Chapter 5: The New Millennium’s First Global Financial Crisis: The Neuroeconomics of Greed, Self-interest, Deception, False Trust, Overconfidence and Risk Perception
Donald T. Wargo, Norman A. Baglini and Katherine A. Nelson INTRODUCTION Politicians, professors and pundits will analyze and memorialize the causes of the new millennium’s first global financial crisis for years to come. One of the most discussed topics will be the alleged ‘irrational’ behavior of ‘sophisticated investors’ (Zweig, 2007). To what extent did behavior that is inconsistent with the basic assumptions of investor rationality contribute to the crisis? This chapter hypothesizes that the originators of the collateralized debt obligations – investment banks, commercial banks and mortgage companies – acted with complete disregard to risks attached to these investment vehicles. Similarly, the purchasers of the collateralized debt obligations – banks, investment funds, municipalities and individuals – acted with disregard to risks attached to these bonds. The answer to why this happened cannot be found in economic or business textbooks. It was the result of overconfidence and the willingness to ignore risks. However, the authors contend that a neuroeconomic analysis of the reward and loss systems of human investors gives us deep insight into the decision failings of the human investors in this crisis. THE MILLENNIUM’S FIRST GLOBAL FINANCIAL CRISIS Financial markets around the world experienced profound losses in 2008 and early 2009 as a result of the worldwide credit crisis. The crisis was 78 The new millennium’s first global financial crisis 79 caused by the collapse of the markets for what were termed collateralized debt obligations (CDOs). These CDOs were bonds backed by mortgages on houses in the USA but the bonds were bought...
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