Thursday, July 31, 2008

Losing sight of human context

Most things begin benign. They aim to serve a good cause. Take subprime mortgage as example. Wall Street bankers looked at the rising price of real estate and figured that it isn’t going to come down any time soon. Their net interest margins (interest collected from borrowers minus paid on deposits by banks) were so narrow and the housing market was so frothy, banks began making high-interest loans to shaky borrowers. That’s how families with annual income of $50,000 got to own million $ homes. Fairytale stuff? You bet!

Sometimes, things aren't as bad as they seem. They're worse.

But, if nothing else, this saga shows the great blind spot that still haunts many western banks. Even some Asian banks fell for it. Financiers have invented so many brilliant mathematical tools to repackage risk that the industry has slipped, almost unthinkingly, into an assumption that “credit” is a collection of abstract equations, stripped from any human context. They became so dazzled with their powers that they have ignored how they interact with the rest of society – or how the tribal aspects of their own institutions can create dangerous traps.

Meanwhile, the cult of models has become so extreme that banks have believed them even when this collides with common sense and popular social constructs like the real meaning of `credit’ - a synonym for worthiness, not wishful assumption. And bankers forget this human dimension to their cost – no matter how impressive the abstract numbers might seem.

Losing sight of human context always results in agony. Earlier we had empire building ambitions of monarchs and dictators that fueled wars and catastrophes. Now economic institutions take turn to wreak havoc. The common factor is human suffering, entirely avoidable.

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