Unintended Consequences

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If you want a better understanding of why unintended consequences occur the way they do, you might go back in time and revisit the causes of the economic meltdown of 2008 and its aftermath. Although this catastrophic event is now a decade old, it’s a sterling example of a place many now dwell in their concern about “how did we get where we are now?”

It is said that those who fail to understand history are destined to repeat it. I suggest that those who fail to understand the human condition are destined to make the kind of mistakes that generate unintended consequences. People greatly resent being let down by those in whom they place their trust. I’m not talking about governments. We know better. In this illustration, I’m referring to banks where most hard-working people believe their savings are safe. As humans, we need to put our faith in something – our religious beliefs usually being seen as the safest harbour.

Today we are again witnessing the rise of populism, a manipulative appeal to the concerns of ordinary people over the economic advantages and political privileges of elites. Resentment is the emotional fuel that drives populism. Without the fertile soil of fear, anxiety and loneliness that affect those who believe they no longer have a democratic voice, it has no foundation.

For average folks, who feel they’re suffering and who believe they have no power to act on their own behalf, populism provides a compelling and plausible narrative by channelling their pain and resentment onto others. When people are in misery, they want an enemy to hurt – someone to blame. And those who repeatedly deliver that sort of message, principally out of their own self-interest, become demagogues. They glide through our post-truth world, aided by the powerful yet sometimes insidious reach of social media, with a promise that we can control our lives. Delusion comforts when truth hurts.

Back to 2008. A month after Lehman Brothers plunged into bankruptcy in November that year, its website still contained the following message: “The effective management of risk is one of the core strengths that has made Lehman Brothers so successful.” That boast, so inspiring to those who wanted and needed to believe it, became its bitterly ironic epitaph. There was a time, when such statements were deemed to be true – not just for banks but also for many so-called leaders.

The economic chaos that followed these large, trusted institutions being brought to their knees, with taxpayers subsequently put on the hook to clean up the mess, obscured a fundamental cause of crisis: a lack of basic thinking skills. The architects of the American economy weren’t stupid. They just weren’t smart. They misunderstood paradox and, more than ever before, we live in a world full of paradoxes.

The paradox in this case was the banking industry’s strategy of avoiding excessive risk by dispersing it. This ended up exacerbating the very problem it was designed to prevent. People chose to ignore history. In 1982, savings and loans institutions were deregulated; the S&L crisis followed in 1986. In 1985, junk bonds were introduced; four years later, that market collapsed. The “Dot com economy” began in 1999. Great ideas but no profits. In 2000, the bubble burst. In 2004, adjustable-rate mortgages and home refinancing schemes were legalized and, in 2007, sub-prime borrowing was incentivized. A year later, the big banks collapsed. All very simple for intelligent people to comprehend, right? In retrospect, obviously not.

Why did so many seemingly smart leaders get it so wrong? Jamie Dimon, then CEO of J.P. Morgan Chase, one of America’s largest banks, said “What the hell were we thinking? These things were way too complicated!” Ken Griffen, CEO of the Citadel Insurance Group, noted that “What happened was not in my range of realistic scenarios.” And even Allan Greenspan, considered by many to be the architect of the nation’s economy observed: “I am in shocked disbelief.”

The cause of unforeseen and unintended consequences lies in the slippery slope. As in most cases, seemingly expert analysis gives rise to the presumption of certainty which then leads to greater complexity and, eventually, self-deception and delusion. Wall Street based its theories, promises and subsequent actions on what its complex algorithms projected about the risks of securities supporting sub-prime mortgages.

But these sophisticated models, incomprehensible to most and driven largely by greed, were sabotaged by basic cognitive fallacies – the kind that usually bedevil analytical thinkers. First, they were based primarily on data that confirmed the thesis, not on evidence that undermined it. Prime mortgages and sub-prime mortgages are two entirely different animals.

Furthermore, the gurus didn’t take into account that many borrowers were financing their payments with new loans. The borrowers’ debts were growing, not shrinking. Their intricate calculations didn’t reflect that observable fact. The assumptions were wrong. But the banks, hungry for short-term (quarterly) profits, continued to serve up even more complex dishes to willing buyers. And, with every new level of increasingly complicated asset mixes, came even greater dangers for investors.

How is this historic market meltdown relevant to the rise of populism we are witnessing today? In the U.S., the glue that holds a diverse population together is called The American Dream. Like most dreams, this notion is more myth than reality. African Americans and other visible minorities have never felt “American” in the way so many white Americans take for granted. History, as usual, provides unassailable evidence. While the U.S. has enjoyed much success as a melting pot, its failures – discrimination, injustice and inequality – stem from an unwillingness to understand the fundamentals of compromise, forgiveness and bi-partisan collaboration.

Thomas Homer-Dixon, a Canadian academic, said the following about the 2008 crash: “People came to believe in a set of mathematical tools to the exclusion of intuition and wisdom. … the mistake has been to assume that imponderable subjective phenomenon, like investment decisions and risk, can be entirely mathematized (i.e., explained by simple analytical constructs). They can’t.”

The problem with leadership today is misunderstanding the essence of the human condition – an inability to predict the future and a belief in our infallibility. This is hubris in the classical sense. People in positions of power fail to understand their responsibility. They come to believe they’re gods and that they alone can see truth. And when one believes that, it’s a short next step to building one layer of uncertainty and complexity upon another.

Who knows where populism will inevitably take us? We are hard-wired to deceive ourselves into thinking good things will happen. But unbridled power inevitably leads to self-delusion. This is where you cannot see that the problem is you. It’s called naive realism. And, in consequence, you resist all efforts of those (let’s call them advisors) who try to tell you otherwise. As a leader, you cannot help others get out of their predicament when you don’t know how to get out of your own.

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