This is a difficult question, so I'll give the simple base answer, and then expand on it. I do also need to point out that a fair deal of the management movements were my impression from my role as a coder, and it's quite possible I'm being unfair or inaccurate, for which I apologise, but my perception of the issue was:
On the development side, I - quite simply - do not think money was being spent excessively. The people I worked with worked long hours with poor wages fuelled mostly by passion - and free pizza. There was an understanding that this was necessary to meet the requirements of the job. So, to reiterate: with the budget development had, we still felt we had to work many extra hours for free in order to meet the requirements.
If anything, the budget for development was too low.
Now, aside from that, I - along with many others - have often clamoured that budgets are too high. So how do we reconcile those two things?
The issue is one of scope, in part. As an independent studio, we were dependent on commissioning projects from publishers; we'd produce prototypes to try to demonstrate a workable game, management would negotiate titles and licenses they'd like to produce. And to do that, to secure that, they had to promise things we simply were not equipped to deliver at the price they agreed upon - but that got money in the company's coffers, and kept us going, it was simply regarded as what was necessary for survival.
One issue, I think, is the workforce, and I'm not so arrogant as to not include myself in that. There was a regular rhythm of getting fresh-faced people in from university, full of energy and passion, and pushing them as hard as they could at a low wage. Again, not through any idea of cruelty, just a feeling that it was necessary. They'd get burned out and leave, and replaced, and the cycle would continue. We had a fairly ridiculous turnover some years - I put that many pound coins in leaving-present envelopes...
I wonder if it may have been more productive - and cheaper in the long run - to have worked with better-paid, more experienced teams rather than having that turnover and relearning process. I don't know, myself.
As I got burned out, my passion and work quality definitely deteriorated. Ultimately, one prototype we'd pushed hard for (and it's been long enough now that I can probably safely say was for Squeenix, a sort of FPS with Pokemon elements - yes, really) fell through, and they needed to make layoffs, and that included me. It hurt at the time, but from a purely pragmatic point of view, I think it was the right thing to do. There were far more valuable and productive people laid off in the same wave, and had I stayed when they went, it'd have been quite unjust.
(As an aside: If I remember rightly, one of the management did suggest to me that Eidos pushed for the title to fall through on the grounds that they disliked us because we now owned what was Core. I... will admit to being somewhat sceptical of that claim!)
I had a point in there somewhere. What was it? Oh yes!
In my opinion: the scope of games is simply too large now, and consumer expectation is too great. The budgets are actually reasonable for the amount of content that's being produced. There's a fear that reducing the scope of games significantly would result in that title being ignored (percieved as 'not as valuable' as the blockbusters), so it turns into an arms race, driven mostly by the big guys.
Smaller games, right now, seem like a smart move. To link to another thread at the moment, Titanfall might well be doing the right thing, even though it's not particularly to my tastes. The problem is convincing publishers that the smaller titles have a better-reward-to-opportunity-cost ratio than blockbusters, and that's tricky.
