Greed is good because the journey itself is the reward

“The journey not the arrival matters.” – T. S. Eliot 
Ever since Gordon Gecko's famous words 'Greed is Good', that phrase is used as a club to accuse bankers and other high paid finance professionals of being greedy, and putting their self interest ahead of society. Indeed, reading the articles on that theme, you would think that to aspire to earn money for the sake of it('greed') instead of just for fulfilling needs, is a crime. But in this post, I argue that for many of those money, greed is good because they see the process of earning money(trading, closing deals etc) as the reward in itself. It is like a game which you play for the fun of it, and get your high from winning certainly, but also from the game itself. To use the Olympic motto, the game is more important than winning! That may explain why billionaires/others work even when they have no monetary need to do so. While even other professionals can do so,  mostly only finance professionals can earn plenty early on to be able to afford to retire early on-hence this post focus on finance.

Without the greed, people would not compete actively in markets and may instead choose the easy way out of remaining small, setting up ventures in SME reserved areas etc. While the idealistic perspective would take the view that social service motto/greater good fuels entrepreneurs, the fact is that economic security is necessary before any such larger good. And to reach economic security, that is where a rational amount of greed works.

Why financial innovation IS necessary and useful

Judging by the number of books/articles/blog posts and Steve Job memorial mentions, one would think that innovators are the most valued ones in this economy, and that innovation is good. But recently, two facets of this debate struck me.

• Students's dream jobs are now in tech companies like Apple, Google and Facebook-which are all glorified despite significant concerns about privacy, impact by creatively destroying other industries..
• Occupy Wall Street(OWS) students ambushed recruiting sessions at Yale of Goldman Sachs/Bank of America and harangued them about how their rocket science had resulted in evil.

 It is fashionable to trash the financial sector for creating instruments and structures which induced helpless real world borrowers to spend more, buy homes beyond their reach, and deceived governments to maintain unbalanced budgets. But even leaving aside this simplistic explanation for a moment,  one cannot deny that many financial structures are products of extreme creativity and innovation, and were originally crafted to address real world issues. So why are they now villifed as rocket science/web of illiquid complex assets etc?

Recently, Mr Masaaki Shirakawa, Governor of the Bank of Japan gave a keynote address, at the
Netherlands Bank conference in honour of Mr Nout Wellink on “Welfare effects of financial
innovation” . He focused on the special aspects of financial innovation, and the speech can be read here(http://www.bis.org/review/r111115h.pdf). The main points he made were

1. Innovation means changing the way business is conducted in order to better serve the clients
   of the business.changes, which provide the same or better service to clients at lower cost, are certainly innovations in the usual sense of the word.
2. Innovation can be technology driven or modality driven. Technology-driven innovation
   crystallizes when the application of technology results in a better way of doing business(like ATMs). On the other hand, modalitydriven innovation aims at rearranging business processes for the better(like derivatives risk transfer)
3. Technology-driven innovations are more likely to be beneficial, because, when the innovator is deliberating on the application of technology, the client cannot usually be ignored. On the other hand, in the case of modality-driven innovations, one can easily lose sight of the client when cutting and dicing existing businesses(emphasis added). Very often, modality-driven innovations are the result of efforts to circumvent regulations, taxes, and accounting rules imposed on the financial industry
4. Problems seem to have arisen when a product or service is insufficiently anchored in inter-mediation or facilitation of payments(the core function of banks)

 The above chain of arguments would lead one to the premise that unless the financial innovation is anchored in 'basics of banking' like cheaper intermediation/payments system, then its utility is doubtful, or at the very least, subject to more layers of scrutiny.

However, the financial inclusion agenda of regulators, would require banks to adopt technology driven innovations, while the infrastructure financing needs would probably need modality driven innovations to come up with innovative financial structures, eschrow mechanisms and build in adequate safeguards(like MIGA guarantee etc) so that the players would have rational incentives to keep up to their word. And more modality driven innovations would be needed for risk transfer. One can certainly argue that the basic bank and investment bank should be split, but that may make both individually riskier(no diversification) and increase capital costs.Hence, before trashing the rocket science/quants/legal eagles of banks, one should also think of their positive uses.

RBI mandates banks to ensure 'reasonable property prices'-how to implement?

While reading the RBI master circular on Housing Finance issued in Jul-11(http://rbidocs.rbi.org.in/rdocs/notification/PDFs/52MC2800611F.pdf), one condition was that banks could extend term loans to builders only for specific projects(no general loans), and not for land acquisition(even as part of project). The subsequent text made my jaw drop.



Care should also be taken to see that prices charged from the ultimate beneficiaries do not include any speculative element, that is, prices should be based only on the documented price of land, the actual cost of construction and a reasonable profit...
 Has anyone even thought about how will the banks enforce this? For a sector without a price regulator, with no accepted costing standards and with so much opaqueness, who will make this work. Let us see each of these 'price elements' which the RBI desires.

1. Documented price of land:- Land transactions involve substantial amount of black money. But accepting the principle that Govt should punish black market deals, this is fine-punishing the builder for undervaluing the land procurement cost.
2. Actual Cost of Construction:- What about overheads, interests, construction delays(avoidable costs) etc? We do have accounting standards for all of them, but they need to be audited, on a project basis,  to be of any use
3. Reasonable profit:- Who determines this? Market(via P/E/ROE/markup) or Govt(price cap etc). This determination is an open invitation to rent seeking.   

Good intentions are fine, but why play to the gallery to mandate something which you know cannot be enforced? This will only give RBI the excuse to point fingers at lending banks, when blamed for rising prices. And at worst, banks may curb term lending and structure it differently. However one slices it, this is just not done.

Commerce for the uninformed is MORE profitable than commerce for the informed

In the book 'Poorly made in China', the author describes an episode where his Chinese interpreter could get brochures from the supplier's stalls, only because she pretended that the author was a 'stupid' foreigner willing to pay any amount. Indeed, suppliers dream of such customers. Couched in the financial context, such a person would be someone who banks with that institution only, does not shop around etc. For such customers, relationship managers can overprice and get away. The customer's wealth or poverty does not make a difference here, a savvy rich customer would probably be less profitable than the poor rustic. The former would demand free services, personalized treatment, lower rates etc, while the latter would be content with being served. C.K Prahlad's vision of 'Fortune at the Bottom of the Pyramid' probably did not intend ripping off the customer, but that is what happens in practice. Financially illiterate customers pay a heavy price by being sold(this is just the tip of the iceberg).

1. Insurance as investment(endowment insurance instead of term insurance+PPF)
2. ULIPs instead of index fund
3. Unnecessary addons/floaters with their existing products/policies 
4. Credit card personal loans instead of cheaper secured loans.

 When the nightsoil hits the fan, the customer(or counterparty as he;s treated) has little recourse. If he refuses to pay, the bank reports the default to CIBIl making it difficult for the person to get further credit facilities. And no one can compell the bank to hold back the negative CIBIL report even for disputed cases. Only if the person is politically well connected/forms group of affected people is justice possible, as happened in the recent cases of Standard Chartered & Citibank where HNIs who were missold certain products, pressured the banks to compensate them.  But only informed people do this. Most just grimace and bear it.

For most private banks, the notion of financial literacy means educating the customer enough to understand the benefits of purchasing their products. Banks like ICICI have now funded credit counseling centres like Disha, but on the general education front, the RBI is fighting a lone battle. And no wonder, why would a bank educate a customer that its most profitable products(endowment insurance, structured products, ULIPs etc) are probably not in his best interest.  The way forward seems to have a 'fit and proper' test for customer acceptance, but this is a Herculean task in any economy, let alone India.