for money’s sake.
But as Robert Shiller points out in The Sub-Prime Solution, at some point towards the beginning of the 1960s, this attitude began to quietly morph. By the early 80s, Wall Street was beginning to lay on rich rewards to attract the best and the brightest to the business of making money with money. Young, highly educated talent were given extraordinary responsibilities – not because they necessarily understood what they were doing or why, (read Michael Lewis’s Liar’s Poker or his latest piece ominously titled The End to understand just how extraordinary this phenomenon was) but because, being smart, they were deemed to possess the skills to trade their investment bank’s book into great fortunes. Soon, notions of “mover and shaker” or “smart money” no longer applied to the industrialists of the day but rather to those astute individuals who knew how to make money by simply being able to turn some money into more money.
Why should we care at all about this transformation? Effectively, as the behavioural economist Dan Ariely points out, the more removed an individual becomes from the reality of what those investment monies mean, who those assets really belong to, and what the gain or loss of those assets may really mean to the broader economy, the less likely the agent of investment is to properly derive insights into their true riskiness. Effectively, for the “professional” entrusted with this critical fiduciary responsibility, this level of disconnect has the potential for disastrous failures in oversight or prudence.
Couple this shift in mindset with the rising phenomenon that professionals across the broad spectrum of services – lawyers, doctors, consultants, and of course, fund managers – were being increasingly pressured over the same timeframe to “commercialise” their service offering, and the stage is now set for all manner of conflicts of interest between “professional” service provider and their own clients.
This inevitably engenders a culture in which business, needing economies of scale in order to remain profitable ignores the individual needs of its clients in favour of cookie-cutter solutions.
Today, nearly 90% (and possibly higher) of all transactions in the markets have some form of agency intermediation – whether it be by the trader acting on behalf of the investment bank, the fund manager acting on behalf of the unit trust investors or pension fund investors, the stockbroker executing trades for individual investors or day-traders, or the analyst making recommendations to the broader public. With every step distancing the investor from the trade comes an increasing risk that markets will continue to be driven by herd mentality and less by fundamental economic logic. Consider this simple point made by Georges de Nemeskeri-Kiss and Yannick Maleverne of Emylon Business School: If most decisions in modern financial markets are taken by agents and not principals, and agents continue to be evaluated and rewarded on the basis of short term performance relative to their peers, it clearly will be safest for them to stick with the herd.
Unfortunately for our markets, as we know from The Wisdom of Crowds, the more herd-like the market becomes, the poorer the quality of decision made by the total sum of its participants. Worse, the herd instinct cannot be regulated by law. As such, it will persist with each subsequent market crisis, unless one tackles the immediate agency conflict that lies at the heart of this changed dynamic.
Unfortunately for our markets, as we know from The Wisdom of Crowds, the more herd-like the market becomes, the poorer the quality of decision made by the total sum of its participants. Worse, the herd instinct cannot be regulated by law. As such, it will persist with each subsequent market crisis, unless one tackles the immediate agency conflict that lies at the heart of this changed dynamic.