Our Responsibility to Ask the Right Questions

In 2008, millions of Americans lost their jobs and homes in one of the most disastrous financial crises in global economic history. My family was directly affected by this. My mom lost her job at CountryWide as a Loan Processor. She was unable to find a job in the sector many years following. My parent’s retirement savings shrank. Lawns all around my block started sporting the “Foreclosed” sign at the same time that those floppy skater shoes started going out of fashion.

(I also joke that she helped cause the financial crisis because she worked at both CountryWide and Washington Mutual before they both tanked.)

In addition to my personal connection with the financial crises, I’ve also grown more interested in the topic of finance and economics through Nate Silver’s The Signal and the Noise. The crisis presents fascinating questions about markets and our behavior as humans and groups of humans.

What better way to investigate the crisis than through The Big Short? One of my favorite movies of 2015, The Big Short is a film about the 2008 financial crisis based off the book written by Michael Lewis (the same guy who wrote Moneyball). With a star-studded cast, fun cameos, and a comedic self-awareness, The Big Short details the origins of the financial crisis of 2008 and how a group of people made millions shorting (betting against) the market.

Although I could praise a lot about the movie, I think my favorite part of the movie is when (minor spoilers ahead) Steve Carrell and his group of analysts leave Wall Street’s cubicles and skyscrapers to check out if the housing market is actually a bubble.

Upon arriving in a Florida suburb undergoing rabid real estate development, Steve Carrell and his analysts encounter houses that look luxurious on the outside but are filled with tenants that have bad credit, low incomes, or no tenants at all. The big realization comes when one of the analysts meets a tenant in one of these giant homes. Here is the actual screenplay:

Danny (analyst) peers in a front window.

A sleepy man with a tattooed neck rubs his eyes.

“Oh. Hello. I’m surveying mortgage owners who are over 90 days delinquent. I’m looking for a… Harvey Humpsey?” Danny asks.

“You want my landlord’s dog?”

“Your landlord filled out his mortgage using his dog’s name?”

“I guess so. Hold up, has that asshole not been paying his mortgage? Cause I’m paying my rent.”

“He is 90 days late on his payments, yes.”

“Seriously, am I going to have to leave?” There’s fear in his eyes, the last thing Danny expected. A child now appears between the big man’s legs. “Cause my kid just got settled in the school.”

“Um. I don’t know. You should talk to your landlord. Sorry. Have a good day!”

When the analysts walk around the neighborhood, they meet this tatted up tenant, see empty homes, and talk to shady businessmen that authorized loans without checking basics such as FICO scores and client incomes. What I realized was that they would have had a much harder time realizing this had they not stepped outside their Wall Street cubicles and looked at what was actually occurring in the market.

What do I mean by “actually occurring”? In the early 2000s, a bunch of mortgages were bundled together into what is called a Collateralized Debt Obligation (CDO) that were being sold to investors. When a bunch of mortgages are bundled together like that, it’s easy to lose track of what is being sold. Throw in some financial jargon like CDO and it becomes even easier to treat these assets as financial abstractions instead of what they are: mortgages that are paid off by people like you and me. So while investors on Wall Street were excited about the rising value of CDOs, most were not privy to what was actually occurring outside their financial abstractions. People weren’t paying back their mortgages because either they had, for instance, bad credit histories or poor incomes. Such little regulation meant that some could get mortgages by signing their dog’s name. (Whether this actually happened I’m not sure but it was hilarious in the movie and, based upon other outrageous facts about the housing bubble, not that far-fetched.) By the time the mortgage defaults started occurring, it was too late. The market realized its own demise before most of Wall Street could.

When I think of 2008, the heuristic “If it’s too good to be true, then it probably is” comes to mind. Like most heuristics, there are problems with this one. The one problem with this heuristic is that we as humans want to believe with every fiber of our being that it isn’t true. We want to believe that things are good, even too good, because our well-being depends on it. Wall Street investors aren’t entirely to blame for the crisis. The way their incentives work forced their hand, to some degree, into a herd mentality. They were “just doing their job”. At it’s best, ignoring this heuristic can be called “optimism” or “hope”. At it’s worst, it can be called “ignorance” or “overconfidence”.

So while Wall Street investors were excited about the rising value of CDOs, most were not privy to what was actually occurring outside their financial abstractions.

How do we avoid overconfidence? How do we avoid ignorance? Some might say it’s to find the right answers, to organize the data in the right way, to solve the problems right. But that’s what Wall Street investors were doing all day. They were looking for cleverer ways to bundle together mortgages and sell them to unsuspecting buyers. But thousands of these problem solvers lost their jobs after a financial crash that was caused by their attempts to solve their problems. Judging a tree by its fruit, it doesn’t seem like finding the right answer is the right answer.

Every answer comes from a question, and every question comes from a set of assumptions. When Wall Street traders were bundling and selling these mortgages, they were trying to solve questions like “How can I boost my bank’s earnings this quarter?”, “How can I sell more CDOs?”, etc. But these questions assume that CDOs would continue to grow. And when everyone and their moms run off this assumption, it’s probably in anyone’s best interest to follow those assumptions.

What was critical about the housing bubble in 2008 was that almost nobody questioned the assumptions. What Steve Carrell and his analysts did in The Big Short when they visited those houses in Florida was they asked questions about the assumptions. In other words, they questioned the questions that they as Wall Street investors were being asked to solve.

When they did that, they got to the core of the housing market itself (houses and their tenants) as opposed to the abstractions layered on top (CDOs and mortgages). The little scene in Florida might have been a storytelling device to make the scenario more tangible for the audience. Be that as it may, it goes to show how we as people (bankers included) need the tangibility to help us realize what’s really going on under all the jargon.

When I watched The Big Short, I was reminded of our responsibility to ask questions and figure out the matter for ourselves, to examine the problems we are tasked to solve to make sure that they even are the right questions in the first place. Gone are the days where we don’t have enough data. We have so much data that we need to know what to do with it.

This is by no means novel or new. Socrates encouraged inquiry as a way of critical thinking and ideation. Jesus hid wisdom in parables to encourage the curious to ask questions. Nate Silver in his book The Signal and the Noise consistently hammers home the fact that more data often complicates the problems we are trying to solve, to the point where we become susceptible to mistaking noise as signal. Indeed, in this time where there is more data than we know what to do with it, it is imperative that we ask the right questions before we do anything with the data. But 2008 in one sense showed that we put our blind trust in institutions, that we embraced questions handed down to us for granted rather than thinking through the questions ourselves. Somewhat paradoxically, being more skeptical about the questions we ask will help us answer the right questions in the long run. And in the worst case, it’s better that we are uncertain and wrong than certain (and thus convince others in our certainty) and wrong.

The latter is what happened in the years leading up to the financial crash in 2008. Wall Street was certain that mortgages could never fail, that they were safe, that they were like alchemists thinking they could turn shit into gold. But it turns out shit is still shit, now matter how hard anyone tries to put wrapping paper and a bow around it.

All it took was for a group of people to stop wrapping shit and ask about what they were even wrapping in the first place. The moment they started doing that, the big short was all but inevitable.

-K