Giant Pool of Money

(1) Confirmation Heuristic

Confirmation heuristic is a tendency to interpret information in a way that confirms one’s preconceptions, find evidence that supports his/her preference, and discount evidence that does not.

Here, confirmation heuristic caused Wall Street people, bankers, brokers, investors, and even borrowers to make bad decisions due to their overconfidence and inability to see the big picture, contributing to the subprime mortgage crisis.

Confirmation Trap

People naturally tend to seek information that confirms their expectation and hypotheses, even when disconfirming information is more useful. They search for information selectively to enable them to come to conclusion they desire to reach. (Bazerman & Moore, 2009).

Since Mike Francis, Mike Garner, and Glen Pizzolorusso benefited from charging large commissions and the demand for high-risk securities such as CDOs was high, they wanted CDOs to work and ignored how risky CDOs were. In fact, Glen Pizzolorusso knew that the borrowers could not really pay for the loans but disregarded the fact anyway.

Conversely, Mike Francis accepted the self-serving data from an analytic software uncritically because it was consistent with his goal (commissions). Because they were making money, everyone in the mortgage-backed security chain relied on the wrong data from the credit rating agencies without scrutiny.

On the other end, Clarence Nathan knew that he could not afford the loan (“I wouldn't have loaned me the money. Nobody that I know would have loaned me the money.”), but rejected the fact and took the loan anyway because he needed the money. (Blumberg & Davidson, 2008)

Anchoring

Here, the credit rating agencies made estimates for the worst-case scenario of the foreclosure rate to be 8-12%, based upon the 2% foreclosure rate of history of mortgages. The assessment of risk was wrong because the historical data—the anchor—was irrelevant. There were several new kinds of mortgages given out to...