How Can “The Best and Brightest” Get It So Wrong?

Last week I moderated a panel on the societal implications of the financial crisis as part of the Westport Library Community Conversation series.  Our panel discussed a variety of topics, and had a lively dialogue with a very engaged, smart and opinionated audience.

I started out by asking each of our panel members to share with us their personal view of the causes of the financial crisis.  What happened?  One of our panelists, Dan Gross, -  a financial and economics writer and senior editor at Newsweek, - recently published a book on the financial crisis, Dumb Money: How Our Greatest Financial Minds Bankrupted the Nation.  I asked Dan to go first.

His answer is along the lines of this Newsweek article that came out around the time his book was published.  He writes in the article

“The people who blew up the system weren't anarchists.  They were members of the club: central bankers and private-equity honchos, hedge-fund geniuses and Ph.D. economists, CEOs and investment bankers.  And the (overwhelmingly legal) con they perpetuated on themselves, their colleagues, their shareholders and creditors, and, ultimately, on us taxpayers makes Madoff's sins look like child's play.”

“. . . during the late, great credit bubble, an Era of Cheap Money devolved into an Era of Dumb Money, and then into an Era of Dumber Money. The culture of Wall Street and the rise of the shadow banking system spawned reckless, largely unregulated lending, borrowing, and trading, a financial culture that preferred short-term fees to long-term gains, and that confused liquidity (access to other people's money) with cash on hand.  Looking back, the investors who believed the stories told by Madoff and Stanford—that they could deliver steady, positive, market-beating returns in any type of climate, despite the manifest failure of virtually every other money manager to do so—were obviously foolish.  But our best financial minds also spun tales and theories with great assurance, making seemingly irrational and unprecedented activity seem completely sensible. And we bought them.”

Dan’s answer and writings reminds me of The Best and the Brightest, the classic book by David Halberstam on the origins of the Vietnam War.  Halberstam’s book is about the brilliant people that President John F Kennedy surrounded himself with, - academics, intellectuals, the top experts in their fields, -  who crafted the foreign policy that led to the Vietnam War, and ultimately resulted in the deaths of over 58,000 Americans, and millions of Vietnamese, Laotians and Cambodians. 

The title of the book “referred to President John F. Kennedy's "whiz kids" – leaders of industry and academia brought into his administration – whom Halberstam characterized as arrogantly insisting on ‘brilliant policies that defied common sense’ in Vietnam, often against the advice of career US Department of State employees.”

 Looking at our financial crisis, it is easy to caricature the high-and-mighty in business and government that once rode so high and how now fallen so far.  There is plenty of blame to go around, including the senior executives of the financial companies and rating agencies, as well as regulators and other government officials. 

But let’s remember that these were not the only alpha males - and they are indeed preponderantly male, - in positions of authority who should have known better.  Most academics and economists not only missed the gathering storm as well, but were complicit in its creation.  Many of these experts consulted or were working for financial companies and government agencies. 

Moreover, at the same time that national academy panels were warning us about the scarcity of US scientists and engineers needed to tackle the massive problems the country and the world face, our universities were building up financial math and computational finance programs to prepare those scarce young scientists and engineers for careers as quants.

Let me offer a few thoughts on how so many of our best and brightest got it so wrong.  First is the Arrogance of Power, a phrase that Senator J. William Fulbright used as the title of his 1966 book in which he attacked the justification for the Vietnam War. 

Power, especially when coupled with great wealth and respect invariably leads to arrogance and pride.  The ancient Greeks used the term hubris to describe the kind of overconfident pride that gets people, especially the powerful and rich, in trouble.  Hubris was typically responsible for the downfall of heroes in Greek tragedy.

It is difficult to find people, especially those whose accomplishments have helped them achieve success, wealth and power, who do not exhibit feelings of arrogance to a greater or lesser degree.  But, especially for those in a position of leadership, it is crucial to be on guard for such feelings and not let them take over.  Good leaders must have their feet firmly planted on the ground.  Otherwise their feelings will lead to a distorted view of the reality around them and of their own capabilities to deal with the troubles that inevitably lurk ahead.

