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Research IssuesDecision Making: Patterns and Deviations in a Time of Financial Crisisby Joseph Gilbert, University of Nevada, Las VegasThe study of decision making often concentrates on individual decisions, and their antecedents and consequences. Students of decision making also pay attention to patterns. When we say that an executive has a history of making good decisions, we are talking about a pattern. An analyst who is seldom wrong in her recommendations also has a pattern of making correct decisions. A thoughtful decision maker has a history of not shooting from the hip; put differently, they have a pattern of carefully considered decisions. The only way to create a pattern of decision making is one decision at a time. In recent months, the governments of Greece, Spain, Ireland, and the United States have been accused of unsustainable patterns of financial decisions, with grave consequences. In his book about his experience as CEO of IBM in the 1990s, Louis Gerstner describes his dismay at finding unproductive and dysfunctional patterns of decision making by executives and managers (1). Jack Welch, in his autobiography, describes his own patterns of decision making (2). Dan Ariely, a widely read behavioral economist, discusses patterns of decision making that are shaped by hidden forces (3). Just as individuals create patterns of decision making through the accumulated effects of individual decisions, so also do organizations. Gerstner, in his book about his years as CEO of IBM, describes how the decision-making style or pattern that he found on his arrival was dysfunctional. Major decisions went through numerous reviews, and any one of the reviewers could "non-concur," or derail the decision. Where speed was necessary for competitive reasons, delay was built into the decision-making pattern. One of his major challenges in trying to improve IBM's performance was to change the pattern of decision making prevalent on his arrival. Once a pattern of decision making has been established by an individual or an organization, it becomes difficult to deviate from the pattern. During the recent financial crisis and in the years leading up to it, CEOs evidenced patterns of decision making that proved to be extremely harmful to their companies and to the economy. There have been numerous books published describing events and decisions at individual companies including Bear Stearns, Lehman Brothers, Merrill Lynch, Bank of America, and other major financial firms. Many of these books are by financial reporters who have covered the companies and the industry for years. While not academics, these reporters have in-depth knowledge of the industry, the companies, and the individuals that form the subject of their reporting. The just-released report of the Financial Crisis Inquiry Commission (4) confirms much of what is reported in these books. Academic articles on these events are so far largely absent, but this may be explained by the lead time involved in journal publishing. These books describe patterns of decision making by executives with long experience in charge of their companies. During the buildup to the financial crisis, decisions were made and repeated concerning products to be offered, pricing of these products, mechanisms for constructing the increasingly arcane financial instruments, and level of perceived risks to the buyers of these products and to the offering firms. Patterns of approval based on the success of existing products and on the actions of competing firms made the approval of new products almost automatic. Serious consideration of the risks of these products was largely eliminated from decision making. Risk managers at investment banks were given relatively low status, and in disputes between traders and risk managers, the decisions almost always favored the traders. A notable exception to this was Goldman Sachs, where risk management was given higher status and more serious consideration in decision making. Executives below the CEOs who urged caution and restraint in the volume and makeup of the more complex financial instruments were not taken seriously by the CEOs with final decision-making authority. In some cases executives urging caution were demoted, had their compensation reduced, and ultimately left their companies. The pattern of approving risky products in the face of warning signs persisted. Even after home sales in the United States began to fall, and foreclosures began to rise, a number of companies increased their sales of complex and risky products and kept parts of these investments on their own books. This was not purely from stubbornness or inattention, although both played a part. The risky products generated high profits and the accounting for these products was complex. In the case of Merrill Lynch, the CEO, Stan O'Neal, was unaware that his company had tens of billions of dollars of these instruments on its books until they began generating huge losses. Similar rigidity in decision-making patterns was shown by some government officials, both elected legislators and appointed regulators. As documented in the Financial Crisis Inquiry Commission report, federal regulators were warned repeatedly by state attorneys general and by respected consumer advocate spokespersons of abuses in mortgage lending and likely illegalities being committed by major lending institutions. Some regulators insisted that all was well due to some combination of sincere belief that this was the case, influence from financial industry lobbyists, and concerns to protect federal regulatory agencies from state intrusions. In many of these cases at several different decision points, the pattern of previous decisions was upheld. In matters concerning proposed changes in regulatory laws, elected legislators on several occasions chose to stick with previous decisions, continuing in previously established patterns of decision making. In a forthcoming article, I have documented how the CEOs of several companies in the last days before bankruptcy continued acting in standard ways, reaching out to both potential large investors and to government regulators, but to no effect (5). It was, as the article title suggests, as if they were vigorously pushing and pulling on levers that were no longer connected. This phenomenon was particularly exemplified at Bear Stearns in March 2008 just before the company went bankrupt and at Lehman Brothers in September 2008 before the same result ensued. In contrast, federal regulators dealing with the crisis had no template to follow. The only previous exemplar from which a decision-making pattern might emerge was the handling of the failure of Long Term Capital Management, a hedge fund that imploded in 1998. In that case, federal officials oversaw an agreement among major banks to establish a pool of funds sufficient to bail out the mortally wounded hedge fund. A similar approach was tried by the key federal