The role of defective mental models in generating the global financial crisis

Purpose – The purpose of this paper is to stress the role that several defective theories or views of the world played in generating the subprime financial crisis. Design/methodology/approach – This is done by describing these views, showing that they were widely held by relevant decision makers, and by analyzing the flaws in these views. A considerable amount of literature is surveyed in the process. Findings – It was found that these defective views did play a major role in generating the crisis. Research limitations/implications – Implications of the analysis for future research are discussed. Practical implications – Implications of the analysis for reform of private and public sector financial policies are discussed. Originality/value – While most of the arguments in the paper are not new, no paper of which the author is aware pulls them together with the same emphasis on how faulty mental models interacted with dangerous incentive structures to play a prime role in generating the crisis. The paper also references a much wider range of literature on the crisis than any study of which the author is aware. The paper should be of value to any one interested in the causes of the crisis and ways to make future crises less likely. JEL classification: A11, A1, A, A12, G01, G0, G