Seven deadly sins of systematic analytical errors helped cause the credit bubble, according to Tim Bond, London-based head of global asset allocation at Barclays Capital.
The human mind is a great thing, but it is circumscribed by a hard-wiring that's designed to give us an advantage on the African savannah, leading people to predict the future based on the recent past, Mr. Bond said while presenting Barclays Capital's 2009 Equity Gilt Study earlier this month.
The sins were:
• Assuming there was no limit to economic leverage;
• Underestimating the importance of the relationship of house prices to mortgage defaults;
• Assuming the corporate sector was unleveraged, which Mr. Bond said was true for individual companies but not in the aggregate. Many companies used corporate debt to buy back more than $850 billion in stock, probably the worst leveraged bet in corporate history, he said;
• Ignoring the warning signs of drastic credit tightening and that credit goes through a cycle based on supply and demand;
• Assuming credit conditions are never independent from monetary policy settings, which they are during financial crises;
• Continually underestimating potential bank loan losses caused by the tightening of the credit cycle and other macroeconomic factors; and
• Generally, assuming an infinite extrapolation of the recent past. Drew Carter