officials in the weekend before the Bear Stearns bankruptcy, but the solution finally implemented was quite different, and was basically devised on the fly within less than 48 hours. J.P. Morgan purchased Bear Stearns for $2 a share (later revised to $10) after Bear Stearns failed as a going concern. This was made possible by the federal government's guarantee to cover up to $29 billion in losses after J.P. Morgan covered the first billion. Six months later, in the most cataclysmic weekend of the financial crisis, the federal officials convened the top bankers in the same pattern followed with Long Term Capital Management. This time, however, there was no federal appetite for a government bailout, no agreement among the bank executives, and Lehman was allowed to go bankrupt. This involved a variety of deviations from previous decision patterns. The bank executives who gathered and discussed the situation for much of the weekend did not provide a rescue fund. The federal regulators did not provide a bailout. Instead, Lehman Brothers was allowed to fail and declared bankruptcy early on the morning of September 15, 2008. On that same day, the sale of Merrill Lynch to Bank of America was announced. Within days, the federal government reversed course and provided tens of billions of dollars to AIG to prevent its failure, and the two remaining independent investment banks, Goldman Sachs and Morgan Stanley, both announced their intentions to become bank-holding companies. The fundamental deviations from previous decision-making patterns of the CEOs of the five large investment banks and of top government regulators were unprecedented. Within a six- month period, two of the five large investment banks declared bankruptcy, one was purchased outright and ceased to be an independent company, and the remaining two gave up their legal status as investment banks. These decisions, unthinkable a year earlier, were forced on the key executives by events that proved to be outside their control. Deviations from previous decision-making patterns by government officials, both regulators and legislators, were similarly unprecedented. Within a short span of time, government regulators changed from a no-bailout policy to providing $29 billion dollars to J.P. Morgan to fund the Bear Stearns purchase, back to a no-bailout policy with the failure of Lehman Brothers, to providing huge financial aid to AIG. Legislators at first rejected, then soon after accepted, the funding of the Troubled Asset Relief Program with $700 billion dollars in government money. These decisions have been the subject of on-going debate, with some legislators currently proposing to recapture funds approved in the TARP that have not already been spent. While debates about the proper role of government vis-a-vis private business have been carried out for many years in many countries, decisions by regulators and legislators were precipitated by events that required some form of action or inaction within a very short time frame. The consequences of decisions made and not made by executives, regulators, and legislators have been profound. With the advantage of hindsight, we can see that some decisions before the financial crisis hit caused it to be worse than it might otherwise have been. Some have argued that it was avoidable. The majority opinion in the Financial Crisis Inquiry Commission report takes this position. Others have argued that it was inevitable. Even those who argue for inevitability tend to admit that different decisions in the years leading up to the crisis might have mitigated some of its effects. Decisions made and implemented during the crisis carry similar impact to those made leading up to it. As academics who study decision making, these recent events present us with both an opportunity and an obligation. The opportunity comes in the form of unusually well-documented major decisions to study. The books and reports described above provide rich material for analysis. They are really extended case studies, containing more background and information about more variables than is typically found in descriptions of actual events. They provide us with a reality that is often missing from lab studies where students are asked to assume that they are CEOs. They provide us with an opportunity to compare and contrast decision making by industry executives and by government regulators and executives. Some of these decision makers are products of our own academic programs, and the available descriptions provide an opportunity to compare theories taught with ideas in practice. The recent events also provide us with an obligation. As experts on various aspects of decision making, we have some obligation to relate our theories and prescriptions to practitioners in the real world. Industry executives, regulators and legislators are among the most important decision makers in our society. To the extent that we, with our combined perspectives and expertise, can understand the decision-making patterns of those involved in this crisis and can communicate effectively how better decisions might be made, we will make a significant contribution to both knowledge and to the well-being of society. Endnotes 1. Gerstner, L. V., Jr. Who says elephants can't dance? New York: Harper Business, 2002. 2. Welch, J. Jack: straight from the gut. New York: Warner Publishing, 2001. 3. Ariely, D. Predictably irrational: the hidden forces that shape our decisions. New York: HarperCollins, 2008. 4. Financial Crisis Inquiry Commission. The financial crisis inquiry report: final report of the National Commission on the Causes of the Financial and Economic Crisis in the United States, Authorized Edition. New York: Public Affairs, 2011. 5. Gilbert, J. The levers are not connected: strategic management in the last days. Journal of Applied Business and Economics, in press.
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Ariely and other behavioral economists show how the way humans actually make decisions differs from the rational maximizing theory of neoclassical economics. This theory describes decision makers as utility maximizers -- individuals who know their preferences and, using costless and friction-free information, make choices on a strictly rational basis among known options in such a way that they maximize their personal utility. Herbert Simon showed many years ago that real humans making real decisions often do not follow the utility-maximizing model. He coined the term "satisfice" to describe what we actually do in many of our decision-making situations. We cast about for a similar problem that we have faced before, consider what solution we used then, and, as soon as we have a "close-enough" approximation, apply the same or a similar solution to our present situation. Ariely and others have developed Simon's insights and given them a more empirical base, but they too agree that many decisions and decision patterns deviate from the utility-maximizing model. 