Odd lots

Failure, it is said, is of uncertain paternity, while victory has many parents. In the midst of a severe financial crisis, blame seeks a ready target. And yet, every financial crisis has a pattern that unfolds with predictable excesses, villains and scapegoats.

If you canvass people who are distant from financial services, invariably they will affix the blame on greed. The fallout from the AIG bonuses confirms this. But consider: Is Warren Buffett greedy? He does, after all, have an outsized fortune. He earned it, not philanthropically, but by spotting the opportunistic arbitrage: The discrepancy between trading price and actual value.

Is the solution to regulate greed? It all depends on how you define it. Greed is what gets you in trouble; self-interested opportunism is what makes you money. It also helps economies function more efficiently.

Let’s take a closer look at the intersection of greed and opportunism. Buffett is trusted. So why can’t everybody be a fair-minded Buffett?

A lack of information is part of it. Regulation seeks, however inadequately, to make the deal fair. Why? Because there’s an asymmetry of information. Used car salespeople, for example, generally know more about the car than the potential buyer. A simple conclusion, one might think, and yet the insight won its author a Nobel Prize in economics.

Let’s take a step back. Alan Greenspan is often accused of letting loose a bull in a china shop, by keeping interest rates low after the dot-com bust. Some trace it back a little further, to the loose regulation of futures markets, hedge funds, subprime mortgages and the like.

Balance this against an acute insight that Greenspan also delivered: The history of 20th century financial markets is the history of risk intermediation—parcelling out baskets of risk to willing buyers.

Some would view this as free markets gone wild. Not so fast. This is an accurate description of the welfare state. Risk is intermediated. It is pooled and then parcelled out, to bondholders, and to taxpayers.

The problem remains one of asymmetrical information. Regulation won’t make it go away. Prudence on the part of the investor and stewardship on the part of the asset manager will tame it, however.

Some Canadians buy Canada Savings Bonds or Canadas outright, rather than plumping for a low-interest savings account, in the certainty that they will be compensated for their risk. On the other side of the coin, they are simply self-interested. They want their money back. Within their limited sources of information, they look for stewardship.

But here’s the interesting twist. They assume that the government is not going to launch into adventuresome spending that carries with it the risk of bankruptcy or default. As Canadians, we have been through a wrenching cycle since the early 1990s, what with cutting deficits, running surpluses and paying back the accumulated debt. In some sense, we were chided, not least by The Wall Street Journal, for not being serious about paying our bills. Now the shoe’s on the other foot. Good for us, and yet also bad for us, as the U.S. struggles to pay its bills.

As a country, we have been evaluated as fiduciaries—as stewards of other people’s money. In the end, that is what this financial crisis is all about: Stewardship.

It doesn’t hurt to remind your clients of this. Good advisors treat client money with the same care they apply to their own.

It won’t salve the pain of investment losses; but it will solidify the fiduciary relationship.