The Situationist

Posts Tagged ‘financial crisis’

The Risky Situation of In-House Lawyers

Posted by The Situationist Staff on December 19, 2011

Donald Langevoort recently posted his worthwhile paper, “Getting (Too) Comfortable: In-House Lawyers, Enterprise Risk and the Financial Crisis” on SSRN.  Here’s the abstract.

In-house lawyers are under considerable pressure to “get comfortable” with the legality and legitimacy of client goals. This paper explores the psychological forces at work when inside lawyers confront such pressure by reference to the recent financial crisis, looking at problems arising from informational ambiguity, imperceptible change, and motivated inference. It also considers the pathways to power in-house, i.e., what kinds of cognitive styles are best suited to rise in highly competitive organizations such as financial services firms. The paper concludes with a research agenda for better understanding in-house lawyers, including exploration of the extent to which the diffusion of language and norms has reversed direction in recent years: that outside lawyers are taking cognitive and behavioral cues from the insiders, rather than establishing the standards and vocabulary for in-house lawyers.

Download the paper for free here.

Related Situationist posts:

Posted in Abstracts, Behavioral Economics, Law, Morality, Social Psychology | Tagged: , , , , , | Leave a Comment »

A Neuroscience Perspective on the Financial Crises

Posted by The Situationist Staff on October 28, 2011

Andrew Lo recently posted his paper “Fear, Greed, and Financial Crises: A Cognitive Neurosciences Perspective” on SSRN.  Here’s the abstract.

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Historical accounts of financial crises suggest that fear and greed are the common denominators of these disruptive events: periods of unchecked greed eventually lead to excessive leverage and unsustainable asset-price levels, and the inevitable collapse results in unbridled fear, which must subside before any recovery is possible. The cognitive neurosciences may provide some new insights into this boom/bust pattern through a deeper understanding of the dynamics of emotion and human behavior. In this chapter, I describe some recent research from the neurosciences literature on fear and reward learning, mirror neurons, theory of mind, and the link between emotion and rational behavior. By exploring the neuroscientific basis of cognition and behavior, we may be able to identify more fundamental drivers of financial crises, and improve our models and methods for dealing with them.

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Download the paper for free here.

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Posted in Abstracts, Behavioral Economics, Emotions, Neuroscience | Tagged: , , | Leave a Comment »

Laurie Santos on the Evolutionary Situation of Cognitive Biases

Posted by The Situationist Staff on August 25, 2010

From BigThink:

Dr. Laurie Santos is an Associate Professor of Psychology at Yale University. Her research provides an interface between evolutionary biology, developmental psychology, and cognitive neuroscience, exploring the evolutionary origins of the human mind by comparing the cognitive abilities of human and non-human primates. Her experiments focus on non-human primates (in captivity and in the field), incorporating methodologies from cognitive development, animal learning psychology, and cognitive neuroscience.

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From TedTalks:

Laurie Santos looks for the roots of human irrationality by watching the way our primate relatives make decisions. A clever series of experiments in “monkeynomics” shows that some of the silly choices we make, monkeys make too.

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For a sample of related Situationist posts, see Michael McCullough on the Situation of Revenge and Forgiveness,” New Study Looks at the Roots of Empathy,” “The Endowment Effect in Chimpanzees – Abstract,” “The Situation of Political Animals,” and “Monkey Fairness.”

Posted in Behavioral Economics, Evolutionary Psychology, Video | Tagged: , , , | 1 Comment »

The Illusion of Wall Street Reform

Posted by The Situationist Staff on October 6, 2008

The following op-ed was co-authored by Situationist contribtor Jon Hanson and a Situationist fellow. In crisis, beware illusion of reform” was published in the Providence Journal.

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IN CASE you missed it, global financial markets have been rocked by a series of unsettling events. The collapse of Lehman Brothers and the $700 billion government bailout package are only the latest in a string of shocks — a string that, if investors’ worst fears are realized, represents the beginning of a much more dramatic unraveling of the global financial fabric.

Seven years ago, American markets were in similar turmoil. Such companies as Enron were using “aggressive accounting,” “special-purpose entities” and other balance-sheet tricks to hide risks and represent themselves as healthier than they were.

