Out of Control Policy Blog

Luck in Capitalism

Jenkins has an interesting piece in the WSJ today on the cultural judgment of finance experts when things go wrong:

Take a typical media indictment of BofA's Mr. Lewis, flayed because he "overpaid for an asset [Merrill] he could have had for much less had he just waited a few extra days." Good grief. If failing accurately to forecast securities prices is evidence of incompetence, why stop at Mr. Lewis? Anyone who didn't buy Google at $85 must be incompetent too (although, thanks to another kind of cognitive bias, they get a pass from the hindsight fallacy).

The Bear Stearns execs, Matthew Tannin and Ralph Cioffi, ran two subprime funds that depended heavily on leverage (i.e., borrowing) to make the rate of return expected by their high-rolling investors. Thus the funds were perfectly positioned to hit the skids at the very start of the subprime crisis, before its full dimensions were suspected.

I agree with him on the Ken Lewis point. But the Tannin and Cioffi trial is about more than just making the wrong bet. Its an issue of honesty with investors. Tannin and Cioffi are on trial for misleading investors, for not giving the whole story when they knew it, for pulling their own money out of troubled funds they were try to sell to others without being honest about that. A bit more sticky is if they were honest in saying the funds were AAA when, in reality, the underlying assets were not. The fund got a rating agency seal of approval because they were selling the AAA pieces of a package of crap loans, but it really wasn't the highest of safety out there. It'll be interesting to see if this issue gets addressed in the rule, largely one of fiduciary and ethical responsibility.

Anthony Randazzo is Director of Economic Research

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