The System was Blinking Red

A few weeks before 9/11 attacks on United States, President Bush received from the Director of CIA an intelligence memo, known as The President’s Daily Brief (PDB for short). The August 6^th PDB summarizes the most important elements of intelligence available to the nation on that particular day. The intelligence headline for the day was : “Bin Laden determined to attack inside U.S.”

We all know what happened a few weeks later.

So the natural question was what was the follow-up by the White House with respect to that warning. At the Congressional Hearings, investigating the failures of US Intelligence, the then National Security Adviser Condoleeza Rice claimed that the aforementioned PDB does not contained an “actionable intelligence,” meaning that it contained no new threat information. In fact, she used the phrase “historical information” in her characterization of the that particular PDB.

Subsequent exchanges between the Senators on the Committee and Condoleeza Rice was partly a political theater and partly a semantical exercise. Fred Kaplan of online Slate magazine described the exchanges as follows:

“Rice insisted this title meant nothing. The document consisted of merely “historical information” about al-Qaida—various plans and attacks of the past. “This was not a ‘threat report,’ “ she said. It “did not warn of any coming attack inside the United States.” Later in the hearing, she restated the point: “The PDB does not say the United States is going to be attacked. It says Bin Laden would like to attack the United States.” [ Italics in the original http://www.slate.com/id/2098499 ]

Furthermore, Rice’s recollection was that no one had briefed the WH about “planes as missiles”, although she cannot be sure whether there is a scenario of the sort secreted in the bowels of the bureaucracy. She said “”No one could have imagined them taking a plane, slamming it into the Pentagon” – I’m paraphrasing now – “into the World Trade Center, using planes as a missile.” To the best of my knowledge, Mr. Chairman, this kind of analysis about the use of airplanes as weapons actually was never briefed to us.

The Queen and Mr. Sarbanes

From every corners of the globe the headlines are screaming “Financial Meltdown” that it might be hard even for a hermit to escape hearing about it. The Meltdown elicits shocked disbelief from everyone, including the Queen of England. At a function, the queen met professor Luis Garicano of the London School of Economics (LSE), and asked him “If these things were so large, how come everyone missed them?” The professor’s answer was: “At every stage, someone was relying on somebody else and everyone thought they were doing the right thing.”

To which, Her Majesty the Queen said a single word, “Awful!”

Her Majesty’s question is of the type that we are familiar as an “elephant in the room”: If there was an elephant in the room, why did nobody notice the elephant? No logical answer would suffice to explain the conundrum inherent in such a question.

No heads were put on the block.

However at the Committee Hearings of the U.S. House of Representatives on the subject of the Financial Crisis and the Role of Federal Regulators, the heads of former FED Chairman Alan Greenspan, former Treasury Secretary John Snow, and former SEC Chairman Christopher Cox were put -- so to speak – on the block. Take, for instance, the statement made by Representative Sarbanes:

“We have been talking a lot about this metaphor, the blind man and the elephant. I don’t really buy that, because I think what – I certainly don’t buy it as an explanation for what happened. I think it’s been used as a kind of excuse to pass the buck and sort of say, well, nobody could see the whole picture, so we were each compromised in our ability to take action that would have mattered and made a difference, but the hearing testimony today just confirms to me that in each part of the world that you each had a clear perspective on, you had tools that you could have used, which if you had used them, might have averted the situation, or certainly lessened its impact.”

I have selected a subset of the answers and explanations from the former FED Chairman Alan Greenspan’s.

1. In 2005, I raised concerns that the protracted period of underpricing of risk, if history was any guide, would have dire consequences. This crisis, however, has turned out to be much broader than anything I could have imagined.

2. What went wrong with global economic policies that had worked so effectively for nearly four decades?

3. To the most sophisticated investors in the world, they [the derivatives?] were wrongly viewed as a “steal.”

4. A Nobel Prize was awarded for the discovery of the pricing model that underpins much of the advance in derivates markets. This modern risk management paradigm held sway for decades. The whole intellectual edifice, however, collapsed in the summer of last year because the data inputted into the risk management models generally covered only the past two decades, a period of euphoria.

5. Had instead the models been fitted more appropriately to historic periods of stress, capital requirements would have been much higher and the financial world would be in far better shape today, in my judgment.

For the contexts of these statements, the readers can go to the original sources of unedited transcripts of the hearings: http://oversight.house.gov/story.asp?ID=2256.