The accounting scandals of the early 2000s and the reform that followed have much to teach us about our approach to the current crisis. Then, as now, the problem stemmed from convoluted financial instruments that few people could disentangle. Then, as now, corporate behemoths that had seemed invincible came crumbling down (Enron was the biggest bankruptcy in history until WorldCom, which was the biggest bankruptcy in history until Lehman Brothers).

Then, as now, virtually everyone agreed that a big part of the solution was to be found in some sort of additional regulation. Today, Barack Obama calls for “regulatory reform,” while John McCain (a long-term proponent of deregulation) has called for “comprehensive regulations that will apply the rules and enforce them to the full.”

It was that sort of regulatory impulse that, in Enron’s aftermath, gave us the Public Company Accounting Oversight Board and the Sarbanes-Oxley Act of 2002 (“SOX”), which President Bush called the most far-reaching overhaul of America’s business practices since the Great Depression.

Sure sounded promising. The latest bailouts and scandals will no doubt lead to similar reforms, some of which are already in the works. An important question, then, is what those reforms should be — a topic that will occupy many scholars, policymakers and commentators in the upcoming months.

Unfortunately, there is a good chance that those reforms will not have much long-term effect. The real risk is that we get the illusion of reform, not meaningful, substantive and lasting reform. Calls for change come loudly when a crisis rears its head. Inevitably, however, the fervor fades, as workaday duties, dentist appointments, American Idol and the pennant races distract the public and, in turn, policymakers.

While the rest of us turn to other matters, the regulated entities themselves will maintain a steady focus on one question: existing regulations and how to weaken them.

In the aftermath of Enron and WorldCom, corporations, to maintain their legitimacy, initially expressed outrage and wholeheartedly supported new regulations. Members of the Business Roundtable were “appalled, angered and, finally, alarmed” about the problem. President Bush was right, in their view, to berate the bad-apple business executives and to call for more rigorous regulatory standards for all. “We must and will be at the forefront of supporting these reforms,” the Roundtable concluded.

Riding the wave of that consensus, lawmakers took a series of steps, patted themselves on the back, and moved onto other matters, and we all assumed the problem was solved. With that, what had been implicit resistance turned to explicit pressure from the business community to minimize and undo the “reform.”

Consequently, the post-Enron reforms never lived up to the post-Enron rhetoric, and the regulatory teeth that Sarbanes-Oxley initially flashed have been blunted by pro-business revisions. Some provisions never made it into SOX, such as a requirement that lawyers report to the Securities and Exchange Commission if a company’s board failed to respond to warnings about misconduct.

Other provisions exist only on paper, such as Section 404’s “assessment of internal controls,” the compliance date for which has been repeatedly delayed (for nonaccelerated filers) and now stands at Dec. 15, 2009. The Committee on Capital Markets Regulation, with the blessing of Treasury Secretary Henry Paulson and in the name of “U.S. competitiveness,” has promoted several reforms that make it harder for companies to be sued and more difficult for the SEC and others to regulate.

The committee’s members include heavy hitters from the world of business and finance, including Thomas A. Russo, the vice chairman and chief legal officer of Lehman Brothers.

If history is any guide, the same sort of dynamic will unfold this time around. The reforms that we see will be largely procedural, not substantive — check this, sign that, certify here, jump a hoop there — and they will not fundamentally change the situation that produced this crisis. The reform will look sweeping, because it will be broad-based and ballyhooed as “tough.” Soon enough, the business elite will complain that, indeed, it is too tough. We will learn that small-business owners and entrepreneurs, not to mention Fortune 500 firms, are being tangled and tripped up in overregulation and needless compliance costs.

The mantra of “markets good, regulation bad” and the primacy of shareholders will return. Erstwhile concerns about third parties — such as the taxpayers who are bailing out companies — will gradually be eclipsed by claims that those very groups are the most harmed by the new regime. After all, these burdensome regulations go too far and “hurt American competitiveness,” “drive business, jobs and tax revenues overseas,” “increase costs for consumers,” and so forth.

Such is the “law of unintended consequences,” which apparently applies to only regulations and regulators, never markets.

