In a briefing with his top economic staff at the height of the subprime crisis, U.S. President George W. Bush suddenly asked in amazement: "How did we get here?"
Hindsight bias
Anybody intend on answering a knotty question about the past must pause and swear allegiance to the ideal of intellectual honesty and humility. Whenever we look back at events and try to trace their antecedents, we have to beware of hindsight bias.
Those who simply fool themselves and others by claiming they predicted the subprime crisis in the U.S. and ensuing global economic downturn are legion.
Further, given a sufficiently large sample of diverse opinions, chances are high that somebody's prophesy will be fulfilled just by chance.
Besides, a watch that has come to a standstill is correct 14 times per week! Some pundits simply kept making the same prediction for decades, eventually were right and then posed as valedictorians in the class of augurs. They rejoiced in making what possibly amounts to the least helpful remark on earth: "I told you so!"
The gambler's dilemma
I like to acquaint those who lament that movers and shakers in politics and business clearly went too far with what I call the "gambler's dilemma": You only know the limit when you have reached it! If you have never missed a flight, you have always arrived too early at the airport and thus wasted your time!
During the gestation of the subprime crisis, there were many signs of a classic bubble in financial markets of sorts. Examples included inflated P/E ratios and high financial leverage facilitated by hazardous lending practices. The very label "subprime" singled out mortgages extended to customers with weaker earning power than prime borrowers.
The U.S. is an open society that provides people with incentives to meticulously analyze economic performance. After all, you legitimately can make money when you gain legal access to valuable information that is not shared by other market participants. Therefore, it does not come to a surprise that the storm clouds were observed by a veritable army of qualified governmental and corporate analysts, who discussed them at length in varied forums.
Rulers were drowning in the flood of information. It was difficult for them to interpret all data points and determine how to act as a result. The predicament was similar to the baffling challenge that security officials are facing. Those are constantly receiving myriad warnings about imminent attacks from secret agents and other informers. The vast majority of predictions turn out to be wrong though, which can numb the guardians' senses.
Elusive action anchors
Alas, the high and mighty were stymied by the lack of economic litmus tests. When exactly can asset prices be judged "unsustainably high"? What is the threshold for leverage to become "unhealthy"? The correct response, "it depends", disenchants those who look for clear-cut answers. He who pulls the strings finds the absence of anchors and trigger points, which can guide action, extremely disconcerting. Without full knowledge and a playbook, many men of action rely on gut feeling, count on their experience and follow others.
Prior to the crisis, most experts concluded that despite the alarming indicators, developments in financial markets were still sustainable and therefore did not advocate dramatic remedial action. In the aftermath of the turmoil, the Bank of England's deputy governor, Sir John Gieve, admitted that his venerable institution had been aware of the borrowing spree and asset price inflation but had underestimated the seriousness of the predicament.
Governments in affected countries would have needed to demonstrate strong strategic leadership, adopting a long-term perspective and rising above powerful special interests. But such behavior is improbable in a democratic system, in which political leaders are swayed by election cycles. Public-choice democrats are eager to maximize votes in the same way that businessmen want to make profits as large as possible. Few politicos try to change even a precarious status quo as long as it still appears acceptable and enables them to stay in power. They instinctively grasp the oftentimes misleading, lopsided mental habit of many people to judge sins of omissions less harshly than sins of commission.
Thus, even after problems with subprime-linked securities had become manifest, political leaders elected to remain passive up until the crisis intensified dramatically. They knew their citizens well: Had leaders tried to engineer a soft landing, pricking the bubble during a period of rapid economic growth, many people would have criticized them for marring the bonanza.
Bismarck as exemplar
It is a sign of outstanding leadership to know when and how to stop. Great helmsmen cease moving when they have achieved significant results but there are still options to go further. They do not wait for an inflection point after which everything collapses, but muster the courage to say "no" in time. Thus, these guiding spirits, many of whom gain tremendous respect during their lifetime, frequently manage to secure impressive gains for future generations. In contrast, those who overrun, often because they are nihilists at heart, regularly destroy themselves and their empires.
Prussian statesman Otto von Bismarck evinced the power of realpolitik, which prioritizes tangible outcomes over ideals. He pursued clearly circumscribed policy aims and created a mighty German empire as a result. After Prussia's resounding victory in the Austro-Prussian War in 1866, he opted for a "small solution" to the question of German boundaries. He chose not to incorporate the defeated Austrian Empire into the Second Reich that he created in 1871. In contrast, driven by his unbridled and insatiable lust for power and expansion, French Emperor Napoleon I ordered his army to invade Russia in 1812 and failed dismally.
Fatal urge for closure
Alas, "stop" seems to be the hardest word for many leaders. Indecisive executives and perennially dissatisfied perfectionists, especially those who pursue utopias, are particularly prone to overstretch. According to my analysis, the pernicious habit of going too far results from a toxic mix of visceral and intellectual ingredients. One reason for leadership extremism is impulsiveness; compulsion provides propulsion.
Another cause is a fatal urge for completeness, closure and certitude. It engenders a destructive curiosity about what fate actually has in store for you. If you push to the limit and reach it, at least you can be certain that you did not miss the opportunity to move further! If you stop before you hit the wall, you might regret your whole life that you did not try at least and that you may not have fully exploited your potential. Some people intentionally overshoot, so that if they subsequently lose their "buffer gains", they still will have reached their target!
Finally, there are those who simply get stuck in a rut and thus continue on a path that they or others have chosen.
It is a monumental error to assume that doing more of what you think caused your success necessarily will bring about further triumphs. Catastrophes like the subprime crisis will occur again as long as humans have not learned to stop before it is too late.
"Prof. Kai on Strategic Leadership" Column Number 16. Kai-Alexander Schlevogt (D.Phil. Oxford) is a professor of strategy and leadership at the National University of Singapore (NUS) Business School and author of The Art of Chinese Management (Oxford University Press). Email: schlevogt@schlevogt.com; website: www.schlevogt.com
