Ron Geffner, a lawyer and hedge fund expert, was a recent guest on Bloomberg’s Hays Advantage. He commented that one of the causes of the financial crisis was that investors were lulled into a false sense of security. (See A False Sense of Security). My corollary observation is the striking lack of investor imagination, skepticism or integrated thinking.
We have become a task focused society. Much of the work in large corporations is task- or project-based. Common business phrases reinforce this short sighted focus on immediate outcomes: “singular focus,” “eyes on the prize,” “mission critical” “pedal to the metal” and “full court press.” These idioms reveal a true but unspoken agenda: put blinders on and accomplish the task at hand. Thus, in the interest of efficiency and rapid results, do not prioritize the long term, which takes much more imagination and thoughtfulness. Let’s look at how a lack of imagination can be harmful not only to our personal net worth, but also to any notion of greater or societal good.
What Were They Thinking?
Group think can be a tourniquet around one’s mind, or if you will, intellectual tunnel vision. Focused on outcome, we brush aside unintended or negative consequences, or worse we don’t even consider them. Let’s look at some of the group think that ushered in the current state of economic distress:
Exotic Securities – Without understanding what they were buying, why were investors involved with collateralized debt obligations, interest rate swaps, auction rate securities and other exotica? Why were brokers and bankers selling these securities when even they did not understand them? See e.g., Fabulous Fab’s s emails.
Counterparty Risk – When making a large bet, one wants to make sure the bookie can make good on the bet. In the financial world, investors did not consider that counter parties (the bookie in the analogy) could be a bankrupt Northern Rock, Bear Stearns or Lehman.
Credit Agencies –When banks paid credit rating agencies and often worked with them to improve ratings, why were investors surprised that those ratings (AAA no less) were in fact false? Today, NY Attorney General, Andrew Cuomo opened an investigation of bank fraud in obtaining ratings. Prosecutors Ask if 8 Banks Duped Rating Agencies.
Housing – When agencies pay mortgage brokers on the basis of dollar volume, why are we surprised that those brokers colluded with homeowners to qualify the unqualified? When we created exotic mortgages such as interest only, no documentation loans, and option ARMs is it surprising that homeowners default in droves? Why didn’t investors, brokers or homeowners ever question the prevailing assumption spouted by leading bankers and public figures that house prices always increase?
The FIRE Economy and Outsourced Jobs – Why did leading economists not question the viability of an economy based heavily on Finance, Insurance, and Real Estate? Our economy has always been at its most prosperous based on strong domestic production of goods and services. As we were outsourcing jobs and freezing wages for workers why did no economist raise the question of why a recession would not result from the decline in good paying US jobs?
Katrina and the Regulatory Environment – Katrina was a wakeup call that the laissez faire Bush Administration could lead to disastrous consequences. Why did investment analysts, Congress and the media not question the ineffectiveness of key government regulators such as the Securities and Exchange Commission, Federal Deposit Insurance Corporation, the Federal Reserve and others? Failure to enforce the laws and regulations on the books has had disastrous consequences for investors.
Private Equity – Corporations such as Chrysler and GMAC were deeply flawed before their failures. Why did we not question how a private equity firm could improve on existing managements?
Programmed Trading – Why are we not surprised when 25 year olds put in charge of computer trading programs that trade against other computer programs can crash the market 1000 Dow points in several minutes?
Sovereign Debt – Why are we surprised that we now question the creditworthiness of nations such as Portugal, Ireland, Italy, and Greece, Spain and even the UK and US, when governments respond to the financial crisis by absorbing the private debt problems of the banks?
Human Nature
It is human nature to dislike hearing bad news. Sometimes it takes a little imagination to conjure up negative consequences. Maybe it is my legal training, but I tend to look at my downside risk before I look at the upside. The public should have been a lot less trusting in some very flawed institutions: banks, brokers, mutual funds, traders, real estate agents, the SEC, the Federal Reserve and others. Unfortunately, one consequence of an uncritical financial media is that presenting a cavalcade of financial “experts” without harsh questioning only reinforces misplaced trust and zero imagination.
We need to encourage some imagination and a whole lot of skepticism before we reach the other side of the Great Financial Crisis and try to stay there.
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Related posts:
- Surfing the Financial Crisis
- Caution! Spin May Be Harmful to Your Portfolio
- The Failure of Extrapolation
- Watershed Event in the Financial Crisis – SEC v. Goldman
- The Tragedy of the Commons Part II: Modern Finance and BP
Tags: credit rating agencies, Cuomo, FDIC, FIRE economy, private equity Katrina, programmed tading, SEC, sovereign debt
