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05/31/2010

Hive Mind: Organizational Psychology and the Financial Crisis


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Illustration by Mark AndresenEconomists agree about the mechanism for the current financial crisis: a plunge in real estate prices led to widespread mortgage defaults, crushing the value of securities backed by those assets. This caused banks to shut down available credit and sent the global economy into a tailspin. “If there hadn’t been a housing bubble, we wouldn’t be having this tragedy today,” says Hersh Shefrin, PhD, professor of behavioral finance at Santa Clara University and the author of Ending the Management Illusion: How to Drive Business Results Using the Principles of Behavioral Finance (McGraw–Hill 2008).

But the psychological causes of the crisis are more obscure. Were lenders and Wall Street financiers simply crooks? Did greed drive them to knowingly sell toxic assets at big profits in the hope that they wouldn’t be the ones who were left holding the bag? Or were other psychological factors at play?

Many organizational psychologists and behavioral economists recognize familiar thought patterns and habits when they analyze the communal mentality that made the meltdown possible. By identifying and examining these underlying behaviors, they can enable businesses to restructure their management and compensation practices in a way that takes human greed, fear, and conformity into account, reducing the risk of abuse.

The January–February 2009 issue of CFA® Magazine includes a report entitled "The Ethical Dimension of the Market Crisis," which features the claim that “managers did not deliberately make bad investments; most probably believed they were doing the right thing with the information given to them. Behavior biases are likely at play in this crisis, and perhaps a herding instinct led investment professionals to make certain investment decisions because they believed that ‘if everyone is doing this, it must be okay.’”

HOTHEADS

Real estate values were able to jump sharply from 1997 to 2006 because bankers, borrowers, and Wall Street financiers refused to recognize that the climb was not sustainable. As Shefrin notes, “We’re not very good at figuring out when we’re in asset pricing bubbles.”

However, according to Robert Arnott, chairman of Research Affiliates, a money management firm in Pasadena, coauthor of The Fundamental Index: A Better Way to Invest (Wiley 2008), and a former editor of the Financial Analysts Journal, not everyone gets caught up in euphoria. In almost every market bubble, a vocal minority speaks out but is ignored, while markets and corporations temporarily favor those yea-sayers who live inside the bubble. The reason that bubbles seem to be “evident in hindsight only,” says Arnott, is “because people who prefer to believe it’s not a bubble are rewarded for that view.”

“I don’t think bankers and traders are evil people—they’re just people. All of us would have done the same thing. If we don’t understand the conflict of interest, it will happen again.”

—Dan Ariely, PhD

Ariely-Dan
 

The bubble in technology stocks burst less than a decade ago. Before the bust, in the late 1990s, industry executives spoke of a “new paradigm” and James K. Glassman and Kevin Hassett coauthored the 1999 bestseller Dow 36,000: The New Strategy for Profiting from the Coming Rise in the Stock Market (Crown). By the time that volume hit bookstores, however, the Dow was closing at 7,400.

Even the sharp rise in oil prices to above $140 a barrel in the summer of 2008 could be construed as a bubble. At the time, Goldman Sachs predicted the price could rise to $200 within two years. Oil recently traded below $50.

“We’re blinded. People are inherently too optimistic. They succumb to a ‘hot hat’ phenomenon,” Shefrin explains.

In one example of a hot hat scenario, a basketball player who keeps making his shots starts to believe he just can’t miss. “It turns out that chance alone will give rise to this—to streaks,” says Shefrin. Likewise, market participants believed housing prices would continue to see double-digit gains each year, instead of appreciating at their historic annual rate of 1.4% over the past century.

Arnott sees hot hat perceptions in all areas of human endeavor, from gambling to politics to business. In the investment realm, he says, it really hurts the bottom line: “Assets are priced to reflect those momentum-based expectations, the notion that what has worked will work. No one looks at his 401(k) and invests in what has done the worst in the past three to five years. Yet we know that if you invest in the best performers over three to five years, you’ll do terribly going forward.”

But Colin Silverthorne, PhD, a professor of organizational psychology at the University of San Francisco and the author of Organizational Psychology in Cross-Cultural Perspective (NYU Press 2004), believes it wasn’t necessarily a hot hat mindset that kept financiers in the toxic mortgage game. He points out that psychologists have discovered that even if an activity brings only “partial reinforcement”—occasional unpredictable rewards—a person will keep doing it. “These people probably knew better. People keep robbing banks till they get caught,” says Silverthorne.

