I’m looking forward to seeing The Big Short, which traces the stories of some who dared to doubt the US housing market before the global financial crisis. Friends and colleagues advise it does a great job of explaining some of the financial magic that caused the crisis, like subprime mortgages, securitisation and CDOs (collaterised debt obligations, in case you're wondering).
Back in 2008, the meltdown was a shock to most of us. I was shocked. I started at the Federal Reserve three weeks before Lehman Brothers went under. That's me at the time, in a rather nervous and stunned staff profile picture.
There were a lot of Fed employees walking around looking like that!
Why were economists shocked? Because many of us, including me, had got so many things spectacularly wrong.
Chief among the mistakes was the belief that the financial markets were relatively free of imperfections. I believed that Wall Street, and the other financial centres of the world, were populated with smart, sophisticated (and well paid) nerds working to channel savings toward the right investments while minimising risk. I thought all the complicated products and acronyms the financial sector dished up were an effective means of accomplishing that task. For example, I would have seen nothing wrong with this 2003 statement from Alan Greenspan, then chairman of the Fed:
What we have found over the years in the marketplace is that derivatives have been an extraordinarily useful vehicle to transfer risk from those who shouldn’t be taking it to those who are willing to and are capable of doing so.
Except they weren’t. For example, Credit Default Swaps, a type of derivative, were central to the crisis.
The crisis, to me, shattered the perception of a near-perfect financial market. That was quite a strongly held belief at the time.
Before the GFC, in polite company it was not acceptable to talk of big market failures in finance. And that contributed to groupthink. No doubt some who thought about speaking up thought twice about doing so. They only had to look at the treatment of Raghuram Rajan, now Reserve Bank of India Governor, in 2005. Rajan presented a paper called 'Has Financial Development Made the World Riskier?' He thought, in some respects, yes. In response, Larry Summers, one of the doyens of academia and US policymaking, apparently called him a Luddite.
The lesson? Being the contrarian in the room should be valued. I’m not talking about valuing argument for argument’s sake. But the world would have been a better place if more people had the courage of Rajan.
I think about this often. Organisations, and even entire academic disciplines, that do not tolerate dissent will make catastrophic mistakes. But everyone can play a role in stamping out groupthink, from the highest doyen and CEO to the lowest grad student and employee.