Introduction to Financial Crisis

In doing some research on the emerging trend of “strategic default” from an ethical perspective, I came across two programs, one audio, one video, on the banking crisis. While not strictly concerned with business ethics, these programs do a nice job in explaining the mistakes of human cognition/decision making that led to the crisis. Ultimately, I think, these perceptual shortcomings, combined with or magnified by unreflective profit-seeking, were to blame for the crisis, not a wholesale breakdown in ethics (or even a one-sided breakdown, which side you blame depending on your political/economic commitments).

For a very fun, non-technical introduction, you can’t do better than This American Life‘s episode, co-produced by the people responsible for the Planet Money blog, “The Giant Pool of Money“. It looks at the crisis from the perspectives of several players in the mortgage production chain (borrower, mortgage broker, banker) and describes how an excess of global capital helped drive the market frenzy for securitized mortgage obligations of various sorts. There is a follow-up program that is worth listening to, as well, “The Return to the Giant Pool of Money“.

For a more technical, yet still very accessible, introduction to the crisis, I suggest watching a brief talk given by Andrew Lo, who is the Director of the MIT Sloane School’s Laboratory for Financial Engineering. Titled Are Mathematical Models the Cause for Financial Crisis in the Global Economy?, he spends most of the talk providing the best introduction to the actual process of securitization that I’ve seen (and I’m someone who spent a good deal of my time actually working with the rating agencies, investment banks, and capital markets experts in putting these securities together). While I don’t think Lo actually answers the question adequately (the answer, in my opinion, is “no, the models didn’t cause the crisis, but the use of dodgy, short-term data and blind reliance on the models did”), the entire 50 minute talk is well worth your time if you want to get a high-level technical introduction to how securitization works and how it magnified the housing bubble and debt crisis.

I’m interested to hear from anyone who has other sources to help people understand the financial crisis. Part of what caused the bubble was that actors all along the mortgage production chain didn’t look carefully enough at the parts of the process they weren’t involved in. This led to a blind faith that “if the investment banks say the bonds are good, they must be good” and “if Countrywide thought this was a good loan, it must be a good loan”, etc. (I was actually guilty of the first one, looking back). If everyone had understood what other parts of the chain were doing, we might have seen the developing crisis much earlier than we did and been able to mitigate some of the worst effects.

Also, as I mentioned above, I’m working on an ethical analysis of “strategic default” and if anyone has any perspectives they’d like to share on it (pro, con, or otherwise), I’d be really interested to hear them.

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