the giant pool of money case analysis

The radio program draws an overall picture of the subprime mortgage crisis, how the subprime market was created, how the crisis happened, what were the result and its impact. (See appendix A – my summary of the case) The primary issues in this case are: why did the Wall Street bankers blindly trust that the risky mortgages were good assets to invest into? And why did everyone involved allow the whole thing to go this far? The Analysis

The Wall Street bankers ignored the fact that the mortgages were risky is mainly due to the confirmation bias, specifically, the Anchoring Heuristic. Bazerman and Moore’s (2009) defines the Anchoring Heuristic as “Individuals make estimates for values based upon an initial value (derived from past events, random assignment, or whatever information is available) and typically make insufficient adjustments from that anchor when establishing a final value”. It was exactly what Mike Francis did when he made the decision to invest in the mortgages-backed securities.

Facing the pressure to find new types of investment for the investors, he looked into the historical data of mortgages, and concluded that because the no income loans existed so far performed well, they would not have much risk in the future. His reasoning was flawed. The historical data set him the wrong perception and it anchored in his mind. Bazerman and Moore further argue that people tend to think that the subsequent information is in consistency with the preexisted anchor (Bazerman & Moore 2009). Therefore, Mike never went back to reevaluate his decision.

The reality is, according to Davidson (Blumberg & Davidson, 2008), the mortgage has much higher foreclosure rates than Mike’s impression and prediction. Another anchor was made by the credit rating agencies like Moody’s. They gave AAA rating to the risky mortgage-backed securities based on the incorrect data. The anchor was that the investors trusted their ratings, as they typically do. They did not reassess the corresponding data. What is worse, when an anchor is externally set, it leads to a biased search for information to be compatible with the anchor (Bazerman & Moore 2009),. urther reinforced both investors’ and bankers’ confidence on the housing market. The bankers paid attention to the increasing housing prices, but ignored the fact that the median household income stayed flat from 2000 to 2007. It was too late by the time a home cost nearly four times of an average family income and people started defaulting their payments did the bankers find out that the performance of those debts was extremely poor(Blumberg & Davidson, 2008).

If it were just Wall Street contributed to the problem, the crisis would not have gone thus far. The irrational escalation of commitment by multiple groups of people prior to the crisis put them into the irreversible situation, just like a train running without a break, it stops only when it crashes. Bazerman and Neale define (1992) irrational escalation of commitment as “people continue a previously selected course of action beyond what rational analysis would recommend”.

There are a few factors that made the crisis an irrational escalation of commitment. The first factor is that the competitive irrationality happened within the small banks which purchased the risky mortgages from brokers. Competitive irrationality occurs when two parties act in a clearly irrational manner in terms of the expected outcomes (Bazerman & Neale, 1992). Mike Garner and his bank were under pressure by their competitors: if they did not sell the risky mortgages, other bankers would take the deals, and they would lose.

Mike’s boss fought against the loosened guidelines, but he was refused just because that other banks were offering it. (Blumberg & Davidson, 2008) A similar competitive irrationality happened within the larger banks. Mike Francis said, “I wish we had never done it. Unfortunately we did it because everybody else was doing it”. Tonko Gast also commented “We were a little early in ’05 by not wanting to do those deals. And people were laughing at us”. Society reinforces people to appear consistent, and they don’t want to admit failure (Bazerman & Neale, 1992).

Therefore no one of them stopped trading the falsified loans until they had to pay for the cost when the crisis came. Just like the 20 dollars auction paradigm, “a bidder may feel that one more bid may get the other person to quit. If both bidders feel this way, the result can be catastrophic. ” (Bazerman & Neale, 1992). The Action From the analysis, the crisis arose from a series of biased or irrational individual and organizational behaviors. To avoid the catastrophic effect, each individual and organization must change their behaviors.

In terms of the anchoring bias, regularly revisit of the original decision based on the newly gathered data needs to be set up within the organization. Additionally, the decision maker should avoid the Confirmation Trap in which Bazerman and Moore (2009) argues that people tend to seek information that confirms their expectations and hypotheses. To recognize the bias, Mike Francis could have done more statistical analysis of the updated data against the old data. e. g. what would be the difference in the population ?

What is discrepancy of the median household income between the average household incomes of the country? These questions could have helped him on making the decision. It is not easy to prevent the irrational escalation, the competitive irrationality, as it is a systematic problem and the individuals couldn’t do much about it. However, to prevent it from happening, the authority or the investors should have hired some auditing agencies to observe the running of the giant pool of money, so that they at least can discover the early indications of the crisis.


•Blumberg, A. , & Davidson, A. (2008, May 9). The giant pool of money. This American Life radio program. Retrieved from http://tinyurl. com/MGMT409GiantPool •Bazerman, M. H. & Moore, D. A. (2009). Common biases. Chapter 2 of Judgment in Managerial Decision Making. New York: John Wiley & Sons. Read pages 14-33 and 36-41 (i. e. , skip bias 10). •Bazerman, M. H. & Neale, M. A. (1992). The irrational escalation of commitment. Chapter 2 of Negotiating Rationally. New York: Free Press.

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