“It is hard for us, without being flippant, to even see a scenario within any kind of realm of reason that would see us losing one dollar in any of those transactions.” — Joseph J. Cassano, a former A.I.G. executive, August 2007

How things change! With the enormous benefit of hindsight, it now seems ridiculously flippant not to see the gaping holes in the policies followed by the players in the sub-prime crisis. With the unraveling of the financial crisis, several questions come to mind to the affected, but as yet uninvolved observer:

1. How did the entire financial industry, with its (supposedly) brilliant workforce and sophisticated tools, collectively make such wrong judgments?

Apart from warning us about the excessive intellectual hubris of the 'i-banker types', it also raises questions about the merits of having a financial system that makes a virtue of greed, with little merit attached to prudence, fiscal or otherwise. And as a management student who will probably not resist the forces that will transform me into another cog of this flawed system, where does that leave me?

Also, aren't those experts and pundits who claim that the crisis will be contained by such and such measure (the latest being the $700 billion bail out plan, while earlier ones were the rescues of Bear-Sterns, Freddie Mac, Fannie Mae & AIG) displaying the same hubris that has led to this entire mess in the first place? There are also hard-to-believe reports saying that India (and other emerging markets) are decoupled and won't be directly affected. This at a time of unprecedented volatility in the Indian stock market, with regular reverses wiping out millions of rupees of small investors.

2. Could the present crisis have been foreseen (and averted) in the face of more responsible investment goals, fair assessments of risk and regulatory oversight?

Did it not show up even as a possibility in any of the risk simulation and measurement processes available to the decision makers?

This reminds me of the conclusions of a study (sorry, no reference) I had come across a while back, which stated that people interpret information to suit their goals. Nothing surprising about that. We all do it all the time. So when such assessments of risk are carried out, would not the models with more reasonable return vs risk measures be intentionally deselected? Is anything being done about this possibly critical systemic flaw?

No one actually knows how this crisis will play out in the coming few months (years?). And that bit of knowledge is itself of great value.


  1. Because of the hindsight bias we can say that the cumulative wisdom of the brightest minds in finance has failed big time. But when the bull run is on and there is great growth seen in a sector people tend to believe it beyond reason that it will continue. The underlying reason in the world of finance is that there is no reason. Whatever is earning you money is worth investing, it is another matter that greed makes you stick too long to it and veils your reason so that finally probability takes its course. Greed and self justification are perhaps the reasons for this great fall and I do not see any reason why people will learn from this and will become more prudent.


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