Financial Fuss (6) - Bad Judgment

The current problems are the result of bad judgement or foolishness. This foolishness has been widespread through the economic and political system. I have described the full cast of fools in Credit Crunch Characters.

American households paid ridiculous prices for houses, because they assumed that house prices would keep going up forever. Some took on huge mortgages, assuming rising prices would eliminate the risk. Congress made banks lend to people who could not afford mortgages. Investment banks bought credit default swaps, assuming there was no risk of the counterparties defaulting. Banks relied on credit rating agencies, assuming that they would never get thing wrong. Hedge funds bought CDOs, assuming the clever mathematical models had eliminated all risk. Investment banks boosted their profits by being leveraged up to thirty to one, but never thought about the consequences of a decline in asset values.

Foolishness and stupidity were rampant and pervasive in the financial system. Good times make fools appear wise, so they gave no thought about what they would do if markets turned down.

Here are some examples of bad judgement, or should I say foolishness.

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

We have a good deal of comfort about the capital cushions at these firms at the moment. — Christopher Cox, chairman of the Securities and Exchange Commission, March 11, 2008.

Foolishness cannot be eliminated regulation. Regulations cannot stop foolish behaviour. The only cure for foolishness is experiencing its consequences.