In addition, people in positions of great power and/or wealth will often interact primarily with people like them, both at work and in their social life, most of whom share a similar world view.  Whether in enclaves inside the beltway, in Manhattan’s upper East side or in the Hamptons, you can become convinced that your relatively small group of brilliant, successful people are the only ones who understand what is going on and what needs to be done.  Everyone who disagrees with you is just plain wrong or worse.  When problems occur, you will tend to circle the wagons and become even more isolated.  The once fresh, brilliant ideas that brought you success and fame have now turned into rigid ideology. 

In the end, our financial crisis is best seen as a systemic failure of massive proportions, from which few of us are exempt in some share of the blame.  Let us hope that we learn from the experience, and are better prepared for the problems that will inevitably keep coming our way in the future.  The one lesson we hopefully will not forget next time around is to beware of the so-called best and brightest no matter how powerful, wealthy and succesful they are.

Comments

[Paul Wallis]

Irving,

During centuries of global economic development understanding precisely how business interacts with flows, firstly of water - then steam - then electricity - then oil, petroleum, and components - has been vital for businesses, the economy and society:

1770s - mechanisation, factories, and canals – water
1830s - steam engines, coal, and iron railways – steam
1870s - steel and heavy engineering, telegraphy, refrigeration – electricity
1910s - oil, mass production, and the automobile – oil; components; petroleum

Over time, the professions of architecture and engineering, and various sciences, co-operated to develop standards and practices of measurement, management, safety, optimisation and valuation to accurately understand these various flows.

The result was clarity about how the business worked.

This created trust.

That is why huge industrial plants are often sited relatively close to centres of population. It is why we don’t think twice about starting a car, turning on a kettle or lighting a gas ring.

There is always operational risk. But all over the modern world, no matter the political system, no matter the economic system, no matter the regulatory regime, the above holds true. The understanding of flow is critical to understanding how the business works and to creating trust.

And where there is trust people are more likely to do business.

Today, most business sectors rely heavily on IT and flows of data.

But unlike, for example, the utilities, finance does not know precisely how data (money) flows through the assets of the business.

There are many technical and business reasons for this circumstance, but in a nutshell, in today’s world finance doesn’t have enough understanding of how everything is put together to make the business, and the financial system, work.

Andrew Haldane of the Bank of England discussed this in his recent speech "Rethinking the financial network", where he spoke of the financial network as a place where ‘complexity caused seizures in certain financial markets’ and ‘financial innovation…increased complexity and uncertainty.’

He went on to discuss ‘appropriate control of the damaging network consequences of the failure of large, interconnected institutions’, and the need ‘to ensure the financial network is structured so as to reduce the chances of future systemic collapse.’

In the U.S., a joint study by the Federal Reserve Bank of New York and the National Academy of Sciences, "New Directions for Understanding Systemic Risk" (2007), opens with:

'Guarding against systemic risk in the financial system is a key undertaking for central banks. Defining this type of risk is difficult, but managing it with precision is harder still. Complicating this task is the fact that institutional consolidation, a broadening range of financial products, and greater connectivity among firms have in recent decades materially changed the nature of systemic risk in the financial system.'

Financial institutions must see things clearly and understand exactly how the financial system works, so as to rebuild trust.

Clarity will be achieved by understanding precisely how data flows.

[@Edw3rd]

What is that phrase? "when you're a hammer, everything looks like a nail"

My concern is that President Obama has assembled his own set of like-minded people. But instead of hammers, they are screwdrivers.

[Tim Dempsey]

Irving,
A post that inspired me to draw analogs with the flow of ideas and the social technologies of web ?.0. I am fascinated with the notion of risk as the flow of ideas accelerates. How do we deliver quality when there are no barriers to entry to the media? Here is is: http://www.elasticbrands.com/blog/2009/07/the-strain-that-will-cause-the-next-web-pandemic-im1/

Are you still lecturing at MIT regularly?

[Kitchen Scales]

I would agree that Mr.President has gone way too far with the socialist theory and trying to get healthcare swaying that way.. It doesn't work.. Socialism never works.