Financial crises: a culture of complacency

Abstract

The aim of this paper is to consider the role of complacency in financial crises over the last two decades, with a closer look at the ongoing Subprime Mortgage Financial Crisis. The theme of complacency and the concept of financial crisis are both explored. Financial crises are better understood by explaining their economic drivers and the fundamental role of complacency in the various transmission mechanisms involved. These drivers are then illustrated by means of recent selected financial crises including the Crash of 1987, the East Asian Financial Crisis of 1997, the Long Term Capital Management Crisis of 1998, the Dot.Com Crash of 2000, and the current Subprime Mortgage Financial Crisis. The paper concludes that complacency not only underlies but plays a pivotal role in recent financial crises. Complacency increases during periods of economic stability, leading to some departure from rational investment decisions, an effect which is then compounded by herding behaviour. Further, with regard to the governance of markets, complacency is both institutional and institutionalised. Finally, adding to this culture of complacency is the irrational belief that crises are unique and therefore cannot be spotted in advance or even in their early stages. To address this culture of complacency, remedies lie in the re-education of key players and the provision of better financial information, a rethink of market governance structures, and some recognition that the transmission mechanisms are both recurring and predictable.