Hedge funds in the psychiatrist's chair

The behaviour of the financial markets is interesting to me as a psychiatrist.
The obvious analogy is to manic depressive illness, now called bipolar. The overactivity and sense of wealth in bull markets is obviously paralleled with the manic phase of the bipolar cycle, as is its detachment from ecological reality. This is followed inevitably with the depressive part of the cycle, when everything changes to the opposite extreme and activity slows down. The bipolar individual has the same relation to monetary wealth: irrespective of the realities of their bank balance, in the manic phase the individual spends money freely, and in depression, the individual believes that they are bankrupt.

So far, so obvious. But there is another more subtle analogy to be drawn between the financial market, indeed, commercial life generally, and psychopathology of obsessive compulsive disorder (OCD).

The obsessive seeks to control and eliminate risk. Since this is impossible in the wide diversity of life, the mind provides a single proxy of risk control which the subject focuses on. It may be bacterial infection, so that the sufferer spends hours every day in ritual hand-washing, or it may be burglary, so that the patient goes back repeatedly to check that the door is locked. In every case, the desire for perfect control leads to irrational behaviour, which the patient knows is irrational, but is powerless to stop.

The control motif is found in managerializationism. Managers in any organisation seek to control the system below them. To do this, they set targets and protocols for their offices to follow. In doing so, they tend to annoy their workers, who find their work routines in a state of continual change, which results in less, not more efficiency. It is the product of the manager to change the system. If they did not change the way things are done, what would they be for?

In the financial system, the control motif is more overt. Banks want to manage risk. Any loan is risky: the debtor might default. In an attempt to manage risk, fund managers have gone to the hedge funds to “insure” themselves against risk. In an attempt to insure their own products against risk, the hedge fund managers have sought to insure their funds with an ever expanding range of derivatives, financial instruments where risky loans are parceled up and sold on.

“Big fleas have smaller fleas
upon their backs to bite ‘em,
and smaller fleas have smaller fleas,
and so ad infinitum”.

One property of some hedge funds is that they are only profitable and secure if the market continues to grow. The economist Hyman Minsky correctly described these types of funds as “Ponzi” – a form of pyramid selling scam. The mangerializationists have been taken for a ride by elaborate scams. The correct response for governments should be to take them to court.

Mangerialisationists, lacking anything real to do (apart from finding out if their office is happy and functioning well, and if their subordinates have any suggestions that would make their work more efficient), find themselves attracted to words. They use obscure words to make their subordinates feel ignorant, so that they do what they are told. Faced with someone selling them a financial instrument with interesting names and unintelligible mechanics, the managers cannot help themselves. To say that they do not understand what is on offer is out of the question. They buy in.

In each stage of this “risk management”, the fund manager who buys the risk also adds his price for taking the risk, so that the liability becomes magnified. This is why the “value” of the derivatives has reached a size somewhere in the region of ten times the Gross Domestic Product of the whole world. The GDP of the world includes some pretty meaningless items such as Russell Brand and Jonathan Ross, but it also includes the cost of providing such life sustaining realities as water, food, housing, energy and waste disposal, not to mention manufacturing and distribution. So these derivatives have grown many times greater than the real necessities of life for all humans on the planet. And they exist because of a mistaken attempt to control risk.

The right way for a bank to control risk is to make sure that their lenders have a reasonable chance of meeting their payments (something that they failed to do) and to lay capital aside in good times to cover their risks in the inevitable downturn (which ther also did not do). Having failed to do the right thing in the real world, they attempted to buy certainty by buying into hedge funds and dodgy derivative schemes, which has made matters worse, just as a person with OCD tries to eliminate risk by unrealistic and endless hand washing or checking, and wastes a large part of his life in doing so.