Wednesday, January 26, 2011

Missing the Obvious

I've talked and written about the importance of failing to see the obvious. It's a common source of error -- and one to which we are all prone -- since most of us believe (understandably, but wrongly) that we would notice obvious things. (See my previous posts on inattentional blindness, for example.)

The latest example comes to us from Financial Crisis Inquiry Commission. The FCIC was established to investigate the causes of the financial collapse that wreaked havoc from Wall Street to Main Street. The Commission's final report is due out tomorrow. But a few news outlets, including the New York Times, have gotten an early look. Here's what the Times had to say:

“The captains of finance and the public stewards of our financial system ignored warnings and failed to question, understand and manage evolving risks within a system essential to the well-being of the American public. Theirs was a big miss, not a stumble.”

Those words echo the testimony of Jamie Dimon, chairman of JPMorgan Chase & Co., who appeared before the Commission a year ago.

"I’ve already mentioned the biggest mistakes we made," he told the Commission. "In mortgage underwriting, somehow, we just missed that home prices don’t go up forever..."

This admission startled one of the commissioners, who asked Dimon, "Did you do a stress test that showed housing prices falling?"

"No," said Dimon. "I would say that’s probably one of the big misses."

Yes, indeed. Home prices still haven't recovered, as the latest Standard & Poor's/Case-Shiller index makes clear. In many big cities, home prices have sunk to their lowest prices in years.

As the article in the Times goes on to point out, "one striking finding (of the FCIC report) is its portrayal of incompetence."

"It quotes Citigroup executives conceding that they paid little attention to mortgage-related risks. Executives at the American International Group were found to have been blind to its $79 billion exposure to credit-default swaps, a kind of insurance that was sold to investors seeking protection against a drop in the value of securities backed by home loans. At Merrill Lynch, managers were surprised when seemingly secure mortgage investments suddenly suffered huge losses."

One way to prevent errors of this magnitude is to impose constraints that other other countries (notably Canada, which avoided much of the mortgage mess) have adopted.

But with the Dow hovering around 12,000 and bankers strutting again at Davos, this seems unlikely.

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It's one thing to see the obvious, but another matter to think what to do about it.

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