Executives had too much confidence in their risk management strategies. Regulators, too, had excessive confidence in the measures that they had in place to ensure safety and soundness of banks and other regulated institutions...
Simply put, there was a widespread gap between what people thought they knew to be true and what was actually true.
In a way, the three chapters of Book 2 are based on three chapters of my life. The first chapter discusses the financial crisis, and it is informed by my experience at Freddie Mac. There, I was a geek in the Suits vs. Geeks divide. However, relative to what took place subsequently, there was not much of a divide. The CEO at the time (until 2003, long after I had left) was Leland Brendsel, who understood what geeks like Bob Van Order thought about the business. Van Order taught us that mortgage defaults were driven by equity, that Freddie Mac made money by leveraging its Federal guarantee, and that preserving our valuable charter required assigning an appropriate capital charge to loans based on a stress test of severely falling house prices. Chapter one looks at how this wisdom got lost, not only at Freddie but in financial markets at large.
When I left Freddie Mac, I started an Internet business. The Internet seemed like an environment where geeks could bypass the suits. Starting an Internet-based business required little capital, and government had a smaller footprint. I believed and continue to believe that the Internet as a medium promotes smaller units of organization with less central planning. Chapter two explains elaborates on that view.
After I sold my Internet business, I started writing on economics and political economy. Because the Internet confirmed my views favoring decentralization and trial-and-error learning, I became attracted by Hayekian views. The third chapter gives those views an applied slant, as I try to describe how to replace top-down government with decentralized mechanisms.