Who is responsible for the subprime credit mess?

We are seeing another bank write-down by UBS totaling  $10 billion. Bank of America is liquidating a $12 billion enhanced cash fund which broke the buck and will pay-out less than 100 cents on the dollar. This fund saw outflows of over $20 billion in the last two months. This is not a money fund, but probably was marketed as a close substitute for a money fund to institutions with a little more credit and interest rate risk.

We have seen Wall Street chief executive lose their jobs, but most of those executive probably believe that they were not to blame for this crisis. It was the market. It was the greed of others. It certainly was not the manager who pushed for higher yield or greater earnings. So who is to blame? I am not writing to assign blame but suggest that the market managers do not have the ability to be self-reflective. They are not able to comment on what their responsibility for this mess should be because most managers do not have the ability to deal with mistakes.

A new book places a number of these issues in perspective, Mistakes were Made (but not by me): Why We Justify Foolish Beliefs, Bad Decisions, and Hurtful Acts by Carl Tarvis and Elliot Aronson. Their premise is that most of us deal inappropriately with cognitive dissonance, the state of tension that occurs whenever a person holds two cognitions that are psychologically inconsistent. How can you believe you are a good manager if you have to recognize that you were pushing bad credit products to drive profits higher? How could you sell product that you know has a high probability of default. You have to justify this by saying that the investor or the borrower are sophisticated or adults and can understand the consequences of their action. You justify your actions by believing this time is different. You cannot hold yourself responsibility for the action of others even though you may be fully aware of the impact of your activities and the actions of others.

Bubbles are based on the suspension of belief on what is normal. Home prices can go up even with income not growing because the market itself has changed and the old laws of supply and demand do not hold. Those who would suggest otherwise have to be foolish and unaware of the new dynamics.

The only solution is the requirement for constant self-reflection and the simple view that if something is too good to be true it is false. For those who engaged in reflection we praise you. For the rest of the market participants, we ask that you take stock before this problem occurs again.