Fear, Banking and Bring On The Wolves

Could real fear be the key attribute that drives your next success?

Ideas from strange places: I found myself asking these questions as I read Where the Wild Things Were: Life, Death, and Ecological Wreckage in a Land of Vanishing Predators by William Stolzenburg.  A gripping account of why the connection between predator and prey is essential to the health and well being of both.  He walks us through a century of eye opening realizations by leading scientists of the damage done when the top predators in a system are removed. 

Who would have thought that killing off the sea otter would destroy the kelp forest?

Who would have thought that killing off the wolf would end the growth of Aspen?

Some of the ah-ha moments presented by Stolzenburg are controversial, but most are withstanding the test of time.  The process by which ‘science’ goes about digesting ideas that turn common knowledge on its head is as fascinating a look at human nature as are the descriptions of how the discoveries are made.

Stolzenburg describes how the introduction of the wolf back into Yellowstone National Park changed the behavior of the elk herd seemingly well out of proportion to the wolf’s actual ability to kill. Within a few years Aspen and undergrowth started returning in spotty patches where growth had been absent for decades due to overgrazing.  The most likely explanation appears to be that the areas where Aspen shoots have returned are dangerous places for elk to wander. While on open land a healthy elk has a 9 out of 10 chance to survive a wolf attack, in these spots the odds go down – and so the Aspen return.  

Sure the herd is being culled. Sure the number of elk is being reduced and controlled in a more balanced way (Seems better than cycles of overpopulation, overgrazing, starvation and die off at least). But most importantly, the elk’s behavior has changed.

What do lions and tigers and fear have to do with finance?  Credit Default Swaps (CDS) and other instruments were the capstone of a number of financial instruments designed to remove risk from financial transactions.  No risk – No fear.  The availability of these instruments changed financial institution behavior.  They started loaning money at interest rates that would have been unpalatable just a few years earlier. This change in behavior effected consumer and corporate willingness to accept debt for two reasons

First – lenders have always been kind of a guard at the door, forcing those with big ideas to pass certain tests before money would be handed out. People who didn’t pass the test didn’t get money. Very similar to a tree keeping fruit on high branches – if you can’t climb or your neck isn’t long enough, no fruit.  Not that our thought process is as simple as a hedgehog’s, but really, should anyone be surprised by how consumers and corporations binged when the institutions that for years had kept debt out of reach started throwing it in the trough?

Second –  consumers and corporations that did not gorge on debt were penalized. Opportunities would go to others, your stock price would falter, you would miss out on tax breaks and real estate deals. In an environment where the risk of having too much debt had been forgotten is it any wonder the herd lined up at the trough?

The elk forgot all about wolves in only a few generations.  A couple of decades. When wolves were first re-introduced, Stolzenburg writes, elks had no fear of wolf smell or howls. The good news is elks learned quickly.  In just a few years the elks re-learned to fear the sound or smell of a wolf, to avoid dangerous areas. And in so doing have allowed biodiversity to regain momentum in the park.

What kind of predator needs to be reintroduced into our financial system? What can prevent overgrazing and encourage diversity that promotes stability in the economic system?  This is probably pushing the analogy too far – but regulators may need to play the part of the wolf protectors.  Any device that works to remove or move risk (the wolf) from the system needs to be regulated fully. Because in the end – if a system claims to be risk free then people and organizations will behave in ways that overburden and break the system in ways that were simply difficult to predict – and introduce a different kind of risk that will control behavior.  Regulators, at the very least, might keep the system open, allowing others to expose risky practice if the regulators are not up to it themselves. (For example – would have been nice to know that AIG’s CDS exposure seemed out of whack with their capital reserves.) This generation appears to be getting the lesson of financial fear reintroduced in the old fashioned, school of hard knocks way – it would be nice if we kept some of the wolves around to keep us on our toes even without a massive recession/depression.

I love books that have nothing to do with business because they so often bring up thoughts that are actually useful in my business life. The economic impact of fear has been studied quite a bit, although the usefulness of that fear probably less so. Fear drives behavior. Perceived fear drives behavior. Lack of fear drives behavior. The large predator concept is interesting because even though a wolf may only kill a few, fear of the wolf affects all. If you get a chance check out Where the Wild Things Were – it prompted quite a few more ideas (and probably will prompt a few more posts) for me.

.