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From this article by Lisandro 'Leloy' Claudio, a Philippine/a Filipino professor of history, politics, South & Southeast Asian Studies (and not necessarily of finance, economics, mathematics or statistics)

a country can become a sad place if its most brilliant minds prioritize profit. In the 1990s and 2000s, most of the top graduates of the American Ivy League went to big Wall Street banks, and it was these geniuses who caused the financial crash of 2008. The world would have been better off if they had done something else.

Question 1: Was the financial crash of 2008 caused by top graduates of the American Ivy Leagues working at wall street banks?

Question 2 and context: Ok I'm gonna be explicit here to be clear at the cost of sounding, or even actually being, arrogant or ignorant. When I 1st read this like I was just about to start grad school in mathematical finance/quantitative finance. No offense or anything, but I actually kinda figured that the prof is not only wrong about this but has no idea what e is talking about. Does the quote make substantial sense?

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    Are you looking for "but for" causation or proximate cause or just what? It's impossible to imagine that there wasn't at least one Ivy League graduate involved in some small way in causing it, but how much more Ivy League involvement is needed? 10% 50% 90% 100%? It would help if you made it clear why you want to know. The quote sounds like pretty standard political criticism from the left and, like all partisan criticism, mixes relatively objective points with polemic.
    – Mark Olson
    Jul 27 at 15:56
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    Any thesis that posits a simple cause for a complex situation is flawed. Any thesis which is built on establishing a class of mustache twirling villains is flawed. People like simple solutions to complicated situations. Solutions are a bit more difficult than finding people to blame.
    – MCW
    Jul 27 at 15:57
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    Given the scale, the most important strategic decisions (i.e. where are we putting our money) would be done at board level. I can't imagine that too many of the graduates from the 90s and 2000s would have reached the boards of the major players by 2008.
    – Steve Bird
    Jul 27 at 15:59
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    Also, notably, "top graduates of the American Ivy Leagues" doesn't necessarily mean "most brilliant minds." Jul 27 at 17:28
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    Can we get a bit of a cleanup on this question? Its currently got what look to me to be 2 good answers (+ one from me). I'm inclined to think a lot of downvotes are because users think the quoted commentator was using a really bad argument, not because the question itself is a bad one. But if the question itself has problems, I'd like to see them fixed.
    – T.E.D.
    Jul 27 at 19:38
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The author was mixing up cause and effect.

The position that the 2008 crash was largely caused by the behavior of lending institutions is quite supportable. The lending bubble was pretty much indisputably the trigger for the crash. If not for the fortunate eventuality of the head of the Fed at the time having been the person who literally wrote the book on the crash of 1929, the results may well have been much more like the Great Depression than they ended up being.

Yes, it takes two to tango, and there were perhaps millions of individual borrowers out there happy to snap up that cheap credit lenders were offering. But borrowers are not necessarily expected to be financial experts, whereas lenders are. Its the lender's responsibility to verify that a rando off the street can pay off their loan, and that its properly secured in case they can't. Lenders were just flat out not doing their jobs.

Is it also a fact that many of these institutions were soaking up what one may consider the brightest young minds of that generation? That's much more debatable. However, there's certainly always going to be sharp young people who just want to train themselves to use their skills in whatever arena is currently hottest, and most likely to make them rich. In the early 2000's, lending was definitely where the action was. Was that a sign there was perhaps a problem there? Sure! Was it the cause? Probably more of an effect.

Its right to ask why lenders were suddenly acting that way. In fact, banks' bundling of loans into securities like they were doing had been explicitly made illegal in the wake of the 1929 crash, as it was deemed to have been one of the causes of the crash back then as well. It had just been re-legalized in 1999 and took all of 9 years to crash the economy again.

Now let's ask, "Why was this behavior relegalized, if it was known to cause financial crashes?" This was part of the general attitude of "deregulation" brought into government in the wake of the Reagan Revolution in 1980, where lawmakers of his particular school of thought fought to reprioritize business convenience a bit more over whatever public safety those regulations were there to protect.

