1. The way a situation is described can have a definite and measurable impact on the outcome of that situation. In particular, “agent” metaphors where, for example, people are told that “the market rallied,” cause people to think that the trend will continue (the thing is described as if it had a life of its own). “Object” metaphors – the share price “bounced” – cause no such expectation. There is the obvious possibility that a truly insignificant or substandard movement or market or product or event can be buoyed up or made to appear significant or credible by carefully crafting the communication about it.
2. Securities ratings agencies are paid by the underlying issuers that are being rated. Of course they’re paid to do so in the best interest of the potential buyers. Of course. But if people aren’t buying, the issuers aren’t making money. If the issuers aren’t making money, the ratings agencies aren’t getting paid. There’s a strong incentive to give a high rating to a fund.
3. Brokers and other “middlemen” are paid when they close deals, not when a deal survives a particular test of time. As a security gets bundled with others and packaged into some other investment vehicle, each agent who plays a role in that process gets a cut of the net gain on that transaction. Because there is some risk with any security that its value will go down rather than up, each agent along the way tries to hold on to that risk for as short a time as possible. This ability to keep handing off the risk is facilitated by the creation of ever more complex “wrappers” to put around the underlying securities. After a while, they don’t look much like the securities they’re made from, but underneath, that’s still what they’re made from. And at some point, some sucker is going to be left holding the bag. Maybe it’s you. Maybe it’s the bond insurer. But it’s not going to be the guy, say, who first approved the mortgage loan for the “subprime” (i.e. non-credit-worthy) customer. He’s long since reaped his reward, and that’s not going to be taken from him.
To me, each of these observations, taken alone, is shocking, staggering. Taken together, it appears almost criminal that we’ve allowed so much of our economy to be hinged on these reward structures that cannot possibly punish anyone but the wrong person for doing something incredibly stupid and shortsighted.
But am I just being risk-averse? I don’t think so. Consider this analogy. Horse shit is very fibrous. Who hasn’t seen it left behind a parade and wondered, “Isn’t there something that can be made from that?” And so imagine whole industries springing up, spinning horse shit into unique shapes, as coasters, window decorations, jewelry. It would all be painted and poly’d so it wouldn’t smell or anything. It’s cheap, and it looks nice. But if you break one, then what’s inside comes out. And what’s inside is still spun horse shit, only now it’s spun horse shit that’s been trapped inside a shell for a long time.
That just can’t be a good thing.