Thursday Reads: Psychological Approaches to the Current Political Situation

Harvard Bookstore, Cambridge, MA

Harvard Bookstore, Cambridge, MA

Good Morning!

Today I’m going to focus on some psychological studies and psychological ideas that relate to the news of the day.

A recent study by two social psychologists at The New School in NYC, found that reading literary fiction improves Theory of Mind, or the “ability to infer and understand other people’s thoughts and emotions” as well as the “capacity for empathy.”

From Scientific American:

Emanuele Castano, a social psychologist, along with PhD candidate David Kidd conducted five studies in which they divided a varying number of participants (ranging from 86 to 356) and gave them different reading assignments: excerpts from genre (or popular) fiction, literary fiction, nonfiction or nothing. After they finished the excerpts the participants took a test that measured their ability to infer and understand other people’s thoughts and emotions. The researchers found, to their surprise, a significant difference between the literary- and genre-fiction readers.

When study participants read non-fiction or nothing, their results were unimpressive. When they read excerpts of genre fiction, such as Danielle Steel’s The Sins of the Mother, their test results were dually insignificant. However, when they read literary fiction, such as The Round House by Louise Erdrich, their test results improved markedly—and, by implication, so did their capacity for empathy. The study was published October 4 in Science….

The results suggest that reading fiction is a valuable socializing influence. The study data couldinform debates over how much fiction should be included in educational curricula and whether reading programs should be implemented in prisons, where reading literary fiction might improve inmates’ social functioning and empathy. Castano also hopes the finding will encourage autistic people to engage in more literary fiction, in the hope it could improve their ability to empathize without the side effects of medication.

There’s a little more detail on the study at the Guardian books blog:

“What great writers do is to turn you into the writer. In literary fiction, the incompleteness of the characters turns your mind to trying to understand the minds of others,” said Kidd.

Kidd and Castano, who have published their paper in Science, make a similar distinction between “writerly” writing and “readerly” writing to that made by Roland Barthes in his book on literary theory, The Pleasure of the Text. Mindful of the difficulties of determining what is literary fiction and what is not, certain of the literary extracts were chosen from the PEN/O Henry prize 2012 winners’ anthology and the US National book awards finalists.

“Some writing is what you call ‘writerly’, you fill in the gaps and participate, and some is ‘readerly’, and you’re entertained. We tend to see ‘readerly’ more in genre fiction like adventure, romance and thrillers, where the author dictates your experience as a reader. Literary [writerly] fiction lets you go into a new environment and you have to find your own way,” Kidd said.

As the authors admit, one problem with this study is determining what is “literary fiction” and what is “genre fiction.” In some cases, there is quite a bit of crossover in the selections they used. For example, they classify Louise Erdrich’s The Round House as “literary,” and Gillian Flynn’s Gone Girl, as “genre” fiction. But The Round House has characteristics of a “thriller,” in that its subject is crime; and Flynn is a fine writer, and Gone Girl is in many ways a “writerly” work with a heavy focus on characters’ thinking processes and internal dialogues.

The Guardian quotes a psychologist who objects to Kidd and Castano’s use of Theory of Mind tests to measure the effects of reading different types of fiction.

Philip Davies, a professor of psychological sciences at Liverpool University, whose work with the Reader Organisation connects prisoners with literature, said they were “a bit odd”.

“Testing people’s ability to read faces is a bit odd. The thing about novels is that they give you a view of an inner world that’s not on show. Often what you learn from novels is to be a bit baffled … a novel tells you not to judge,” Davies said.

“In Great Expectations, Pip is embarrassed by Joe, because he’s crude and Pip is on the way up. Reading it, you ask yourself, what is it like to be Pip and what’s it like to be Joe? Would I behave better than Pip in his situation? It’s the spaces which emerge between the two characters where empathy occurs.”

Nevertheless, it’s an interesting study. Now if we could only get the Tea Party folks and super-rich Wall Street types to read more literary fiction!

Harvard Bookstore, Harvard Square

Harvard Bookstore, Harvard Square

The results of another social psychological study, this one at Duke University, showed that people with “extreme” political views have a sense of superiority over people with different views. From Psych Central:

Duke University investigators examined whether one end of the American political spectrum believes more strongly than the other in the superiority of its principles and positions.

They found both sides have elements of “belief superiority,” depending on the issue.

