Too lazy to be knowns January 30, 2012 at 4:15 pm
You will recall the famous (and unfairly derided) Rumsfeld quote:
[T]here are known knowns; there are things we know we know.
We also know there are known unknowns; that is to say we know there are some things we do not know.
But there are also unknown unknowns – there are things we do not know we don’t know.
Until recently, I thought that this was sensible. But musing about what people knew about AAA RMBS, it strikes me that there is another situation: the things that we are too lazy to know.
Let me explain. In 2006, some people – including some people I knew – knew that AAA RMBS were sensitive to house prices. They knew that prices could fall, and that if they did, the securities would drop in value. However, they had not done the analysis to go beyond that, so they didn’t know how sensitive some of these securities were to a drop in house prices (especially one early in their life, before reserve accounts had been built up). In short, the risk of these assets was not a known unknown, nor an unknown unknown, but more of a too-lazy-to-be-known.
This form of ignorance is widespread and important in finance. People are peripherally aware that there is more to be known about a topic, and that that knowledge is somewhat relevant, but they don’t find out. They prioritize, they ignore stuff that’s difficult; whatever. The point is that it isn’t just Knightian uncertainty and risk that can get you: it is the stuff that some people know, but that you have never looked at properly.