The Financial Crisis – An Economic Psychological Analysis

After a brief review of the main economic dimensions of the financial crisis, this analysis introduces and applies a framework of economic and financial psychology. This discussion focuses on two main dimensions: The transparency of available financial products (i.e. whether they can be easily understood by potential buyers), and the reciprocal coordination of market participants. The analysis reveals that the assumption of an efficient market for financial products was not justified, because the high degree of complexity of financial products resulted in substantial information asymmetries. Instead, the transactions that took place were fragmented, and mainly involved the sale of customer tailored products (mainly credit derivatives) to specific buyers. Recent court decisions have confirmed the view that these products were deliberately designed to take advantage of the lack of understanding on the part of the buyers, and that their economic loss could have been anticipated. Relatively closed teams at investment banks developed products that were difficult to understand by non-members, or outsiders. The group dynamic processes are similar to those described by the theory of group-think, by which Janis tried to explain a range of disastrous team decisions. There is some doubt as to whether the financial regulation measures that are currently being discussed will be sufficient to prevent a similar crisis in the future.