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Overconfidence caused the crash, author argues

By   /   Friday, March 12th, 2010  /   Comments Off on Overconfidence caused the crash, author argues

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The global financial crisis was caused by the overconfidence of experts in the field, according to author and journalist Malcolm Gladwell.

Speaking at the Arlington Theater in Santa Barbara on March 10, Gladwell said people often attribute mistakes to incompetence but that the financial crisis was actually caused by expert failure.

“As our world gets more and more complex, and as our lives are more and more controlled by groups of highly specialized experts, the problem of expert failure is going to become more and more significant,” he said.

Gladwell is a staff writer for The New Yorker and was named one of Time Magazine’s 100 most influential people in 2005. He is also the author of multiple best-selling books, including “Blink,” “The Tipping Point,” “What the Dog Saw” and “Outliers.”

Gladwell compared the financial crisis to the Battle of Chancellorsville, a famous Civil War battle. Union General Joseph Hooker’s new military intelligence strategy led him to believe that he knew the Confederate army better even than Robert E. Lee. Hooker’s defeat, which occurred despite “perfect information,” happened because of overconfidence — an attribute which is actually a form of “miscalibration,” Gladwell said.

Gladwell also discussed a 1965 study in which researchers examined the confidence level of doctors when it comes to patient diagnoses. The doctors’ confidence levels grew as the research process was repeated and they were given more information, although their actual rate of correct diagnoses remained the same.

The 2008 collapse of investment bank Bear Stearns occurred under similar circumstances, Gladwell said. Then-CEO Jimmy Cayne — who was at one time “the smartest and savviest man on Wall Street,” according to Gladwell — spent his weekends golfing in the lead-up to the collapse. On the day the investment giant folded, Cayne was absent at a no-cell phone bridge tournament where no one was able to reach him. And when the Federal Reserve Bank of New York refused to give the 28-day loan of $25 million to Bear Stearns, Cayne was furious that someone as insignificant as then-New York Fed President Tim Geithner thought he could decide the company’s fate.

“You know who the Bear Stearns was in 1929? Goldman Sachs,” Gladwell said. Goldman Sachs banker Waddill Catchings had leveraged every dollar that the bank owned into a hedge fund, ignoring warnings leading up to the Black Tuesday crash. The bank was almost wiped out and did not turn a profit again until 1949.

“Waddill Catchings and Jimmy Cayne were just like, in that moment, fighting Joe Hooker,” Gladwell said. “They were miscalibrated. They were blinded by their overconfidence. The world around them had changed and they couldn’t see it.”

“Incompetent people make lots and lots of errors … they are relatively trivial” Gladwell continued. “People who are overconfident are experts; when experts make mistakes, those mistakes are consequential.”

Gladwell prescribes feedback, common sense and modesty as the cures for such overconfidence.

Warren Buffet’s folksy wisdom helps keep him humble and rooted to his common sense Nebraska upbringing, the author said. “In times of trouble we think that what we need from our experts is the benefit of their expertise, and its not. What we need from our experts is their humility.”

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