Arrogant people believe what they say

I’m repeating someone else’s idea (again), but I can’t remember who said it, when or where. But it is a good idea so stick with me.

I happen to think the Moral Hazard story of the financial crisis has some serious holes in it. The story goes that banks that were too big to fail knew they were and therefore the people working there took greater risks than were justified because they knew (or suspected) they would be saved by government.

Now a major problem with this story is that the financial services industry is full of arrogant pricks. They’re selected for overconfidence as Chris puts it. So when a person who…

  • graduates from an elite school and university,
  • is paid a fortune,
  • is told they are at the top of the economic pyramid daily,
  • reads the FT’s “How to Spend It”,
  • drinks Laurent-Perrier Rosé,
  • works for one of the most powerful firms in the world,

…offers you a collateralised debt obligation (a AAA rated senior tranche of subprime mortgages, for example) and they tell you it is a fantastic product that will make you money, that person believes it is a fantastic product that will make you money.

I don’t believe that the thought their super-clever financial innovations would decline in value catastrophically (and that failure would be highly correlated with everyone else’s super-clever financial innovation’s decline in value) crossed many of these people’s minds.

Certainly not in the way much of the discussion of Moral Hazard hinges on. These people were clearly reckless, but a lot of them didn’t think they were they thought they were financial whizz kids because that is what they trained as, lived as and were treated as.