Final Paper - Mitch McMichael Professor Schulze AEM 4140...

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Unformatted text preview: Mitch McMichael Professor Schulze AEM 4140 December 6, 2011 The Great Recession The financial crisis that began in late 2007 and reached a climax in 2008 had wide reaching effects that are still felt today. While recessions in the late 1980s and early 2000s had very negative impacts on our economy, such a deep and long recession has not been experienced since the Great Depression of the 1930s. It is very difficult to pinpoint exactly what caused the crisis, since so many factors led to this devastating economic catastrophe. However, it is very easy to point out the many decisions that helped to contribute to the downfall of our financial institutions and to bring our economy to a standstill. No single party can be held completely responsible, as many different groups contributed. While many have found big Wall Street firms to be very easy to blame, individual consumers/households, the Federal Government, credit rating agencies, as well as the big banks on Wall Street are all partly to blame. When these groups acted together, and individually, they often made some very bad decisions, which can only be described as behavioral anomalies, when setting their priorities and deciding on future plans. The fact that these decision anomalies were made by nearly all participants in the countrys financial industry shows how the crisis had an effect on so many people and corporations. No one escaped the wrath of the recession and no one was free from decision anomalies in the time leading up to and during the financial crisis. Individual consumers/households played a major role in the financial crisis. Despite everyones blaming of Wall Street for Main Streets problems, households could have avoided a lot of the financial burdens if they had been smarter and avoided decision anomalies. One anomaly seen from the decisions of the American household is Hyperbolic Discounting. This is when people show a preference for a reward that arrives sooner rather than later and they highly discount the value of the later reward, by a factor that increases with the length of the delay. This was mainly demonstrated when we saw people continually spending more money than they had, using credit and facing very high interest rates in the future, in order to obtain the immediate reward. We also saw this in the mortgages people were taking out on their homes. These balloon mortgages had low initial payments with sky rocketing interest rates in the future, but people clearly valued the immediate reward much higher. Another behavioral anomaly demonstrated by American households was Risk Seeking behavior. This is when people take on more risk in an effort to make up for perceived losses. This was also seen when people misused their credit. In an effort to make up for their perceived losses on credit cards, people often paid off some cards with other cards or put a majority of their purchases on credit. Households were trying to make up for the perceived losses in the spending purchases on credit....
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This note was uploaded on 01/08/2012 for the course AEM 4140 at Cornell University (Engineering School).

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Final Paper - Mitch McMichael Professor Schulze AEM 4140...

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