September 22, 2008

One Hell of a Hangover: Wall Street’s Credit Crisis

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It’s no surprise that as the market continues to dramatically fall apart, the intense debate around underage drinking has resurfaced. At least, that’s what my organizational behavior professor said earlier this week. Citing many regulatory failures and lack of oversight, many see the crisis as a product of an over-eager and greedy Wall Street that got out of hand. Just like your buddy who doesn’t know his tolerance and when to quit, Wall Street just needed one more drink and he would be set….
Basically, the wealthier bankers in Wall Street engaged in high-risk finance ventures without care or concern for the dangers they were creating for themselves and for the American public. In a post on the New York Times’ blog “BITS”, writer Saul Hansel noted how Wall Street executives deliberately “chose to program their risk-management systems with overly optimistic assumptions and to feed them oversimplified data. This kept them from sounding the alarm early enough.”

Not keeping track of their bar tab, the people on Wall Street had a lack of regulatory oversight in the actual lending of sub-prime mortgages. Still, the bankers weren’t completely drunk on wealth. According to Hansel, there was some effort to ensure that bankers paid close attention to the risk models projected by the computers so that if the model saw trouble looming, bankers would take notice and back up their bets in case something went wrong.
As every good drunk (and investment banker) knows, though, to get around this system all you need to do is change what constitutes as drunk. In this case, the bankers set overly optimistic conditions so when they fed the risk models through the computers, there was no alarm even though the market was getting ever closer to falling apart into the chaos we saw this week.
In other words, Wall Street tried to drink more than it could actually handle, and thought that it had come up with the perfect way to hide the level of its problems. Wall Street, in essence, is just like that person at the bar who’s had ten shots of vodka and can barely stand while insisting to his friends that he can take one more.

In that clip, you can hear some people snickering in background, kind of like the way college kids do after finding out their friend can’t remember peeing on the coffee table the night before because he was so wasted. But it doesn’t seem right to treat financial chaos with the same attitude.

As I’ve mentioned, there are a lot of similarities between the issues of underage binge drinking and Wall Street’s chaos. Underage drinking is taboo, and like all things taboo, it becomes incredibly interesting as a result. The potential problems that come about from binge drinking are sensationalized and often dramatized to a point that they can seem improbable. Drinking is also inextricably tied to social life in college. That is to say, it’s very hard to have fun at a party where everyone is drinking and be sober.

These problems apply to Wall Street too. Being reckless with money is taboo (we’re often encouraged to be prudent and frugal but rarely are so). Events like the 1929 stock market crash are distant enough that they’ve taken on an feeling of being an improbably legend. And, money is vital in life. You can’t buy a house, a car or drinks, for that matter, without money. In order to deal with binge drinking and the debauchery that follows on campus, currently, 130 university presidents have signed the Amethyst Initiative, a measure calling on elected officials to openly debate the 21 year old drinking age. By signing this measure, the presidents have indicated that the laws and standards governing drinking should be scrutinized, realizing the current laws are not working. Some argue that the drinking age should be lowered, while others believe that more regulation needs to be put in place if the drinking age is lowered. At the other end are those that advocate the drinking age should actually be raised. What the financial collapse ultimately tells us is that it is worth looking at the current systems in place and whether they are achieving their desired goal. Who knows what will result in the next few years, but it’s certainly time to reopen the debate and consider if the policies we’ve set in motion, have put us in a place we want to be.