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Financial Peer Presure

It seems investors might overestimate the ability of their peers to make sound decisions, a very convincing explanation for several of our recent economic crises. In essence, I can should pay a lot for a mortgage backed security (or dot com stock, or bankrupt investment bank) because everybody else is (and everyone else should be pretty smart).

Another gem about why banks were so unprepared for a catastrophic economic situation:

The individuals who were running large financial institutions had an opportunity to pursue strategies that resembled, in terms of their reward structures, going short on extreme market volatility. Those strategies paid off for years but ended in disaster. Until the volatility actually arrives, this trading position will appear to yield supernormal profits, and indeed, the financial sector was enormously profitable until the asset-pricing bubbles burst.

From a publication by economist/blogger Tyler Cowen. See the full article here.