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Piketty Digest #9: Two Worlds

Failures to Anticipate the Global Financial Crisis: Challenging the Argument that ‘They Should Have Seen it Coming’

by Allan McConnell on September 15, 2014

My colleague Andrew Hindmoor (University of Sheffield) and myself were fortunate to receive a grant from the Australian Research Council (DP 1093159) to research aspects of political behaviour in response to the Global Financial Crisis (GFC). Almost everywhere we looked there were accusations (accompanied by media feeding frenzies) that banks, regulators and politicians had been negligent in failing to see warning signs. It was as if warning lights had been flashing and alarm bells ringing, only for these to be somehow ignored. For us, this hindsight argument seemed exceptionally crude, personalised, as well as being at odds with much of social science research which addresses the importance of institutions, ideologies and power as well as (to varying degrees) the importance of perceptions and interpretations. We didn’t have a specific book, article, report or film to criticise (although we read and watched a lot). Instead we wanted our analysis to be more detached from the cut and thrust of post-crisis angst. We embarked, therefore, on a research journey which led to a publication in Political Studies (entitled ‘Why Didn’t They See it Coming? Warning Signs, Acceptable Risks and the Global Financial Crisis’), as well as receiving the Harrison Prize for the best article published in in the journal that year.  How do we approach our task?

As with all extraordinary threats, from missing aircraft to mass killings, if we look back into the past with knowledge that the story will end badly, we construct a narrative that leads to abysmal failure, originating in signals missed, evidence cast aside and so on. We wanted to minimise our hindsight bias and think of the pre-crisis context. More particularly, we felt that if the ‘they should have seen it coming’ argument were valid, five sets of conditions would need to exist for key individuals in the political and financial establishments to have ignored metaphorical warning signals and alarm bells. We drew on conceptual literature form a wide range of disciplines, including international relations, political psychology, public policy and organisational studies. Our conditions were that:

  1. Warning signals would need to be clear and from credible sources.
  2. The phenomena under threat would need to be of significant importance for pre-emptive action to be considered.
  3. Relevant institutional frameworks would need to be effective in transmitting signals.
  4. The benefits of pre-emptive action would be greater that the costs of doing nothing.
  5. Decision makers would need to have a pathological attitude when confronted with evidence of likely failure.

In a sense, therefore, those arguing with the benefit of hindsight, focused on the last of these conditions (the pathological decision maker), with no or little examination of the broader contextual factors that would need to exist. We looked principally at the US and the UK  (note: a subsequent paper by myself and Andrew Hindmoor address deeper empirical aspects of the UK in the pre-crisis period, forthcoming in Journal of Public Policy, entitled ‘Who Saw it Coming? The UK’s Great Financial Crisis’). We argued that none of the assumed conditions existed in any significant way. Extensive detail is provide in our  Political Studies article but in summary, we found in terms of the five conditions that:

  1. Financial signals and market in the period 2004 to (mid) 2007 were generally ‘positive’ and healthy, buoyed by stable capital reserves in banks, steady inflation and strong profits. Signals of risk were few and far between, often coming from risks managers whose role was regarded by some as that of a ‘professional pessimist’. ‘Signals’ were overwhelmingly positive rather than pointing to failure.
  2. The wars in Iraq and Afghanistan, as well as terrorism, were at the time perceived as the main societal threat, with any challenges to the financial system portrayed as the one of the implementation of regulatory rules (e.g. surrounding the exposure to derivatives and credit fault swaps) rather than risks of trading per se. The global financial system was not considered to be under threat.
  3. There was no cross-institutional joining up of ‘warning signs’, such as they were. Markets were considered generally to be self-regulating; central banks and the IMF were engaged in broad horizon scanning, and regulators and banks were involved in ‘light touch’ regulation. The fragmented institutional framework of global finance was not geared up in time to transmit clear warning signs.
  4. In a time of economic boom, any regulator seeking to curb banks’ attitude to risk would, as the Governor of the Bank of England, Mervyn King, argued retrospectively, have taken on a ‘massively difficult task’. High economic returns prohibited doing things differently.
  5. Assumptions about the self-correcting markets permeated all aspects of the financial system. Any evidence of market failure or excessive risk were considered not as evidence that something that was seriously wrong, but as a temporary phenomena that would stabilise in due course. Decision makers viewed evidence through the lens of market efficiency.

Overall, our argument did not point to failures to anticipate the GFC as principally one of incompetent or corrupt individuals in key positions across political, finance and regulatory systems (although of course we do no deny such possibilities). Instead, we concluded that if we want to understand why no-one anticipated and acted prior to the meltdown of 2007-8, then we should look principally to dominant ideological assumptions surrounding the efficiency of markets, which created systemic agenda biases that filtered out warning signs or interpreted them as acceptable risks. Our argument may not be as headline grabbing or blameworthy as ‘greedy bankers’ and ‘incompetent politicians’ but we consider it to be more plausible and rooted more realistically in the fabric of our societies.

