Giant Pool Of Money Summary

In This American Life’s “Giant Pool of Money” two biases are present, the regression to the mean and the confirmation bias. Almost everyone thought that the housing market would increase forever, all the while intelligent people who knew better, kept listening only to what they wanted to hear. By dissecting these two biases we can gain a better understanding of what was driving the actions that lead to our most recent credit crisis. In doing so we can learn to make our own decisions without these biases.
In this story borrowers failed to recognize the regression to the mean bias which states that over time things will average out. This meant that home prices cannot simply continue to rise but that they will eventually settle back to a normal level. Borrowers believed that home prices would continue to rise and that they were making safe investments. There was little fear of adjustable rate mortgages because borrowers thought that they could always sell their home for more than they paid and walk away with a nice return. Clarence Nathan is an example of this, he viewed a $540,000 NINA loan as a quick solution to his financial problems. He thought that he would be out of his situation within a year and could move forward with his life. This particular loan has now put
him into a much dire circumstance. Also, the higher appraisal values allowed homeowners to take out home equity lines of credit that put people further into debt and in many cases were used to make the original mortgage payments.
This bias was seen with banks and investors as well. Many mortgage lenders that were enjoying large returns did not anticipate an end. In some cases they leveraged themselves 20 to 1 and once things started to unravel they could not move their current mortgage holdings so they were forced out of business. The investors (The Giant Pool of Money) that were buying CDO’s also were ignoring the historical ups and downs of the housing market. They continued to invest additional money, pushing lenders to make riskier loans in order to meet their demand. Mike Francis an employee of Morgan Stanley stated “It was unbelievable, I mean, we almost couldn’t produce enough to keep the appetite of our investors happy. More people wanted bonds than we could actually produce.”
The confirmation trap bias is also apparent in this news story. The parties involved seemed to feed off of any information that further supported their actions. Borrowers would look to each other for reassurance that the housing market would remain strong. They saw prices soaring and when offered unrealistic loans by pushy lenders they would agree. Whole neighborhoods would fall victim to this false sense of security.
Banks also looked to each other for support, once one bank would offer a new type of loan, the others would quickly offer the same type. According to Mike Garner “And once one person buys them, usually all the rest follow suit.” No bank wanted to miss out so they would believe that if one bank is offering a loan than it was ok and they should as well. Lenders also looked at recent foreclosure data to support these new loans. They would use complex computer programs to show that foreclosure rates would be low and that their mortgage pools were solid investments. But we now know that they were using the wrong data and no one wanted to dig too deep because they were afraid at what they might find. Alex Davidson summed it up nicely “A big part of this whole story, the whole crisis, is that a lot of really smart people, people who knew better, fooled themselves with this data. It was the triumph of data over common sense.”
The Giant Pool of Money was also receiving confirmation for their continued investments through inaccurate credit ratings. The credit agencies were not using the correct data in their evaluations of these new mortgages. Investors believed the AAA ratings on these now known risky investments and didn’t question the data because it supported what they wanted to hear. They looked at the projected returns and they just could not buy enough of them.
In order to prevent the confirmation bias from negatively impacting our decision making process we must have better knowledge of ourselves. It is human nature to search for supporting information that backs up our beliefs and we must be able recognize this behavior. Being able to keep current opinions while also keeping an open mind to refuting evidence will allow us to make more informed decisions.
This American Life report gives a great overview of the process that lead to the subprime mortgage crisis.
It is easy to look back and say what were these people thinking but when you take a closer look at some of the biases involved involved the borrowers, the lenders and the investors are to blame. The system just seemed to lack the necessary checks and balances and finally spun out of control. In the end the borrowers, the highly leveraged banks and the investors (Giant Pool of Money) all lost. By failing to recognize and adjust for these biases people continued down a very slippery slope. This story serves as a great example of how biases can have major large scale negative impacts in our
world.

Today, many people support increased bank regulations and more rules to protect homeowners. Although these may help prevent similar occurrences in the future, I would prefer that the focus be put on transparency to the investors. The large CDO’s were hiding a lot of “toxic waste” and very few if any investors would knowingly purchase such funds. Without buyers these funds would not have existed to the extent that they did and the NINA type mortgages would not have been offered to homeowners. There will always be individuals that will take advantage of a system but if investors know exactly what they are purchasing then they will not give opportunities for these issues to arise in the future.