I saw an interview on the Daily Show recently where the guest claimed that leading up to the recent credit crisis, people on Wall Street “fooled themselves”. While this may be true, I think the dominant driver was the self-interest of people at the expense of their companies.
To illustrate what I mean, imagine that you play a game each day on your company’s behalf where you toss 4 dice and your company collects a million dollars if they don’t come up all 1s. If they do come up all 1s, your company must pay $5 billion.
The expected payoff of each roll is a $2.86 million loss, a terrible deal for the company. But, what happens if you play anyway? For a few years you make a million dollars for your company each day. All this apparent profit seems wonderful. The company pays you, your colleagues, and management big fat bonuses for generating so much “profit”.
This continues until the fateful day when the worst happens and the company goes bust having to come up with $5 billion. From your point of view, though, this has been wonderful. You’ve collected a lifetime of income in bonuses in a few years and can retire comfortably.
People on Wall Street were blinded to the risks their companies were taking on, but this blindness may have less to do with ignorance than it had to do with greed.