PANTS ON FIRE

Economist Dan Ariely, PhD, author of Predictably Irrational (Harper 2008), says widespread cheating was at the heart of the crisis. Market players—from mortgage lenders to investment bankers—weren’t stealing money outright, but they were engaging in transactions they knew were too risky, or selling securities they suspected were toxic.

Ariely is a professional flimflam man—but not because he’s a cheater himself. The senior fellow at the Kenan Institute for Ethics and James B. Duke Professor of Behavioral Economics at Duke University, he has studied cheating by students at a host of top American educational institutions. He says his research provides insight into why market participants collectively cheated us into the current mess.

“We’ve done a lot of research on cheating. We gave people a chance to steal money from us. A lot of people cheat just a little. People don’t cheat more when they get more money, or when there is a lower probability of being caught,” he says.

Cheating tends to happen more among groups of peers. “What happens when you see someone cheating in an egregious way? If it’s in a group you identify with, the cheating goes up. If it’s not, the cheating goes down,” Ariely says. He contends lenders made loans to people who couldn’t afford them, and bankers packaged and sold securities backed by those risky loans because everyone in the industry was doing it.

HARVARD EXPERIMENT: A LOT OF PEOPLE CHEAT A LITTLE

Ariely asked a group of Harvard undergraduates and MBA students to take a test consisting of 50 multiple-choice questions, such as “Who wrote Moby Dick?” and “What is the world’s longest river?” (The experiment was repeated at MIT, Princeton, UCLA, and Yale, with similar results.)

Group 1, the control group, wasn’t given the chance to cheat. Students had 15 minutes to answer the questions; then they were asked to transfer their answers to a scoring sheet and submit it to a proctor. For each correct answer, the proctor would hand them 10 cents.

“We talk about predatory lending. What about predatory borrowing? If a broker encourages someone to lie on a mortgage application, both the broker and borrower are at fault.”

—Robert Arnott

Rob Arnott

 

Group 2 took the same test as Group 1, but this time the correct answers were already marked in gray on the scoring sheet. Participants who chose the wrong answer on the worksheet could lie and mark the correct answer on the scoring sheet. They were told to write the number of correct answers on the top of the scoring sheet and hand it to the proctor, who paid them 10 cents per correct answer.

Students in Group 3 were instructed to shred the original worksheet and hand only the scoring sheet to the proctor, destroying any evidence of cheating.

Group 4 destroyed both the original worksheet and the premarked scoring sheet. Students didn’t even have to report their correct answers to the proctor. They merely needed to withdraw their earnings from a jar full of coins.

The researchers found that the majority of people will cheat when given the opportunity—but just a little bit. The students didn’t seem to be influenced by the risk of being caught. Those in Group 3 (who shredded their worksheets) cheated just as much as those in Group 2 (who retained the evidence of their wrongdoing); both groups increased the control group’s score of 32.6 correct answers to 36.2 correct answers.

What about students in Group 4, who could have claimed a perfect score or taken all the money in the jar—$100? None of them did so. “Everybody has what I call the personal fudge factor. We cheat up to a level where we still feel good about ourselves,” says Ariely.

UCLA EXPERIMENT: NO CHEATING UNDER OATH

Students at a UCLA lab were given five minutes to try to solve 20 simple math problems, after which they were entered into a lottery. If they won, they would receive $10 for each problem solved correctly. Group 1, the control group, was not allowed to cheat: participants had to hand their work in to the proctor. Each student in this group averaged three correct answers.

Those in Group 2 wrote down the problems that were answered correctly but were able to dispose of the original worksheet. This allowed them to cheat, and they did, a little. The members of Group 2 averaged 4.1 correct answers apiece.

But only some members of Group 2 cheated. When participants first entered the room to take the test, some were asked to remember the names of 10 books they had read in high school. This subgroup accounted for all the cheating in Group 2.

The rest of the participants in Group 2 were asked to recall the Ten Commandments. Members of this subgroup did not cheat at all; they averaged three correct answers, the same as the control group. The students who could remember only one or two commandments were as honest as the students who remembered all 10, indicating, Ariely believes, that it wasn’t the commandments themselves that encouraged honesty, but the contemplation of a moral benchmark of some kind.

Occasional oaths or statements of adherence are not enough; rules must be recalled at or just before the moment of temptation, he writes. On Wall Street, this means firms must be structured to remove the potential for conflicts of interest.