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    @jamesqf - A bank that is restricted to lending has to make sure the underlying loans are sound, or they lose money. Its simple. A bank that can also bundle loans together into a security has an incentive to make as many loans as possible, so they can sell more securities. That's an incentive that works directly against making sure all the loans are good. Bad loans can be (and routinely were) hidden by throwing them in with the good loans, and then of course selling the bundle to someone else. So now there's nobody in the "bank" who cares if the loans are good.
    – T.E.D.
    Jul 28 at 13:23
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    That's ... a bit harsh. I'd rather say he's got some good points that he expressed badly. I suspect the intention was just to rag on the supposed superiority of the Ivies a bit by pointing out the mass stupidity they engaged in during the bubble, and that's probably a decent point. I don't think it was his intention to propose a deep explanation for the financial crisis, just a deep explanation of why he's skeptical of people with business degrees.
    – T.E.D.
    Jul 28 at 14:58
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    ...but in the general case, yeah you can't expect people to act contrary to their financial incentives (no matter where their degree is from). I don't have your Finance training, but my Econ101&102 courses were enough to learn that. Incentivizing crashing the economy, and then trying to put the inevitable result on greedy degrees (or on dumb greedy borrowers) misses the point. Hate the game, not the players.
    – T.E.D.
    Jul 28 at 15:15
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    Well, looking it over, it appears to have been intended as an impassioned defense of a traditional Liberal Arts education. Its OK for that (although I've seen better. Its quite well-trod territory, and some of the practitioners are really good writers). Whatever the author's specialty in History is, I'm sure they are great at that. But I certainly wouldn't take them as an expert outside that realm. Is it a "bad" economic history analysis? Well, yeah, in the same way that a hammer is a bad screwdriver, or John 1 is bad astrophysics.
    – T.E.D.
    Jul 28 at 15:26
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    He appears to specialize in Asian history, particularly of the Philipines. Jul 28 at 23:05
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During the crisis I worked in the team that was creating pricers for the complex derivatives in the bank where CDSs were invented.

2007-8 crisis has many reasons. The origin of it lies in easing the rules for lending in 1980s by a certain US president who wanted to win re-election. This enabled mortgage borrowing for so-called NINJA (no income, no job or assets) voters. At some point the real estate market got over-heated, making subprime mortgages a toxic asset, and then there was a domino effect.

Many parties are to blame for it. If you want a very careful detangling of all causes, to understand the role of politicians, regulators, rating agencies, banks obviously, and more, I recommend Andrew Lo's (MIT) "Adaptive markets", chapter 9 (ca. 30 pages).

CDS on a name is equivalent to a portfolio of 2 bonds: buying a CDS on a name is like buying this name's bond and selling a riskless bond. There were some technical problems with CDSs (before the crisis they were traded at par, so the CDSs on the same name could not be offset). After the crisis, financial industries has solved this by setting up a clearing system and by changing the was CDSs are traded (fixed spread instead of trading at par). I wish other parties who are to blame for this crisis were acting as swiftly and efficiently…

If you look a bit further down in history, for cultural reasons of the 2007–8 crisis, you might want to watch It's a Wonderful Life, a cult American Xmas movie (1946) that involves subprime lending and voluntary (!!!) bailing out of a banker by the general public. When one watches it in the context of 2007–8, it's jaw-dropping :)

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Fairly obviously not. The problems of 2008 were the consequence of a great many people (far more than the total number of Ivy League graduates), all acting in ways that they thought would be profitable. It was mostly not the actions themselves, but unforeseen interactions that led to problems.

Take for instance mortgage backed securities. The people who invented them thought they had a good idea: bundle a bunch of mortgages, and you reduce the risk of one defaulting: https://www.thebalance.com/role-of-derivatives-in-creating-mortgage-crisis-3970477

Mortgage companies thought this was a good idea: we can bundle up our mortgages and sell them to securities companies, thus allowing us to lend more mortgages. Since there weren't all that many people with good qualifications and 20% down payments out there, they had to relax the qualifications a bit. But that's no problem: one or two defaults in a bundle surely aren't going to be a problem: after all, that's why those bundled securities were invented in the first place. And so you got into a cycle where the end result was zero-doc, no down payment mortgages.

Potential homebuyers thought this was great: the economy's doing well, I can make the payments and get on the home appreciation ladder. More people buying houses increases the price, via supply & demand.

That's fine, as long as folks still have the good jobs they had when they took out the mortgage. The problem is what happens when the economy takes one of its periodic downturns, a bunch of people are out of jobs and can't make their mortgage payments. You have a bunch of foreclosed houses, house prices drop, people get scared because they're underwater on the house and panic sell, prices drop still further, those securities become so much worthless paper, companies that hold a lot of that paper (expecting regular dividends from them) no longer have that cash flow and perhaps go bankrupt...

So it wasn't the fault of any one person or small group, but of the large-scale interactions between groups, each acting in perfectly reasonable ways as seen within their smaller compass.

