Self Interest

I've been noodling on this for a while now.

Last month in testimony Alan Greenspan said he'd discovered a flaw in his thinking (see the Times article among others for reference) about the "self-interest" angle in capitalism. Specifically, the theory was that you could always rely on financial institutions to act in their own best interest.

The self-interest principle really got me to think, and I've come to the conclusion that it's correct but not in the way it was generally interpreted. What it boils down to is that you have to consider the self-interest from an individual's perspective, not from a collective self-interest. You can rely on a person to almost always act in their (perceived) self-interest, which may or may not align with a larger institution's interests.

Once you start with that idea it's easy to see why things went the way they did. A loan officer might approve a risky mortgage knowing full well it's a risk to the company if for example she was earning a commission for each loan brought in to the company. The commission probably isn't tied to the perceived risk to the company so much as its size. A CEO might push for risky financial moves if for example he's pressured by the shareholders after they notice the competition pulling them off, and so on.

In each case, the person in question knows that this isn't necessarily something in the best interests of the company. But their self-interest is in conflict with the company's self-interest, and what's good for them in their minds will trump what's good for the company.

Finally, I think the other key factor in all this is the fact that people tend to favour the more short term self-interest over the long term. That's just basic human nature and it's why we buy that HDTV instead of putting the money in our retirement. It's also why people went with the ARMs and interest-only mortgages-sure it costs more later, but it's cheaper now! Ditto for filling out next quarter's profit margins vs. worrying about the balance sheet 10 years down the road.

So if I had to summarize my theory, it's that individual self-interest dominates, and the more immediate the interest the more it dominates. Sadly I don't see how this helps any of us, but at least it helps me make sense of where things went wrong. :)