It often seems that changes and threats come out of nowhere – until we learn later that the signals were there all along and we just didn”t read them correctly. One step toward reading them better is understanding why we misinterpret them in the first place.
Editor’s Note: The following is an excerpt from a work in progress titled “Detecting Weak Signals.” It will be completed for the Spring issue of the Review. The authors aim to identify “methods that will help managers improve the process of surfacing, amplifying and clarifying potentially important weak signals.” Here, they address the factors that inhibit managers from spotting those signals from the start.
It’s the Question everyone wants answered: Why did so many smart people miss the signs of the collapse of the subprime market? There were many danger signals about the impending housing bubble and the rampant use of derivatives as early as 2001. Yet these signals were largely ignored by such financial players as Northern Rock, Countrywide, Bear Sterns, Lehman Brothers and Merrill Lynch until they all had to face the music harshly and abruptly. Some players were more prescient, however. In 2003, investment guru Warren Buffet foresaw that complex derivatives would multiply and mutate until “some event makes their toxicity clear.” In 2002, he derided derivatives as financial weapons of mass destruction.1