MIT EXPERIMENT: PEOPLE CHEAT MOST WITH PLAY MONEY

At MIT, Ariely’s team asked students to solve 20 simple math problems in five minutes. They would get 50 cents per correct answer.

In the noncheating control group, participants took their worksheets up to the experimenter, who graded the work and paid the students accordingly.

In Group 2, participants were told to tear up their worksheets and simply tell the experimenter their score in exchange for payment.

In Group 3, participants told the experimenter how many correct answers they had without presenting the sheet. But this time, instead of receiving cash, they received a token that could be redeemed for 50 cents from another experimenter across the room.

Participants in the control group got an average of 3.5 correct answers. Those in Group 2 claimed to have solved an average of 6.2 questions correctly, a differential Ariely attributes to cheating. Participants in Group 3 claimed to have solved an average of 9.4 problems. “What a difference there is in cheating for money versus cheating for something that is a step away from cash!” he writes.

Ariely compares the tokens in the experiment to securitized assets. CDOs (collateralized debt obligations) and the like are so far removed from cash that they make it easy to cheat. Ariely says a salesperson getting paid $10 million to sell mortgage-backed securities and portray them as a good deal is just rationalizing cheating. When all of Wall Street was doing the same thing, the cheating increased.

“I’ve talked to some home buyers. They said, ‘Don’t worry. If everyone’s doing it, it means the government is going to make sure we’re not all going to fail.’”

—Robert Bell, PhD


Robert BellJohn Ricasoli

But based on his research into cheating, he doesn’t think bankers and traders are any more dishonest than the rest of us. “I don’t think they’re evil people—they’re just people. All of us would have done the same thing. If we don’t understand the conflict of interest, it will happen again. We can’t put them in conflict-of-interest situations,” Ariely says.

The way brokers and salespeople are compensated adds to these conflicts of interest. “We pay incentives that are misaligned with jobs,” he asserts, adding that commissions aren’t inherently bad, but brokers and salespeople should make more money if their clients make money. In addition, he contends, bonuses and other incentives should be based on performance over long periods, not just one quarter.

HERD MENTALITY

On October 16, 2008, the Singapore newspaper the Straits Times published an article by Michael Frese, the chair for work and organizational psychology at Germany’s University of Giessen, and Richard Arvey, head of the department of management and organization at the National University of Singapore’s business school. Frese and Arvey claim, “By and large, financial executives, like most people, tend to look for confirming rather than nonconfirming evidence when discussing potential scenarios: what confirm[s] happy expectations, no matter how flimsy, [is] highlighted; and what doesn’t, [isn’t].”

Financial executives overestimated their ability to cope with the potential negative consequences of the risks they were taking. After all, other firms were scoring huge profits taking those risks. Therefore, the executives assumed they could take the same risks themselves. “Once individuals adjusted to a certain risk level—and got away with it unscathed—they adopted even more risky practices,” write Frese and Arvey.

Hersh Shefrin calls this phenomenon “collective confirmation bias,” explaining that people tend to pay most attention to the information that confirms their beliefs. “The whole industry was caught up in this madness,” says Shefrin.

When the market started to get out of control, it was time for financial professionals to turn contrarian and save themselves. Like the child in the “Emperor’s New Clothes,” Shefrin says, “you need to say there’s something wrong with you or them and get off that merry-go-round.” Yet few financial professionals seized the opportunity to escape. “There isn’t safety in numbers when everyone is crazy,” he affirms.

Colin Silverthorne blames investors, not just the investment bankers who sold them the goods, for failing to heed the warning signs. “A lot of investors let this ride. I’m surprised they haven’t been more active as stakeholders in these companies. Investors could see that things were amiss. They ignored it because they were doing fine.”

SHOOTING STARS

Psychologists have discovered that, in comparison to other nationalities, Americans lack a long-term perspective when it comes to business and other pursuits. Part of this stems from our culture, while another part is a function of our political structure.

“There has been extensive psychological research on time and how we view it,” says Silverthorne. “In Asian cultures, there’s a very long-term perspective. In America, people want to get it while they can.”

The timing of US elections also fosters this mindset, often leading to foolhardy decisions by policy makers. “There’s a national election every two years in the US. That’s not true of any of our allies in Western Europe,” points out Robert Bell, PhD, chairman of the department of economics at Brooklyn College and author of The Green Bubble (Abbeville Press 2008). He adds, “It’s never in the interest of the incumbent politicians to be in a bad economy. Now that mechanisms exist to pump it, it’s always pumped.”