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    @BCLC Is your primary motivation here to determine the truth of the matter, or to prove that the professor is a bad person? Jul 27 at 19:50
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    @BCLC: IMHO he either has no idea what he's talking about, or he does know but is lying about it. Or perhaps at some level he's lying to himself, because observation conflicts with the way he'd prefer things to be. But I'm certainly no expert, and could perhaps be wrong.
    – jamesqf
    Jul 27 at 22:29
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    It reads to me like a flippant bit of political rhetoric. Political rhetoric always vastly oversimplifies to the point of being near pure bullshit. Jul 28 at 0:15
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    Questions intended to "promote or discredit a specific idea, theory, cause, group or person" are specifically off-topic here. Jul 28 at 19:46
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    I think this is a perfectly interesting question worth answers, but comments like this "do you agree that the prof has no idea what e is talking about?" are not going to be answered. (Or at least shouldn't be.) That's up to you to decide from the factual answers. :-P Jul 28 at 19:48
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What you referred to about "top graduates" was a "symptom," but not the underlying "disease."

The real problem was the "pedal to the medal," and "anything goes" mentality of the turn of the century. This was particularly true of the tech boom and bust, with financial products (e.g. "ninja" loans. So the Wall Street firms hired a disproportionate number of finance graduates, and the tech companies a disproportionate number of engineering graduates. A similar thing happened in the "roaring" 1920s, that ended with the 1929 crash.

I am the author of A Modern Approach to Graham and Dodd Investing, a book published in 2004 that predicted a "1929" type crash in "2004-2006," that happened in 2008.

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  • thanks Tom Au! actually to also ask another thing. do you agree that the prof has no idea what e is talking about?
    – BCLC
    Jul 27 at 17:36
  • 'What you referred to about ' --> shooting the messenger?
    – BCLC
    Jul 27 at 17:36
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    There were actually all kinds of people screaming about the lending bubble in the months leading up to the 2008 crash. I remember that vividly. However, nobody wanted to listen while there was all that seemingly free cash floating around (remember that vividly too). Voting this up, because IMHO people who were publicly right despite the Emperor's New Clothes vibe going around deserve to be listened to.
    – T.E.D.
    Jul 27 at 18:41
  • I have vivid memories of someone on one of the news shows warning of impending collapse and literally being laughed off the program. Jul 27 at 19:47
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    Here we go Jul 27 at 19:54
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I worked in the financial services industry back in 2007/8 in software engineering and saw the crash happen with a front row seat.

The root cause of the crash was the massive overvaluation of CDS (Credit Default Swap) instruments, combined with new software (created by the company I was working for) that enabled them to be traded in high volumes, combined with the mortgages that comprised those CDS instruments defaulting en masse.

Those mortgages had been the result of laws passed in the USA in the mid/late 1970s to make it easier for poor people to get mortgages. Problem was the buildings in question and the people that had gotten those mortgages didn't cover the mortgages and by the time they ran out exactly 30 years later (which is the standard duration of a mortgage) the buildings were worth less than the value of the mortgage and the people owning them didn't have the money to make up the rest, leaving the holders of the CDSs financially liable for massive payments to the lien holders (that's how CDSs work).

The result was that a few small financial institutions got into accute cash flow problems, leading to a massive selloff of their portfolios. This triggered automated trading systems to sell all stock in these institutions. This in turn triggered a massive selloff of stock in all financial institutions across the board. A snowball effect was achieved that had automated systems sell just about everything they could at whatever price they could get.

The blocks to prevent catastrophe after previous crashes had been changed from manual intervention (trading used to be stopped when certain drops in major indicators were reached until manually assumed) to automated systems, automated systems which happily assumed that the panic was no reason to stop the markets, effectively removing the blocks completely.

My job involved among other things visualising the value development of CDS instruments, and maintaining the predictive software that aided in their pricing. As such I (and the team I was part of) were some of the only people in the industry who knew anything about how these things worked (even most of the actual traders had no idea, all they knew was that they had been going up in price rapidly until then so must be a good deal).

That's the real story.

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    It would make sense to distinguish between "cause" and "reason/occasion/trigger"? As 'cause' is quite a bit more complex than just 'CDS' (by the way: that's what? While I might know the acro, but the A needs it spelled out), as you might see in TED's & jamesqf's As a few other 'causes'. Jul 29 at 7:11
  • To put it more bluntly, there's a reason they were over-valued. I suspect for most market bubbles you'll find associated financial instruments were over-valued just before the burst.
    – T.E.D.
    Jul 29 at 14:03
  • thanks jwenting! actually to also ask another thing. do you disagree that the prof has no idea what e is talking about?
    – BCLC
    Jul 30 at 0:42
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    Could you please spell out CDS on first use? That abbreviation means many things in the financial world. Jul 30 at 6:19
  • @CareyGregory sorry, for the people involved it is well known to mean Credit Default Swap
    – jwenting
    Aug 3 at 6:50

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