Responses to the External Environment Can Escalate Risks

The financial crisis of 2008 occurred because banks failed to comprehend the risks they took with asset-backed securities and other derivatives. Incentive systems drove bankers to take on excessive risks for excessive profits. They denied the evidence presented to them, and when the bubble burst, the results were catastrophic. For example, when warned by his chief risk officer, who proposed shutting down the mortgage business in 2004, the head of Lehman Brothers threatened to fire him! This rush for profits drove many banks. Chuck Prince, the head of Citigroup at the time, just before the credit markets seized up in August 2007, said, “As long as the music is playing, you’ve got to get up and dance. We’re still dancing.”13

Clearly bankers misread both the ethical and business implications of what was going on inside their firms. Either there was collective myopia at work with respect to mounting evidence of excessive risk from very credible sources,14 or the rewards and short-term performance pressures were such that they chose not to attend to the warning clouds.

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