Welcome to Part Three in our behavioural finance series! We hope you got something out of Part One and Two in helping you understand how psychology plays a major role in your investment decisions as well as found it interesting! In this addition we will open your eyes into the greed of financial institutions that lead up to the GFC on an extremely basic level. Believe it or not, a lot of the same emotions and behaviours that were discussed in the first two parts played a major role into the GFC, and continue to play a role with over conservativeness now.
You may ask how can personal behavioural influences have such a dramatic effect even in big banks? Simple. Behind the big banks and financial institutions who do you find? Not robots or AI, but people. It’s human behaviours that were behind the decision making of the big banks and financial institutions. When things start going well, confidence builds, and sometimes human psychology can become tunnelled vision on constant success not realising the potential for failure, or a complete financial crisis. It’s imperative to learn how to step outside the tunnel vision and to look at your investments taking everything into perspective.
One emotion that hasn’t quite been touched on yet is Greed. You may have been raised and told that it’s not nice to be greedy nor is it respectful to be greedy, but otherwise to be appreciative– financial greed, it’s a whole different world.
So what exactly is “greed” in the financial world? There’s an old Wall Street saying that “financial markets are driven by two powerful emotions — greed and fear.” Although an ever so simple saying, it’s quite truthful and the GFC is point proven.
When the markets were at high, and increasing with confidence several emotions come into play. Overconfidence, Herd Behaviour, Cognitive Dissonance, Greed. Is it possible these individually felt emotions carry over to board meetings and financial managers? Absolutely.
With the above emotions in play, financial institutions over-looked its usual protocols and logical thinking. Loans were given out easily with minimal down payments required, some not even a cent required. These loans were also given out to otherwise not creditworthy individuals, which isn’t okay. The entire point of establishing credit worthiness is proving you can pay back your debts, however financial institutions became increasingly greedy turning a blind eye. It wasn’t just greed on the financial institutions, homeowners became greedy as well seeking loans they otherwise wouldn’t have sought knowing their creditworthiness isn’t good. Wall Street saw an increasing amount of greed with the use of MBS (mortgage backed securities), CDS (credit default swaps), and CDOs (collateralized debt obligations). Executives of corporations have been notorious for greed with ever increasing compensation packages that make us just shake our head in disbelief. Financial institutions greed of credit cards and sending an application to every teenager and trying to sign them up before they understand the do’s and don’ts. Consumer greed using credit cards to pay for things they otherwise couldn’t afford, not being able to pay back debt, going into default, and losing credit worthiness. Simply, this is greed pitted against greed.
It is important to realise that while you can’t control third party emotions, you can control yours. Greed can be the start to becoming narrow minded then leading to the other emotions and behaviours discussed in Part One and Two. If you sense yourself becoming greedy take a step back and have a read through our Part One and Two to better understand the feelings and stay calm. Be excited to invest, be do so with smarts!
We could write for ages about this specific topic, but we want to keep it short and simple. Our goal? To help you see that the emotions you feel, are emotions corporations feel as well and it’s ever so important to acknowledge all these emotions exist when investing in the stock market. It’s important to determine whether a corporation is greedy and doesn’t care about it’s investors, or if the too good to be true credit interest rating is a greedy bank/financial institution. Protect yourself by educating yourself.