Bell is referring to the monetary policies and coordinated actions by exchanges and regulators that Ronald Reagan put in place in 1988, via a program called the Working Group on Financial Markets. “The federal government has become a bubble-pumping machine,” Bell says.

Of course, the adrenaline-fueled culture of competition on Wall Street also played a huge role in getting us where we are today.

“Organizations encouraged this. It wasn’t just human nature,” says Charles Scherbaum, PhD, professor of industrial and organizational psychology at Baruch College in New York City. Scherbaum recalls the comment on risk made by Charles Prince when Prince was still CEO of Citigroup. “As long as the music is playing, you’ve got to get up and dance,” Prince told the Financial Times in July 2007.

The way to make bonuses was to take exceptional risk. The way to get hired was to demonstrate comfort with high levels of risk. “You’d be foolish not to take those risks, because everyone else was taking them. You would be seen as a weak performer,” says Scherbaum.

“Can we find leadership that focuses on what matters over the long term? How can you reconcile that with shareholder expectations?”

—Charles Scherbaum, PhD

Charles Scherbaum
 ©2009 Jerry Speier

He compares the addiction to risk on Wall Street to professional athletes shooting steroids: “Everyone is looking for a competitive advantage.”

Even with routine drug testing in professional sports, even with a credit bubble primed for detonation, the minute-by-minute scramble for survival in a cutthroat environment doesn’t allow for sage reflections on the long-term viability of players’ strategies. It’s hard enough just to stay alive and swinging.

LEHMAN ENVY

In many cases, the risks were taking place in organizations that were thrown together as a result of successive mergers—think Citigroup and Bank of America. These institutions were forced to grow and integrate their operations and cultures so quickly that “it was a recipe for disaster,” according to Scherbaum. “The businesses were so complex, no one truly understood them”—even their CEOs.

For other firms, such as Merrill Lynch and UBS, Hersh Shefrin says, the drive to win at all costs was the destructive force. As housing prices surged, those companies found themselves lagging behind competitors—especially Lehman Brothers—in the mortgage-backed securities arena. “They had, I would say, Lehman envy,” says Shefrin.

As a case in point, Shefrin adds, in 2004 Merrill’s second-quarter performance was positive but well below that of its chief competitors, especially Lehman Brothers. Merrill Lynch’s second-quarter net income rose as earnings growth in its private-client and investment-management units offset weakness in investment banking and global markets. But the results fell short of Wall Street analysts’ estimates, partly because of a 44% drop in principal trading revenue.

Lehman’s second-quarter fiscal profit, on the other hand, rose 39%, buoyed by higher revenue from bond trading and investment banking. In order to bridge the gap with Lehman, Merrill ratcheted up its mortgage presence. From 2005 to 2007, Merrill Lynch acquired a host of mortgage lenders so that it could extend loans directly to homeowners. It bought residential and commercial mortgage-related companies or assets and purchased commercial properties around the world and a loan servicing operation.

This acquisition spree meant that Merrill could originate mortgages, package them into CDOs, and sell the CDOs to investors. Merrill’s acquisition of US subprime lender First Franklin in September 2006 drew controversy, occurring just as defaults by mortgage holders were mounting.

“They wanted to be number one. The focus on immediate gratification was enormous. Like overeating, drinking, smoking—they give you pleasure today, but there may be a huge cost down the line,” says Shefrin.

THE VOID AT THE TOP

In his presentation at the 2009 TradeTech conference, former Securities and Exchange Commission chairman William Donaldson insisted that “we must move to restore the trust that has been so damaged.”

Change, he said, has to come from the highest levels of the government and corporations. Regulations have to be streamlined to reflect the complexity of global markets. At the same time, corporate chief executives have to set the ethical tone for their organizations.

He noted that Sarbanes–Oxley, which tightened financial reporting standards for boards of public companies, management, and public accounting firms, and put the onus on boards to rein in corporate misdeeds, “took power from the omnipowerful chief executive and placed it back with the board. I call it the DNA infection of a company with a soul or heart that says this is the way we do things around here—an ethical approach that reaches up from the bottom and down from the top. The chief executive can be the embodiment of that,” Donaldson urged.

“One of the functions of leaders is to set strategic priorities and set the priorities of the organization,” agrees Charles Scherbaum, noting that such role models are all too rare. “Everybody looks to the CEO to set the direction. If the CEO suffers with the company, it sends a strong message. On Wall Street, you don’t have those kinds of legendary figures,” he says.

