Could we have avoided the 2008 financial crisis?

Since the early 90's, banks - Consumer, Corporate and Investment - have become very savvy in adopting and implementing sound risk management practices. In fact, if you were to ask the Chief Risk Officers of (almost) all banks in 2006, you would have gotten statements like - 'We have the best global risk management practices', 'Our risk management dept is staffed by 54 PhD's', 'we have the best consultants advising us', etc, etc

So where did (almost) everyone go wrong????

I see a few root causes:
- Musical chairs: No one wanted to be left behind. As Chuck Prince famously said in July07: "As long as the music is playing, you’ve got to get up and dance. We're still dancing".  Although this statement applied to leveraged buyouts; it had implications across lending; including consumer finance.
- Complexity: Risk management got too complex.  In fact, the moment you have 54 PhD's managing your risk, no one knows whats going on.  Simplicity brings Clarity. (disclaimer: I sport a PhD myself)
- Not enough business sense: Everyone had the best mathematical models.  What was missing was expert judgement that would have allowed us convert them into contextual information and allowed us to stress test our assumptions and these models.
- Pass the pillow: A connected global market meant that we could 'diversify' risk; essentially meaning that the loans a bank made could be broken up into smaller pieces and sold (along with their risk) to someone else in some other country.  So everyone had incentives to underwrite but few had incentives to ensure that they were underwriting profitably.

In the end, banking is not too complex.  You borrow money at low interest rates; and you lend at higher rates.  The idea is that you make money on the interest rate spread while ensuring that your debtors pay you back.  Some companies are doing this all too well.  Check out Annaly (they have managed to run their business quite well; the crisis notwithstanding.  So far.......).

Sounds simple; doesn't it ????