Forbes: What Causes The Biggest Bad Decisions

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They happen when too many different parties have their interests aligned and complexity is too great.

Edward Conlon, 08.02.10, 03:36 PM EDT

Edward ConlonThe Challenger disaster has become standard at business schools for showing how big and important decisions in organizations can go terribly wrong. The major lesson from it is that even when decision processes are carefully planned and mapped out, a combination of business interests and uncertainty can conspire against making the right choice.

The Challenger launch probably wouldn’t have taken place had NASA followed the prescribed decision process it had used for every other manned space flight. On the morning of Jan. 28, 1986, the temperature at the launch site was in the low 30s, much colder than for previous launches. The cold threatened the effectiveness of critical seals designed to prevent the main rocket engines from igniting and exploding the attached fuel tank.

However there were special and compelling interests present. And along with a high degree of uncertainty, those interests conspired to push key decision makers to accept risks they would have otherwise avoided. Specifically, the engineering team at Morton Thiokol, the company that had designed and manufactured the rocket engine, recommended against launching at such a low temperature. They felt there was a significant chance the rubber seals would be too hard and therefore not function properly. Usually this no-go recommendation would have stopped the launch sequence.

But then business and political forces exerted themselves. For Morton Thiokol, there was the prospect of damaging its relationship with NASA if it called off the launch. For NASA there was congressional pressure to perform. And the White House had plans to showcase Christa McAuliffe, about to become the first teacher in space, during the upcoming State of the Union address. Although science supported the engineers’ recommendation not to launch, there wasn’t enough data about low-temperature launches to prove that the seals would fail. Consequently the no-go recommendation was reversed, and the countdown continued. Challenger spectacularly disintegrated 73 seconds after launch.

We are currently witnessing the consequences of two other decision failures that are eerily similar to the Challenger one. Both the subprime mortgage crisis and the Deepwater Horizon tragedy share the common elements of having compelling and aligned interests among their decision makers and the uncertainty that is inherent in novel circumstances. In both cases, those elements combined to lead to disaster.

In the case of the subprime mortgage crisis, the interests involved were threefold: a well-intentioned national policy of increasing the number of Americans owning homes; the opportunity created for investors to earn attractive returns by funding residential mortgages for those new homeowners; and the opportunity for financial businesses to create and market the mortgages to prospective homeowners and to package and sell the cash flow they created as investments.

Altogether these interests created a surge of activity selling new kinds of mortgages to new kinds of homeowners and packaging the mortgages as new kinds of investment vehicles. They also created a regulatory environment that wanted to support national policy as far as seemed reasonable.

Uncertainly and ambiguity arose with the creation of new more relaxed qualification standards for residential mortgage loans, new kinds of complex investment instruments (including collateralized debt obligations) designed to raise the capital needed to support the residential mortgage loans, new kinds of insurance policies on investments (credit default swaps) designed to mitigate the risks for investors, challenging levels of complexity for the agencies that rated the investment vehicles and an assumption that the collateral value of residential real estate in America would remain strong enough to limit potential losses.

For a time it all worked. The new financial engine succeeded in creating a whole new class of American homeowners, happy mortgage brokers, happy investors and happy bankers. Home ownership reached nearly 70% in 2004. Home prices jumped nationally at nearly 9% a year from 2000 to 2006. A home worth $150,000 in 2000 was worth $251,565 in 2006. READ MORE>

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