Allan McConnell
Professor (Public Policy), Department of Government and International Relations, University of Sydney.
Leave a response
  • Jonathan Oates
    September 17, 2014 at 1:06 am

    Dear Professor,
    I reacted this morning to Prof Morton’s tweet advertising your blog post. I am against headlines and soundbites which might be taken (in haste) to mean nobody saw ‘it’ coming. This would not be true.

    My kneejerk response was to offer a couple of things I have read – surveys by Jamie Galbraith and Dirk Bezemer, looking for pre-crisis (sic) views that something was going to hit the fan. Now, having taken up Prof Morton’s suggestion of a comment here, I see you are not saying that nobody, anywhere, saw it coming. So, to get that out the way first, I would like to strenuously underline that the 2007/8 crisis WAS seen coming, and not just by perennial Cassandras, as I think JG termed them. For the most part, it was a small section of the academy, with a few exceptions. They were right though, for the right reasons. There are some inside and outside the academy that like people to think that it came out of the blue. Not so.

    In case I don’t get round to a more apt response, I’ll post this now so it is available to all.

    Best regards from the Old Country

  • Shahar Hameiri
    September 17, 2014 at 10:34 am

    Dear Allan,

    Thank you for the interesting piece. I agree with the previous comment by John Oates. I’d add to it though that it seems to me you’re bashing a straw man. Sure, the media ran this argument a lot, but the vast majority of informed observers already know the significance of power/ideology/institutions/etc at shaping perceptions of risk for example. Therefore I’m not sure they’d struggle to understand how come they didn’t ‘see it coming’.

    Thanks again,


  • Jonathan Oates
    September 17, 2014 at 10:19 pm

    My second bite. Brief I’m afraid, but hopefully more apposite.

    I understand your argument to be charges of incompetence or corruption on the part of bankers, regulators, and politicians only work if a number of conditions applied before the events of 2007/8.

    I’d agree that we are not talking about a number of ‘bad apples’, but groups of people.

    I disagree that therefore we can absolve people of charges of incompetence or corruption.

    For me, key bankers, regulators, and politicians were/are guilty of wilful blindness, or worse.

    I don’t think your conditions – if they held – absolve individuals or groups of individuals of wilful blindness.

    Second, I don’t think your conditions did obtain. Not all bankers were acting similarly; some were shorting assets they were recommending to clients. And, above all, in a regime of self-regulation and good corporate governance (officers of the company and the market would protect shareholders’ interests etc), C-level people were treating their risk managers – the officer charged within the corporate structure with monitoring the balance of risk etc – pretty shoddily.

    The post-crisis response does not exactly convey the impression of a Damascene conversion, though Martin Wolf and Adair Turner appear to have changed their minds somewhat.

    It reminds me more of this, which I feel summarises things pretty well :

    within market, the key officer of the corporation

  • Allan McConnell
    September 19, 2014 at 2:18 am

    Thanks for the feedback. Perhaps I can backtrack a bit to address the issue that ‘no one saw it coming’. Everyday in all societies, there are concerns of looming failure – impending housing crises, drugs crises, environmental crises etc. Academics, think tanks, employees of public and private organisations, media and many others routinely critique the status quo and warn that unless something is done to address vulnerabilities, we are headed for a ‘crisis’. So it’s a fair point to question the argument that ‘no-one’ saw it coming when critique and warning signs are a daily norm. In a sense, the almost mundane nature of routine warnings almost devalues them. In the article, when we say that ‘no-one saw it coming’, we were addressing the post-crisis concerns that somehow major, persistent and credible warning signs were ignored by those in positions of power and responsibility. In the end, we didn’t find any signs of any significance, partly because they weren’t there and partly there was the assumption that the stabilising power of markets and light touch regulation was filtering out and correcting any weakness in financial systems. We’re not saying that such assumptions are desirable or that (in)actions are blameworthy. We have attempted to steer clear of normative assumptions as much as we can, focusing instead on why political elites, regulators and financial systems seem to have been caught largely unawares.

  • John R Bell
    December 11, 2014 at 12:34 pm

    I managed to pull all my money out of investments that were at all risky back in 2007. I did so because I recognized that markets are not self-regulating in the way that should matter to Marxian economists in the contemporary era; that is to say, markets (especially financial markets) can not be counted on to self-regulate in such a way as to reliably support rather than to progressively undermine the reproduction of material/real/substantive economic life. The logic of capital does not have the capacity to reliably manage the use-value life of any and all societies in all historical periods. Only a certain range of use-values are amenable to reliable management by the largely autonomous or self-regulating capitalist market. Any economist who defends the capacity of the market to self regulate should also know what are the limits of that capacity would be in given use-value contexts unless of course the economists in question are guided by something akin to religious faith. If you are not guided by faith and you attend to how the kinds and levels of financial activity that prevail in the contemporary economy eventually and repeatedly destabilize not only financial markets but also material economic life, you will not be taken entirely by surprise though, of course, you will not be able to ascertain the precise day or moment when a crash may occur. The fact that neoclassical/neo-liberal economists could not see it coming indicates the bankruptcy of their thought and their negative contribution to economics, which now seems to have contaminated some heterodox economic thought. Pity.

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