Tweet 
Like An interesting story out of the BBC: one priest, Father Tim Jones, recently gave an incredibly provocative sermon where he offered controversial advice–to shoplift. His argument is basically that those who are less fortunate may often turn to illegal means: they can rob, they can become prostitutes, etc… Jones is arguing that of these “evils,” shoplifting, especially from large corporations, has the least impact on society, and thus, somehow, is the least immoral. Of course from a psychological standpoint this is our intuition. It is easy to do harm to large corporations because we think that we are spreading our damage out evenly among more individuals, and, moreover, those individuals are faceless people wearing suits. However, giving this more thought, we can also sense that if we were to allow this to happen as a society (or be more forgiving of poor people who steal from big corporations to get by), we could very quickly slip into a system of mutual distrust. Before you know it, we will all be having to have our bags checked at entrances and exits, with costs going up for everyone. On the whole, this might leave fewer people with jobs, and the cycle could continue to spiral out of control. As we know, many of the biggest financial blunders of the recent years had to do with tiny misjudgments that added up to larger and more catastrophic costs, with the resulting mutual distrust freezing credit and badly hurting the economy. One thing we must beware of is the allure of thinking that our tiny, seemingly inconsequential decisions won’t matter much in the long run. As history and research have shown us, it’s the little decisions that we gloss over that end up hurting us most in the end.
Surowiecki starts by describing a very important observation made by Thomas Schelling about the N.H.L:
“At the time, players were allowed, but not required, to wear helmets, and most players chose to go helmet-less, despite the risk of severe head trauma. But when they were asked in secret ballots most players also said that the league should require them to wear helmets. The reason for this conflict, Schelling explained, was that not wearing a helmet conferred a slight advantage on the ice; crucially, it gave the player better peripheral vision, and it also made him look fearless. The players wanted to have their heads protected, but as individuals they couldn’t afford to jeopardize their effectiveness on the ice. Making helmets compulsory eliminated the dilemma: the players could protect their heads without suffering a competitive disadvantage. Without the rule, the players’ individually rational decisions added up to a collectively irrational result. With the rule, the outcome was closer to what players really wanted.”
In the rest of the article, Surowiecki tries to make the case that we all feel the same about cars with higher fuel-economy — and that we want to be forced into this situation.
I am not sure I agree. There are clearly situations where we want to be forced into a better social equilibrium (for example, I want other people to drive safer), but this strikes me more as a situation that we want others to start driving more fuel efficient cars and less about a social coordination.
What do you think?
From taxes to golf — many people cheat just by a little bit ….
This video was produced by spark creative and Diamond consultants — thanks
This week we learned that former Nasdaq chairman Madoff likely swindled investors out of $50 billion – arguably the largest financial fraud ever. And thinking about the gravity of the scam, it occurred to me that Madoff’s scam could be compared in terms of its effects to terrorism. Here’s how:
Consider that there was a time when terrorism wasn’t the big deal that it is now. This was before advances in technology, when terrorists only had recourse to low-level weaponry like stones and knives – which, while harmful on an individual level, are not quite weapons of mass destruction. In time, though, “better” technology came along, leading in turn to “better” terrorist tactics: suicide bombing and the like. Still peanuts, though, compared to what came later: 9/11 planes, bio terror – this is when things really got serious; now even one crazy person can cause a world of damage.
Now, I think Madoff’s case is equivalent in a financial sense. Whereas in the past one person’s monetary misdeeds could affect a handful of people at most, now there’s more at stake: a single person – like Madoff – can cause a whole lot of fiscal damage. And the reason lies in interconnections: when companies began investing with other companies, any fraud can spread and cause damage across many companies.
There’s one other similarity here. What makes terrorism so powerful are its randomness and intentionality: it can strike any time, and you never know when you’ll be a victim and it is done on purpose. Things that we can’t predict, control or at least think we can control make us more afraid. And that’s exactly the case with Madof’s scheme: the investers probably assumed that they were in control and all of a sudeen we all learned that we are much less in control, and that someone can do this to any of us.
If we view the stock market through this terrorism perspective, and we understand that just a few individuals can cause so much damage, it becomes clear that more regulation is needed – we do so much to check people at airports — shouldn’t we use the same level of security for hedge funds?
Recently I had an interesting experience being poor. It didn’t last too long but it was quite distressing and I learned how difficult this is. The story is as follows. I was out of the country for a month and during that time my car insurance expired. When I got back I called my insurance agent and I asked them to renew my policy. “No, no, no, ” they said, “If your insurance has elapsed you can’t do it over the phone and you have to come to our office in person.” Well at that time I was living in Princeton and my insurance agency was 300 miles away in Boston. So I took the train up, got to the insurance office on time and I was ready to hand them a check and renew my insurance.
