Decision Making Analysis

Decision Making Analysis

Situational Factors:

• Potential for a big gain

• Low Fed Funds rate 1% vs low-risk high-return 5-9% mortgages investment

• Certainty delusion

• All the data reviewed on loans, years ago, was positive and performed very well.

Psychological Factors:

• Confirmation bias

• Housing prices were rising, fast. The faith in US housing prices never go down.
• Even if the worst happens and someone defaults, the bank would then own the house which is now worth even more than when they gave out the loan.

• Psychological attachment to others decision

• Once one investment bank bought the loan, all the rest of them follow suit.

Social Factors:

• External-justification- need to maintain reputation and show off in a fancy luxury life.

• Glen Pizzolorusso didn't worry about if the loans were good but he’s luxury life

• Peers willingness:

• Mike Garner’s staff complained of some loans they were not allowed to offer.

Organizational Factors:

• Pressure to meet the market needs

• The Wall Street is under pressure to loosen the guidelines to find more people to take out mortgages, lending to people who never would’ve qualified before.

• The CDO faced the pressures to loosen standards, to make CDOs out of lower and lower rated pools.

Decision Heuristics - Anchoring & Adjusting on “foreclosure rates remain fairly low”

Wall Street forecast the foreclosure rates based the number on past year’s data – as the anchor point. They figured absolute worst-case scenario based on the historical foreclosure rate is generally below 2%. Taking this as anchor points, they estimated a foreclosure rate of 8% or 10% or even 12%. But the historical data was irrelevant and meaningless. All these new kinds of mortgages were given out to people who never would have gotten them before. Some mortgage pools today are expected to go beyond 50% foreclosure rates.

Decision Heuristics – Confirmation Bias on “housing prices would continue to rise”

Wall Street see what they expect to see. “From 2003 to 2006, due to the easy getting home loans, the increased demand for houses caused the prices to increase. And the rising prices created even more demand, as people started to look at homes as investments, investments that never went down in value. “

All weights are given to continue rising housing prices from past data. Too little weights given to the reasons of the increase and doubts on the incomplete data. For example, the median household income stayed flat from 2000-2007. How would those people pay back the loan?