The reform, which might look promising initially, will be rolled back, whittled away and watered down (corporate lobbyists are already positioning themselves to grab a piece of the $700 billion bailout).

That’s the thing about illusions: What appears to exist doesn’t. To address the financial crisis, regulatory reform is certainly needed. But no less important will be mechanisms for girding those regulations against the influence of the regulated. Beware the illusion of reform.

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For a related Situationist post, see “The Situation of Illusion.”

Posted in Deep Capture, Illusions, Law, Politics, Public Policy | Tagged: , , , , | 5 Comments »

Retroactive Liability for our Financial Woes

Posted by The Situationist Staff on September 27, 2008

In the following editorial, “Take the Banker’s Porsche” (published in The Seattle Post Inquirer), Situationist contributor Adam Benforado makes an interesting case for a tort-like response to our financial situation.

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With our eyes focused on the staggering price tag of the impending bailout, it is easy to overlook the fact that a significant number of people profited handsomely as they took actions that led to the latest global financial crisis. Over the past five years, much more than $100 billion of bonuses were paid out to the Wall Street elite (including $39 billion just last year). Multimillion-dollar homes in East Hampton were bought; Bentleys were purchased; Gucci handbags were scooped up by the handful; Warhols were hung.

Most of those luxury items will be kept. And, over the next decades you — the medical resident in Philadelphia, waitress in Reno and musician in Nashville — will be receiving the bill.

The story of the mortgage debacle is a complex and meandering tale, but the endgame math is just that simple. The harm has happened, someone has to pay and, because of our discomfort with retroactive statutes and regulations, the burden is going to land on taxpayers in general.

It does not have to be that way and it ought not to be that way. Those who were directly involved in the decision-making and profited from the deals that ultimately resulted in the economic collapse have been unjustly enriched. To satisfy the $700 billion hole the government will soon find itself in after buying up the private sector’s bad debt, we should first look to the tainted assets of those whose hearty bellows stoked the fire.

Perhaps the most famous piece of retroactive legislation, the Comprehensive Environmental Response, Compensation and Liability Act (popularly known as Superfund), reflects exactly this sense of fairness: Although dumping hazardous waste may not have been illegal at the time it occurred, those who created the waste — and profited from it — ought to be liable for the consequences of their actions.

Under the act, the government — and, thus, the people at large — is to pay response expenses only “where a liable party does not clean up, cannot be found or cannot pay the costs of cleanup.”

Those who reaped great benefits from the subprime mortgage market have left us with a toxic mess and it is upon their shoulders that the responsibility for market decontamination should fall first.

There are at least three reasons why retroactive liability is particularly justified in this context.

First, one of the main grounds for reluctance as to retroactivity is that new laws applied to old conduct tend to catch people unfairly by surprise. However, if we look at the situation here, a lot of the market players knew that what they were doing was risky: The writing had been on the wall for years that the housing and credit bubbles could not be sustained. Those involved were gambling that they could milk a little bit more from the system before things went sour. It was greed not naiveté that kept them at the teat.

Second, the “due notice” concern is only one type of relevant fairness consideration. A competing — and arguably more fundamental — concern is that those individuals who commit harms should have to pay to make things right and those that are comparatively innocent should not. In America, it’s “You break it; you bought it.”

Third, and most important, the complaint of unfair retroactivity is really a red herring because, in truth, the implicated bankers are in no different position than taxpayers as a whole in this regard. Actions were taken in the past that resulted in grave economic damage and now someone has to pay to repair the system. The choice is not between retroactivity and nonretroactivity; the choice is between potentially liable parties.

Are there significant legal, political and practical barriers to making financial insiders responsible for the mortgage crisis before taxpayers? Yes, but those challenges do not dilute the arguments made above.

The strength of this approach is not just that it would be fairer than the alternative, but also that it would act as a powerful deterrent to those who would be tempted to engage in similarly risky strategies in the future.

As any economist will tell you, a moral hazard problem exists when government bailouts occur: The key actors are not forced to internalize the costs of their harmful behavior. Putting investment bankers back where they started — and using their seized assets to treat the problem they engendered — would be a powerful warning to those looking to exploit financial markets in the future.

Posted in Law, Public Policy | Tagged: , , , , | 2 Comments »

 
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