“You basically bought the mortgage on trust. You trusted that the person selling it wouldn’t deceive you. You were buying on faith when faith wasn’t warranted.”

—Hersh Shefrin, PhD

Hersh Shefrin
 

Instead, despite the financial crisis, CEOs have continued to draw huge bonuses. In December, John Thain, then the CEO of Merrill Lynch, waived a $10 million bonus only after a public outcry. And insurer AIG notoriously spent $165 million in taxpayer bailout money on bonuses to top employees and executives.

Scherbaum says leaders need to accept responsibility for the company’s performance and align their personal fortunes with those of shareholders. “If we’re all losing money, they need to say that there are not going to be these kinds of payouts. It has to start with the CEOs,” he says.

But more importantly, he adds, chief executives must reward behaviors that have long-term value for the company and shareholders. Too often, investors focus on the next quarter’s profit above all else. “We’ve all heard CEOs complain about it,” he says.

Corporations need to encourage employees to take appropriate risks without punishing them for appropriate risk avoidance. There should be rewards for behavior, just as there are for outcomes—salespeople should be incentivized for servicing existing clients as well as for bringing in new clients, for example.

“It means identifying critical competencies that lead to successful performance. It has to come from the top,” says Scherbaum. “Can we find leadership that focuses on what matters over the long term? How can you reconcile that with shareholder expectations?”

Few financial institutions were able to resist the profits that came with taking huge risks in the mortgage market. But there were exceptions. Goldman Sachs walked away from the CDO market before its rivals. “A lot of others didn’t. It took a lot of courage,” Scherbaum affirms. He credits CEO Lloyd Blankfein’s “participative” style of leadership, as opposed to one of “command and control.” Blankfein’s subordinates warned of the risks and he heeded their advice. “When people down in the trenches every day tell you this, a good CEO’s going to listen,” says Scherbaum, who also praises JPMorgan Chase and the Royal Bank of Canada for leaving the table relatively early.

In the case of JPMorgan, CEO Jamie Dimon, an architect of Citigroup and a protégé of Sanford Weill, had a longer-term perspective than most of his peers. “He didn’t need to make every dollar at all costs. All CEOs focus on the stock’s price but some focus more than others,” Scherbaum says.

BLAMING THE VICTIMS

As the Bush administration vigorously promoted an ownership society, dishonest mortgage lenders unquestionably enticed some homeowners to borrow more than they could afford with offers of “no money down” and low teaser interest rates. But homeowners had their own reasons for succumbing to these seductions.

“We talk about predatory lending. What about predatory borrowing?” says Robert Arnott. “If a broker encourages someone to lie on a mortgage application, both the broker and borrower are at fault.”

Colin Silverthorne divides borrowers into four categories: those who believed prices would keep climbing; those who knew it was crazy to buy but did anyway; those who were in denial, suspecting their actions were misguided but repressing the thought; and those who didn’t read what they signed. Referring to the last group, he quips, “There are stupid people out there. That’s a psychological term we use a lot.”

People piled into real estate as prices escalated so as not to miss out on the boom. “There was tremendous social pressure,” explains Robert Bell. When a person of limited means heard that a friend had acquired a mortgage and saw the friend’s new home, that person thought, “‘What an amazing transformation in lifestyle that is. Maybe I could do the same thing,’” Bell says.

Bell sees moral hazard—borrowers’ belief that they would somehow be insured against their own folly—as another factor. “I’ve talked to some buyers—my students or their parents. They said, ‘Don’t worry. If everyone’s doing it, it means the government is going to make sure we’re not all going to fail.’”

Dan Ariely maintains that another reason home buyers borrowed more than they could afford was that they relied on a flawed rule of thumb. For years, lenders have recommended that home-owners borrow no more than 40% of their income.

“Mortgage calculators hurt you. They only figure out the maximum—not the amount you should be borrowing,” Ariely argues. And lenders took liberties with this guideline. For instance, a borrower’s monthly payment could be reduced by stretching it out over 40 years instead of 30, or with an interest-only mortgage.

“We gave borrowers a lot of responsibility and no tools to figure it out,” says Ariely, who’s working with Bank of America to create a “humane” mortgage calculator that better reflects the level of debt a borrower should assume.

“There has been extensive psychological research on time and how we view it. In Asian cultures, there’s a very long-term perspective. In America, people want to get it while they can.”

