Disentangling the Epistemic Failings of the 2008 Financial Crisis

In David Coady & James Chase (eds.), The Routledge Handbook of Applied Epistemology. Routledge. pp. 196-210 (2018)

Lisa Warenski
CUNY Graduate Center
I argue that epistemic failings are a significant and underappreciated moral hazard in the financial services industry. I argue further that an analysis of these epistemic failings and their means of redress is best developed by identifying policies and procedures that are likely to facilitate good judgment. I call these policies and procedures “best epistemic practices.” I explain how best epistemic practices support good reasoning, thereby facilitating accurate judgments about risk and reward. Failures to promote and adhere to best epistemic practices contributed to the 2008 financial crisis. Suboptimal epistemic practices were implicated in (at least) the following three areas: (1) the assignment of radically-inaccurate risk ratings to real estate mortgage-backed securities and CDOs on the part of the large credit rating agencies, (2) lack of due diligence on the part of investors, and (3) poor risk management on the part of some large financial institutions. I discuss these in turn. Finally, I touch some of the ways that best epistemic practices have been implemented to correct faulty methodologies and to prepare for possible catastrophic economic scenarios in the future. In effect, the 2006 Credit Rating Agency Reform Act, including its expansion by Dodd Frank, and the subsequent statutory regulation by the SEC aim to facilitate best epistemic practices. These regulatory reforms are examples of proactive and forward-looking regulation, although they were implemented retroactively in response to perceived failures of the rating agencies. I conclude by observing how proactive regulation for best epistemic practices might help us to anticipate and avoid future crises.
Keywords 2008 Financial Crisis  Applied Epistemology  Business Ethics  Risk Culture  finance  banking
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Philosophy of Money and Finance.Boudewijn De Bruin, Lisa Maria Herzog, Martin O'Neill & Joakim Sandberg - 2018 - In Edward Zalta (ed.), Stanford Encyclopedia of Philosophy. Palo Alto: Metaphysics Research Lab, Stanford University.

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