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:
- Warning signals would need to be clear and from credible sources.
- The phenomena under threat would need to be of significant importance for pre-emptive action to be considered.
- Relevant institutional frameworks would need to be effective in transmitting signals.
- The benefits of pre-emptive action would be greater that the costs of doing nothing.
- 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:
- 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.
- 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.
- 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.
- 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.
- 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.