As each domino fell, beginning in the summer of 2007, it became increasingly clear that the economy was in deep trouble. But the surprising truth was that almost everyone, from economists, investors, politicians to consumers, played the game to the end. They played along until the evidence was so overwhelming that they were forced to capitulate and acknowledge the mistakes of the past and the consequences these mistakes had for the global economy.
As a step? Why didn’t our leaders in the financial and political communities see it coming? And why were these leaders so quick to fire the few who saw it coming?
One explanation is that the financial tsunami started slowly. Some have suggested it was started by easy money from 2001 to mid-2008 that kept mortgage interest rates low (30-year fixed-rate mortgages went from more than 8 percent in 2000 to a low of 5 ¾ percent in 2004 and then increased to 6 percent in 2008). Then the tsunami began to gather momentum as would-be buyers rushed to buy homes at attractive interest rates, many with a small down payment. Fueling the frenzy were mortgage brokers, motivated by high commissions, who arranged loans with low down payments and often looked the other way when it became clear the buyer was barely able to meet the monthly payments. But few critical voices were raised, no one listened, and the financial tsunami continued.
Collateralized debt obligations (CDOs) were created to help financial institutions that were eager to ride in the good times by earning high returns. These CDOs simply packaged up mortgages, some of which were marginal, and sold them to banks and insurance companies as high-yield investments. Credit default swaps (CDS) were then created to secure the CDOs. As a result, any investment bank that purchased a CDO along with a CDS to insure the CDO would be confident that their investment was insured. Top-tier ratings agencies, including Standard & Poor’s and Moody’s, are not ones to crash a good party and have given CDOs the highest ratings. Once again, few critical voices were raised, no one listened, and the financial tsunami continued.
When house 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 houses were put on the market, leading to lower prices, and the spiral continued. Defaults began to increase. But because there were many disconnects 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 a weakened balance sheet, financial institutions, such as Lehman Brothers, went bankrupt or closed their lending operations for fear they would never be repaid. Now, however, some critical voices have emerged, some people listened, but we were assured that the damage could be contained.
Then the recession came. Credit dried up, businesses laid off workers, and consumers tightened their belts. The damage was so great, with no end in sight, that the silence abruptly ended. Now he started pointing fingers. Everybody was listening.
But it was too late.
What was unprecedented was that the conspiracy of silence lasted for so long. Yes, some economists and politicians warned that we were on a collision course and that the economy could not sustain the pace and level of debt for long. In 2005, Robert J. Shiller, a Yale economics professor, warned of a housing bubble. Then, in September 2007, he told Congress that the downturn in the housing market could become the most severe downturn since the depression. Shortly after, in November 2007, at an international conference in Dubai, he warned that global collapse was imminent. Indeed, Shiller, like others, including Paul Krugman, winner of the 2008 Nobel Prize in economics, spoke out, but few listened.
And the silence was not limited to Wall Street. The management of the three big car companies remained silent. Even if some questioned a corporate strategy focused on designing cars that would confront the world’s growing fuel and environmental crises, most remained silent. And investors, as well as 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 that consistently produced returns far better than returns from other funds. However, nothing came out of the article. Apparently they all “went off to get along” and in the process reaped the short-term financial benefits or, in the case of the Big Three, secured their short-term personal futures.
One way to make sense of this process is to borrow the term group think of the management literature.
group think is often used to describe situations where people “get along to get along”. It occurs when social pressures within a group prevent people from expressing their concerns. It occurs when conflict is minimized and, as a result, group processes and group decisions face few difficult tests.
group think during this financial crisis was widespread. No one wanted to ask questions about what was going on. The few that did were ignored. In fact, this may have been the most vivid example of groupthink since Irving Janus wrote extensively on the subject in 1977.
Unfortunately, group think it may be impossible. It may be a systematic bias that we all share in a wide range of human social behaviors whenever we collaborate with others to achieve common goals. It is prevalent in modern organizations, both business and government. Only the most open, externally focused and agile organizations can guard against this. Established bureaucracies such as General Motors, Ford and Chrysler are at greatest risk.
If there is a lesson for organizations, one that has been underscored by this financial crisis, it is this: Group Think sacrifices critical analysis and conflict for immediate comfort.