—Colin Silverthorne, PhD

Colin Silverthorne
 

The government also encouraged home ownership with incentives for first-time buyers and generous tax breaks. “The government encouraged stupid loans because you could package them and shift them off to Fannie and Freddie,” says Arnott.

Bell agrees that the government fueled the home-buying binge. “This was true of the past two administrations, Clinton and Bush. As long as the body was warm you could get a loan.”

BLIND FAITH

Securitization of mortgage assets made it easy to perpetuate the belief that home prices would keep going up. Investors in mortgages never interacted directly with homeowners because the loans were pooled, packaged, sliced, and diced.

“You basically bought the mortgage on trust. You trusted that the person selling it wouldn’t deceive you. You were buying on faith when faith wasn’t warranted,” says Shefrin.

CFA Institute comes to a similar conclusion about CDOs and their offshoots. According to the report in CFA Magazine, “Many investment professionals apparently did not fully understand the acronym-heavy securities—CDOs, CDO-squared, etc.—that they were creating, rating, or purchasing, despite the fact that many came with a prospectus of 1,000 pages or more.” Purchasers of the securities relied on credit rating agencies to assess quality and safety. Almost no one demanded better information or performed an independent analysis.

As for auditors, Bell alleges that they often failed to understand the mathematics of the massively complicated CDOs. Yet because they were hired by the firms whose books they were checking, they were loathe to question executives.“Had they had real outside auditors, the madness would have become apparent. That might have stopped it,” says Bell. “It was 100% conflicts of interest.”

Bell suggests the compensation model for auditing be changed. Companies, he says, should take out financial statement insurance. The insurers could pay firms to audit companies using the insurance premiums. Alternatively, stock exchanges could act as the go-betweens for audit services, choosing and paying the accounting firms and billing the listed companies. In either instance, “the cozy relationship between auditors and top management wouldn’t exist,” he says.

Shefrin points out that the people within rating agencies and on Wall Street who did know there was junk in the pools also knew someone was willing to buy it. “Everybody was sort of shutting their eyes, thinking the game would go on forever. There was an illusion of safety,” says Shefrin.

Frese and Arvey’s Singapore Times article speaks to this willful disregard of danger, showing how people “have difficulty believing that drastic worst-case scenarios can ever happen. That is why they live in earthquake zones and other dangerous places … Psychologists call this tendency ‘discounting.’”

Intellectually, financial executives may have understood the risk, but emotionally, they couldn’t believe the worst-case scenario—home prices falling drastically—would take place. Even when firms began incurring actual losses, their rivals still could not take in the fact that they themselves were vulnerable. Those analysts, managers, and bankers who did understand the paradoxes driving their firms’ huge profits also understood that speaking out could spell career suicide.

Bell sums it up: “John Maynard Keynes said a good banker is one who goes broke with all his fellow bankers. A bad banker goes broke on his own. We’ve seen a lot of good bankers here in Keynes’s sense of the word.”

–Marlene Givant Star is a freelance journalist based in the New York area. Formerly an editor for the Associated Press, Crain Communications, and Bottom Line/Personal, Star has written recent articles for Institutional Investor’s Alpha magazine and Newsday.

Illustration by Mark Andresen.

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Comments

Isn't the "hot hand" referred to as "hot head" in the article. I believe Gilovich went over this years ago.

In contrast to the majority, I put the blame of the financial crisis squarely with the government. In 1999 Gramm-Leach-Bliley law signed by Clinton intentionally created an entire "grey", in essence, unregulated sector between banking and insurance. It de-facto allowed unregulated lenders to enter consumer-finance market. Senator Gramm then decamped to the banking job with an undisclosed salary probably in excess of $5 million.

While this legislation created a time bomb, its mechanism was winded by 2005 Bankruptcy Abuse Act. In effect, it triggered massive refinancing of the credit card debt through the loans-on-equity (see my paper abstract=1150512 on ssrn.com). The first real estate depreciation shock in these conditions was bound to create a wave of consumer defaults.

In a word, I do not see anything new or unusual in the 2008-2009 financial crisis. As the Great Depression it was created by perverse philosopies of the people (like Mellon) with concerns very distant from that of ordinary men, conflicts of interest and the incentives to create leverage without caring for the credit and liquidity risk.

Peter Lerner, MBA, PhD is semi-retired and teaches one business course on Manhattan. He also is an author of ssrn working paper "Alternative View of the Current (2008) Crisis in the US Financial System", which appeared in June 2008 when the scale of the impending disaster was far from clear.

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