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In what is now widely and infamously known for the near collapse of the financial sector in the United States, the Federal Reserve ignored warning signs associated with massive sub-prime lending for nearly two years. In the wake of this disaster, the Fed had to make decisions about what banks to save with an infusion of cash, what banks to save by negotiating sales to other banks, and what banks would fail. Despite these failures, Fed management contends the agency is the best choice for continued oversight of the nation’s banking system (with a little tweaking). Some lawmakers are not so sure.

QUESTIONS:

  1. There can be no question that the Federal Reserve’s actions (or lack thereof) are consistent with behavioral decision making. What cognitive limitations kept the Fed from making good decisions? Consider the Fed’s response to the crisis. Is there any evidence of satisficing?
  2. Which of the three heuristics most likely influenced Fed decision making? Why?
  3. Escalation of commitment is evident at several points in this story. Pick one and identify the factors that led to escalating commitment. What would you do to ensure no further escalation occurs?

SOURCE: B. Appelbaum & D. Cho, “Fed’s Approach to Regulation Left Banks Exposed to Crisis,” Washington Post (Retrievable online at http://www.washingtonpost.com/wp-dyn/content/article/2009/12/20/AR2009122002580.html?hpid=topnews)

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