Well, here again, I was wrong. It turns out I could not do it by check. The insurance company would not take a check from me because, after all, I have shown I am financially irresponsible. “Will a credit card do?” I said. “Of course not. Only cash.” The limit I can take out with my ATM card is $800 a day and the insurance was almost $3,000 (needless to say they also increased my premium). So I could not solve it this way. “Luckily” the insurance agent had a solution at hand that was designed for this very particular problem. There is another company they told me that would finance my insurance fee. Interestingly enough, the cost of this financing included 20% interest rate on the loan itself plus a $100 fee just to enroll in this program.
I had no choice but to take this particular loan. So I paid the $100 fee, I paid the 20% in interest, and I got my insurance. I took the train back to Princeton. A few days later, of course, I canceled this terrible loan and paid it off. But here is what I learned from this distressing lesson, the moment you make one financial mistake the chances that you will be hit with all kinds of fines, all kinds of difficulties, all kinds of financial obstacles, are much, much higher.
If I was on the verge of financial difficulty there is no question that this particular incident would have pushed me over the edge, making my financial life much more difficult and maybe even impossible. I think that this is, in fact, what we do to people with financial constraints all the time. We impose substantial penalties on the people who violate financial responsibilities, not taking into account their viability and therefore make their lives much, much worse.
How can we get over this issue? I think we have to reconsider the punitive systems all the financial institutions use (insurance, banks, credit cards, etc.), and think more carefully about how we want to share responsibility and payment across people. After all when someone goes bankrupt, they of course suffer, but so does the whole system around them. From this perspective, it is easy to see how the punitive systems we are using are not only bad for the individuals but they can be very damaging for the whole society.
Can it be that adding food makes people believe they are eating less?
A recent study by Brian Wansink and Pierre Chandon report that this can indeed be the case (this version of the study was done with John Tierney of the NYT)
Half of the people were shown pictures of a meal consisting of an Applebee’s Oriental Chicken Salad and a 20-ounce cup of regular Pepsi and they were asked to estimate the amount of calories in the entire meal. The other participants were shown the same salad and drink plus two Fortt’s crackers prominently labeled “Trans Fat Free.” The crackers added 100 calories to the meal, but given that they were “diet” how will their presence influence the estimated amount of calories in the entire meal?
The first group estimated that the meal contained 1,011 calories, which was a little high. The meal actually contained 934 calories — 714 from the salad and 220 from the drink. But, the second group estimated the total amount of calories to go down. Now the average estimate for the whole meal was only 835 calories — 199 calories less than the actual calorie count, and 176 calories less than the average estimate by the other group for the same meal without crackers.
The original study was interpreted as a halo effect of items labeled as diet. I suspect that this is correct, but I think that it is also possible that people have a hard time computing totals and that instead they compute averages – which makes the estimation when the crackers are present to be lower.
Dear Irrational,
I am a partner in an asset management company whose purpose is to manage investments for individuals, families, and foundations. The principles of Predictably Irrational made me think about the effectiveness of each component in our investment process. My end in mind is: 1) to identify failure ingredients in my investment process and 2) engineer out their removal.
My question follows:
Is ‘falling in love’ with an investment hazardous to one’s financial health? Does ‘falling in love’ with an investment result in predictable behaviors (in me) that lower (or negate) what would otherwise have been an excellent investment performance?
——-
Dear Investor,
We have not done any research directly on this question. Nevertheless, I suspect that the answer is that we do get attached to investments, that it is not good for us, and that it has the potential to influence our judgment for the worse.
First, regarding ‘falling in love’ with an investment; I think that we would. What we know about the endowment (ownership) effect is that people tend to fall in love with anything they happen to own (mugs, pens, cars, kids). Once we have something, it becomes ours and we perceive it as special. As a consequence, we value it more. I suspect that the same could occur with investments.
On top of that, in the current economy people are feeling like they are in a losing situation (if you don’t feel this way look at your retirement account) but losses in the stock market are not psychologically realized until they are truly realized. So in people’s desire to hold on to what they have you might suspect that in this economy there is going to be an even stronger tendency to ‘fall in love’ with an investment.
Why is this not good for us? Because the expected value of investment options are about their future potential and the past is just water under the bridge.
The good news is that you can do something about it, and advise your clients to do the same. Imagine that at the start of every month you don’t look at your portfolio and instead you design your strategy and market positions as if you started from scratch. The idea is that if you start from scratch you have a clean past with no commitments to past decisions. I am not sure if the ‘falling in love’ with an investment sentiment will go away completely but I think this way it will be less powerful.
Irrationally yours
Dan