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Viewpoint: Did big personalities worsen the financial crash?

Michael Douglas and Charlie Sheen in the Wolf of Wall Street Image copyright Alamy

Charisma is usually regarded as a good thing, but is there a field where it could be dangerous, asks Elesa Zehndorfer.

There are certain expectations that we have of great business leaders.

One is that they are charismatic. But while company boards continue to prioritise charisma as a quality in their chief executives, the data tells us that charismatic bosses are less likely to be effective.

They are also more likely to be to narcissistic, to take overly risky decisions, and to demand higher pay.

The appeal of the charismatic leader is strongest at times of uncertainty and crisis, which explains why it might emerge with particular strength in the financial markets.

The markets are, after all, characterised by volatility, and it is that very volatility that renders participants vulnerable to a charismatic voice. Traders' performance is benchmarked (sometimes daily) against their peers, and they "live or die by their profit and loss".

Both factors increase the likelihood of "herding" (following the crowd) and "churning" (excessive high-volume trading as a means of gaining higher financial incentives via commissions on trades).

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The disproportionately suave image of the stereotypical Wall Street trader is at once vilified and mythologised. Oliver Stone's villain Gordon Gekko still serves as an unintended role model for many aspiring traders.

The Wolf of Wall Street, a biopic of Jordan Belfort's life, remains Martin Scorsese's most profitable film to date. Belfort was, in fact, never known as the Wolf of Wall Street. His firm Stratton Oakmont didn't even trade out of a Wall Street address, but he has become something of a modern-day heroic persona.

Charisma is at the root of it. Charisma is at once seductive, volatile and utterly compelling, yet often completely rejects rational logic.

To paraphrase the sociologist Max Weber, in order to take a share in charisma, one must turn one's back on the world. This process couldn't have been more evident in the 2008 financial crisis.

In June 2007, Bloomberg Markets magazine dedicated an issue ("Toxic Debt") to a 36-page special edition on the dangers of subprime mortgages - home loans made to people with a riskier credit history - and the mortgage-backed securities associated with them.

But on 17 July that year, Federal Reserve Chairman Ben Bernanke delivered a speech designed to draw confidence back to the markets. At the same moment a hedge fund named FrontPoint hosted an open conference call to warn of exactly the opposite.

Bernanke's rhetoric was flawed yet effective, while Bloomberg and FrontPoint's warnings remained unheeded.

In April 2007, hedge fund managers Jim Chanos and Paul Singer had warned the leaders of the G7 of the impending financial instability that would soon hit Wall Street. They were met by little more than "polite applause and stifled yawns".

Hedge funds largely rely on what short seller Chanos referred to as financial detective work - a "back to basics" approach that rests on the rigorous analysis of data and thus remains relatively immune to the emotional contagion, charismatic rhetoric and hubris so characteristic of the speculative investor in the wider markets.

Hedge funds have consistently outperformed the market. Between 1994-2014, hedge fund returns were 1.4 times (445%/314%) higher than the wider equity market (eg the US S&P 500 index of companies) with only half the volatility (7.2%/15.1%).

Distressed hedge funds (those specialising in companies that are in trouble) performed even better. They demonstrated 2.2 times higher returns (695%/314%) with only 6.4% volatility.

But the warnings of hedge fund experts were ignored. They contradicted the powerful groundswell of over-optimism and euphoria so characteristic of charismatic authority - a tidal wave of euphoria so powerful that it demanded the destruction of any logical dissent that got in its way.

History shows that charismatic rhetoric relies on the demonisation of an enemy to deflect blame and to continue to stoke the fires of emotion. In the financial crisis, those who predicted falling prices, the short sellers (such as hedge funds managers like Chanos and Singer) were blamed illogically by everyone from Wall Street chief executives to the Archbishop of York as the key architects of the crisis.

The financial markets have a tendency for charismatic hubris and sentiment. In the case of the 2008 crisis, this enabled a small coterie of chief executives and traders to exploit the US housing bubble for their own benefit at the expense of other investors who trusted their insights.

Termed "financial porn" by writer Jane Bryant Quinn, the explosion in 24/7 cable news networks, internet investing sites, investing manuals and financial spam further muddies the waters for investors, promoting confusion and irrationality.

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Take, for example, the annual Lehman Brothers company meeting on 15 April 2008, where chief executive Dick Fuld stated: "The worst of the impact of the financial markets is behind us."

Such a bold statement encouraged further investment in subprime, which naturally exacerbated the aggressive nature of the ensuing crash. His claims were built on sand - as one could see from the data available at that time.

With debts standing at $619bn, Lehman's bankruptcy filing remains the largest in US history. Fuld earned $34m the year before the bank's demise.

Company boards continue to prioritise charisma as a quality in the chief executives that they hire, but the data indicates that charismatic chief executives are less likely to be effective.

Ultimately, charisma is, by its very nature, seductive, yet volatile - a star that burns bright, but fades quickly. In the case of the 2008 financial crisis, the cost of this seduction was high, yet it is a price that man always seems willing to pay.

You can listen to Charisma and the 2008 banking crisis on BBC Radio 4 on Monday 24 August at 13:45 BST or catch up afterwards on iPlayer

Elesa Zehndorfer is the author of Charismatic Leadership: The Role of Charisma in the Financial Markets.