What we can learn from this credit crisis

There are several cognitive benefits from the current credit crisis.

First, we can estimate how blind people near or at the top are. The dismal but not surprising conclusion is - blind as a bat, or worse. At least bats don't fly into things. This type of blindness doesn't limit itself to the poor or un-educated, but seems to be equally prevalent among the rich and highly trained.

Example: New York Times, Aug 19, 2007
How Missed Signs Contributed to a Mortgage Meltdown

Bear Stearns’ failure to sense the early tremors was especially glaring. In 2006, it was rated as the best risk manager among United States brokerage firms in 2006 by Euromoney, a respected trade publication. Unlike other firms, though, Bear’s problems eventually claimed a high-profile casualty — in early August, the brokerage firm’s co-president and heir apparent, Warren J. Spector, was forced to resign.

It wasn' just there. The article continues

Within weeks after the Bear Stearns disclosure, the action shifted to the rating agencies. On July 10, Standard & Poor’s announced it was downgrading $7.3 billion worth of securities sold in late 2005 and 2006, and the ensuing conference call quickly turned testy. Steven Eisman, a portfolio manager at Front Point Partners, an investment firm that had made a major bet against the subprime mortgage market, did not mince words.

“I’d like to know why now?” Mr. Eisman demanded to know. “Why didn’t you do this many, many months ago?”

Maybe this never happened before? The article adds:

Some mortgage executives take a different view. Larry A. Goldstone, president of Thornburg Mortgage, said the trajectory of the current crisis in subprime closely resembled the arc of past mortgage crunches. Thornburg is not a subprime issuer, but like Countrywide it was also hit with rumors that it could go under last week.

“I’ve been in this business since 1983, and this is the fourth time we’ve had this in subprime,” said Mr. Goldstone, ticking off similar squeezes in 1987, 1993 and 1998. Maybe so, but what is different now is how much bigger the subprime market is than in the past, totaling $600 billion last year, up from $120 billion in 2001, according to Inside Mortgage Finance, a trade journal.

So, in fact, there is the opposite of a "learning curve" - not only the lessons of the past forgotten, but they are forgotten and repeated on ever larger and larger scales. (That's not very reassuring.)

In a different article, "The Unforgivingness of Forgetfulness", the Times adds some other views:

Not long ago, people were slapping their foreheads, too, after the tech-stock boom busted earlier this decade. Much of the talk of new paradigms turned out to be worth the pizza boxes that many a dot-com business plan was written on.

All of this raises questions: Why such short memories? Why did so many homebuyers ignore recent lessons — to be skeptical about can’t-lose, instant-wealth machines like tech stocks — and start viewing real estate as such a certain and profitable bet?

“It is amazing how quickly people forget,” said Robin Greenwood, an economist at the Harvard Business School, who has studied investor behavior during the late-1990’s boom.

One explanation is that many investors tend to have selective memories. They may have been burned in the stock market, but they view real estate as something altogether different, governed by its own laws of nature.

“From 40,000 feet, it looks like an investment world gone crazy in both cases,” said Susan M. Wachter, a professor at the Wharton School of the University of Pennsylvania, who has written about the dangers of aggressive lending practices in real estate. “But closer in, it’s a different part of the forest.”

All of which again supports my contention that "things" we perceive as "obvious" may bear very little resemblance to reality. There is clearly also no protection in crowds, or herds all stampeding the same direction either.

In fact, it may be far easier to stampede a herd (or steer it) than to stampede one individual.

And that's fascinating. All you need to get moving are the dumb ones, and the herd motion will cascade and convince the brightest and best ones to ignore their own good sense and run with the herd.

I heard about how this might work from a banker. He was trying to be responsible while other banks were making crazy loans, but figured out this -- there was no value in trying to be sensible. If he saved his money, sooner or later the banks would all realize most of them had drunk the wrong water, and they'd fine every bank a proportionate amount of the bill it took to fix the mess -- whether the bank had participated in making the mess or had refused to do so. So, if the zany investments paid off, other banks got rich and his got nothing. If the zany investments crashed and burned, every bank would get a bill, regardless. So, the logical strategy was clearly to join the herd while commenting "this is insane..."

Anyway, the reliability engineer in me now asks, with a blind spot on the gatekeepers that large, what OTHER terrible ideas have already gone out the barn door and are ticking time-bombs? Apparently we can trust nothing these "experts" say or do, and the closer one gets to the "action" the deeper the mental stupor or addiction to insane greed seems to become.

It's not clear as well that any foreign investors will ever again trust something Americans rate as "AAA" or "a sure thing."

American corporate expert judgement seems to be seriously flawed, not self-correcting, and, in fact, if corrected, self-breaking shortly thereafter. Not only is there no learning curve, but the errors missed are getting successively larger.

A strategy of "fix each problem as it breaks", seems somewhat like "we'll fix that bridge when it breaks." Historically, neither hearings nor investigations nor analysis seems to fix this kind of problem.

Probably, if asked what they are doing about their problem (of terrible judgment) they'd probably say that the problem (the most recent incident) has been fixed by the Feds.

The more important problem is "Why is there no learning curve on a social level?"

Bhe exact same "kind" of defect in catastrophe-avoiding-judgment, multiplied by exponentially increasing costs of catastrophes as the stakes rise and include nuclear and biological warfare , presents an increasing risk. So, no, it is not good enough to "stay as dumb as we are and have been getting by with."

We have to get better AT LEAST AS FAST as the costs of errors in collective judgment are rising.

We are, as a nation, about to make some rather important choices regarding global warming, the economy, responses to perceived threats around the globe, etc.

It does seem sometimes that everyone is too busy "forgetting" life to heed a call to pay more attention to it.