Bankerss Living in World of Dreams

David Reilly in the Wall Street Journal wrote an interesting analysis of the banking system i which he argues that the institutions need as much of an overhaul as the auto industry.

The crisis, they have argued, is down to an impossible-to-predict perfect storm, predatory hedge funds, panicked investors, unrealistic accounting rules and economic changes that emerged so quickly there was no way to be prepared for them.

If only. The reality is the crisis is due to bad lending and investment decisions.

I agree, but would extend this a bit. Bad decisions caused the problem. The trigger was a series of events that stressed the business model enough that it crumbled.

The problem with the banks' explanation is that it effectively says, "If only things hadn't gone wrong, we'd have been fine." But nothing goes right forever. Bankers rode a long string of wins, and then kept pushing their luck. They didn't test extreme scenarios. That was heinously inept. As I've mentioned before, when you have events that are independent of each other, the probabilities of at least one happening add. Maybe some of these events aren't completely independent, but they're not completely dependent either. As the number of things that can go wrong increases, so are the chances that one of them will.

Executives who cannot grasp this simple fact and who keep telling themselves that everything will be fine are nothing more nor less than addicted gamblers. There is a reason that some financial institutions with a reputation for being overly conservative have lasted hundreds of years. They don't look for the short cut to profit.