How Much Is A 30-Year Fixed-Rate Mortgage Going For No One Listened As the Economic Crisis Unfolded – Was Group Think to Blame?

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No One Listened As the Economic Crisis Unfolded – Was Group Think to Blame?

As each domino fell starting in the summer of 2007, it became increasingly clear that the economy was in serious trouble. But the surprising truth was that almost everyone, from economists, investors, politicians to consumers, played along until the very end. They played along until the evidence became so overwhelming that they were forced to capitulate and admit the mistakes of the past and the consequences those mistakes had on the world economy.

How did this happen? Why didn’t our leaders in the financial and political communities see it? And why were these leaders so quick to reject the few who expected him?

One explanation is that the financial tsunami started slowly. Some suggest it started with the easy money from 2001 to mid-2008 that kept mortgage rates low (30-year fixed-rate mortgages went from more than 8 percent in 2000 to the low 5 ¾ percent in 2004 and then increased to 6 percent in 2008). The tsunami then began to gather momentum as would-be buyers rushed to buy homes at attractive interest rates, many with small down payments. Fueling the frenzy were mortgage brokers, motivated by high commissions, who arranged loans with low down payments and often looked away when it was clear that the buyer could hardly meet the monthly payments. But few critical voices were raised, no one heard them, and the financial tsunami continued.

Collateralized debt obligations (CDOs) were created to help financial institutions that were eager to participate in the good times by earning high profits. These CDOs simply bundle mortgages, some of them subprime, and sell them to banks and insurance companies as high-yield investments. Credit default swaps (CDS) were then created to insure CDOs. As a result, any investment bank that purchases a CDO along with a CDS to insure the CDO will be confident that its investment is secured. Not one to spoil a good party, blue-chip rating agencies including Standard & Poor’s and Moody’s have given top ratings to CDOs ? Again, few critical voices were raised, no one listened to them, and the financial tsunami continued.

When housing prices stopped rising, the housing bubble collapsed. Prices fell and a growing number of homeowners owed more than the market value of their homes. Then more homes came on the market, which led to lower prices and the spiral continued. Defaults began to mount. But because there were many breaks in this complex web, financial institutions continued to hold CDOs on their balance sheets at prices that no longer reflected the fact that many of the mortgages included in the CDOs were at risk. With weakened balance sheets, financial institutions such as Lehman Brothers either failed or shut down their lending operations for fear they would never be repaid. Now, however, a few critical voices have emerged, a few people have listened, but have assured us that the damage can be limited.

Then the recession hit. Credit dried up, companies laid off workers and consumers tightened their belts. The damage was so great – with no end in sight – that the silence suddenly stopped. Now the finger pointing has begun. Everyone listened.

But it was too late.

What was unprecedented was that the conspiracy of silence lasted so long. Yes, some economists and politicians have warned that we are on a collision course and that the economy cannot sustain the pace and level of debt for much longer. In 2005, Robert J. Shiller, a Yale economics professor, warned of a real estate bubble. Then in September 2007, he told Congress that the downturn in the real estate market could become the worst recession since the Depression. Shortly thereafter, in November 2007, at an international conference in Dubai, he warned that a global collapse was imminent. Indeed, Shiller and others, including Paul Krugman, winner of the 2008 Nobel Prize in Economics, spoke out, but few listened.

And the silence wasn’t limited to Wall Street. The management of the big three car companies remained silent. Even if some questioned a corporate strategy focused on designing cars that would face the world’s growing fuel and environmental crises, most remained silent. And investors, like regulators, were suspicious of Bernard L. Madoff’s alleged Ponzi scheme, but said nothing. In 2001, Erin Arvedlund, a reporter for Barrons, wrote an article that raised questions about Modoff’s strategy producing consistent returns far superior to those of other funds. Still, nothing came of the article. Apparently they all “went out to find out” and in the process reaped the short-term financial benefits, or in the case of the Big Three, secured their personal short-term futures.

One way to make sense of this process is to borrow the term Groupthink from the management literature.

Groupthink it is often used to describe situations where people “get along to get along”. This happens when social peer pressure prevents people from voicing their concerns. This occurs when conflict is minimized and as a result group processes and group decisions face several difficult tests.

Groupthink during this financial crisis was widespread. No one wanted to ask questions about what was happening. The few who did were ignored. In fact, this is perhaps the most striking example of groupthink as Irving Janus wrote extensively on the subject in 1977.

Unfortunately, Groupthink it may be inevitable. It may be a systematic bias that we all share across a wide range of human social behavior when cooperating with others to achieve common goals. It is prevalent in modern organizations, both in business and government. Only the most open, externally focused and flexible organizations can protect themselves from it. Established bureaucracies such as General Motors, Ford and Chrysler are at greatest risk.

If there is a lesson for organizations that has been highlighted by this financial crisis, it is this: Group Think sacrifices critical analysis and conflict for immediate comfort.

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