Oh how soon we forget…

The specially appointed Financial Crisis Inquiry Commission released their report yesterday and despite the importance of unraveling what really went wrong, the WSJ covers it only on page 4! Now of course, the economy is picking up steam and the stock markets are back above the levels of late 2008 … so maybe we can just forget the whole thing ever happened and…. but of course, almost all of us know where that leads… particularly in the era of QE2.

Phil Angelides, the chairman, says “The crisis was the result of human action and inaction, not of Mother Nature or computer models gone haywire“. Well yes of course, human decisions by definition must be at the heart of the matter. The question remaining however is what can be done to educate and induce better decisions – particularly in risk management – in the future.

Lots of talk right now focuses on behavioral economics – or the research that really tracks our choices. The idea that we make “rational” decisions obviously isn’t the real model of the human. What lacks however in the whole field of behavioral finance is the “why”. Generally the answer given is that we didn’t think hard enough but that just can’t be true. We thought as hard as we are capable – at least under the current model.

We are taught from early on to use logic, reason and by extension – math. But numbers look you in the eye and lie.

This strategy also doesn’t take into account what is becoming more clear every day – we make all of our decisions within a context of feelings. I call it the all-important “fC”. Those feelings – or these “fCees” (what is going to be the plural of that anyway?) – include our pre-existing beliefs, our confidence, our assumptions and our fears. Certain fears for example have been proven to be more motivating – the fear of missing out for one.

Understanding the financial crisis requires rethinking thinking itself. It requires understanding what an over-arching role feelings and emotions play in decisions about uncertainties in the future. This is what we are finding the brain does. It isn’t an argument I am making. It is how our brains fill in the blanks when not all the information we need is known. It is what our brain does when we are contemplating how things will play out in the future.

We need a revolution in our own conscious minds that makes us see ourselves as we are once and for all. We need to admit that how we feel makes all the difference in the world to what we do or decide.

This is the qualitative side of risk management. It is the missing piece that if employed by enough people, would prevent another crisis.