"Shared delusions" run deep with risks
Letter to the Editor

Ministr/Bigstock

Article Highlights

  • Assets that are perceived as safe become #risky and consequently cause crises

    Tweet This

  • Intelligent people rationalize asset expansion, but these are usually self-falsifying ideas #itsbeendone

    Tweet This

  • Emotional performances lead the #US into risky situations #sappy #debt

    Tweet This

Andrew Kahr's excellent discussion of how "Systemic Risk Is About Assets, Not Size" rightly focuses on bubble-inflating movements in the aggregate balance sheet of the financial sector. We should expand on three of his insightful points:

1. "When the industry as a whole gorges itself on a new class of assets," it is likely to be assets previously well behaved with attractive credit experience. As Richard Milne wrote recently in the Financial Times, "Risky assets do not cause crises. It is those perceived as being safe that do." Precisely because they are perceived as safe, they become risky.

Perceptions of uncertain future events like credit safety or credit risk are inherently subjective and highly influenced by the views of all the others who are doing what you are doing. That is why (in my paraphrase of a famous thought of J.M. Keynes) a prudent banker is one who goes broke when everybody else goes broke!

2. "Banks' shared delusions generate systemic risk"--yes indeed, but bankers are far from alone in sharing the delusions. The cognitive herding also includes regulators, consultants, central bankers, investment bankers, investment managers, entrepreneurs, brokers, accountants, academics, rating agencies, borrowers, speculators, and in a leading role, politicians. Plausible and clever rationalizations for why the systemic risk-generating asset expansion is a good idea are always produced by very intelligent people, going back at least to John Law in 1717, whose ideas turn out to be self-falsifying.

3. "A sappy emotional preference for promoting further European integration" led the march into the European sovereign debt debacle. Yes: and a sappy emotional preference for promoting housing led our own mass march into the debt quagmire. O Tempora, O Mores!

Alex Pollack is a resident fellow at AEI.

Also Visit
AEIdeas Blog The American Magazine
About the Author

 

Alex J.
Pollock

What's new on AEI

AEI Election Watch 2014: What will happen and why it matters
image A nation divided by marriage
image Teaching reform
image Socialist party pushing $20 minimum wage defends $13-an-hour job listing
AEI on Facebook
Events Calendar
  • 20
    MON
  • 21
    TUE
  • 22
    WED
  • 23
    THU
  • 24
    FRI
Monday, October 20, 2014 | 2:00 p.m. – 3:30 p.m.
Warfare beneath the waves: The undersea domain in Asia

We welcome you to join us for a panel discussion of the undersea military competition occurring in Asia and what it means for the United States and its allies.

Tuesday, October 21, 2014 | 8:30 a.m. – 10:00 a.m.
AEI Election Watch 2014: What will happen and why it matters

AEI’s Election Watch is back! Please join us for two sessions of the longest-running election program in Washington, DC. 

Event Registration is Closed
Wednesday, October 22, 2014 | 1:00 p.m. – 2:30 p.m.
What now for the Common Core?

We welcome you to join us at AEI for a discussion of what’s next for the Common Core.

Thursday, October 23, 2014 | 10:00 a.m. – 11:00 a.m.
Brazil’s presidential election: Real challenges, real choices

Please join AEI for a discussion examining each candidate’s platform and prospects for victory and the impact that a possible shift toward free-market policies in Brazil might have on South America as a whole.

No events scheduled this day.
No events scheduled this day.
No events scheduled this day.
No events scheduled this day.