When asked about nine hot-button issues, conservatives feel most superior about their views on voter identification laws, taxes and affirmative action. Liberals feel most superior about their views on government aid for the needy, torture and not basing laws on religion.

The study is found in the online edition of Psychological Science.

Investigators questioned 527 adults, (289 men, 238 women), ages 18-67, about the issues. They then examined whether those who endorse the extremes of conservative and liberal viewpoints demonstrate greater belief superiority than those who hold moderate views.

The study asked participants to not only report their attitudes on the nine topics, but also how superior they feel about their viewpoint for each issue.

According to Diana Reese at the Washington Post, 

The study was inspired by the 2012 presidential election campaign. “We were looking at things like comments on blogs and pundits and politicians on TV,” Dr. Kaitlin Toner said in a phone interview. “It seemed like there were a lot of people who felt very certain that their views were correct but they contradicted one another and there’s no way that everyone could be 100 percent correct all the time.” Toner, the lead author on the study, did the research while a graduate student at Duke….

Don’t confuse belief superiority with dogmatism, though. The latter is “a personality trait,” Toner explained. “It’s a measure of inflexibility….You’re holding a belief rigidly and won’t change.”

In other words, you can hold “superior” beliefs that you’re right and the rest of the world is wrong about a particular issue, but still be able to change your mind, unless you’re dogmatic about your viewpoint.

Previous research has shown that conservatives tend to be more dogmatic, and Toner said their study found the same results, with dogmatism increasing as views moved to the right of the political spectrum.

Another social psychologist from Duke University has a post at HuffPo called The Psychology of Being Online, in which he discusses several studies of the ways in which people react to being in virtual world. You can check them out at the link.

City Lights Bookstore, San Francisco, CA

City Lights Bookstore, San Francisco, CA

Here’s a fascinating article by Justin Fox at the Harvard Business Review. It’s based on behavioral economics–a sort of combination of economic and psychological theories. Fox attempts to explain our current political/economic impasse using game theory. You should read the whole thing, but here an excerpt:

Some portray it as a Manichean struggle between good and evil. Warren Buffett says it’s “extreme idiocy.” I’d like to recommend another way of looking at the government shutdown and the looming battle over the debt ceiling in Washington. It’s a game, played by flawed-but-not-crazy human beings under confusing circumstances. In other words, it’s an interaction among “agents” who “base their decisions on limited information about actions of other agents in the recent past, and they do not always optimize.”

That quote is from economist H. Peyton Young’s “The Evolution of Conventions,” one of several works of game theory I plowed my way through this week in an attempt to find a way to think about the government shutdown and looming debt ceiling fight that didn’t make me want to bang my head against a wall. My reading made the dynamics at work in Congress and at the White House a bit clearer — and thus slightly less maddening, if not less ominous.

The debt-limit game

There are lots of different games being played in Washington at the moment, but the main one I have in mind pits the Democratic White House and Senate against the Republican House of Representatives over the federal budget. The deadlocked players have already landed us in a partial government shutdown, but it’s the 18th since 1976 and thus really not that big a deal. The far bigger stakes involve the federal borrowing limit that is due to be breached in a couple of weeks if Congress doesn’t approve an increase. Without further borrowing, much higher taxes, or draconian spending cuts — none of which may be possible or even legal on short notice — the government might not be able to service its existing debts, leading to a default. Congress has never allowed this to happen, so the consequences are unknowable, but they could be really bad.

Now go read the rest if you’re interested, and see what you think.

Here’s another interesting article that combines economic and psychological approaches by Douglas T. Kenrick of Psychology Today: Cruzonomics: The Problem of Free Market Psychology,

Senator Ted Cruz is a fan of the classic model of economic decision-making: sometimes called the Rational Man* view.   On this view, every one of your decisions is designed to maximize “utility” – which translates loosely into personal satisfaction.  If it feels good now, or will make you feel good later, choose it!  Advocates of this position believe that we are, in general, pretty facile at processing information, and at coming to shrewd self-serving decisions.  If you read the book Freakonomics, the authors explain how even seemingly senseless decisions, like changing one’s occupation from computer technician to prostitute, or living at home if you are a drug dealer, are well explained by economic incentive structures.  We are all, on this view, continuously operating like the high-roller in the movie Wall Street, who, while considering a shady deal, asks: “What’s in it for moi?”

Ask NOT what you can do for your country…

On this view, selfishness is not a bad thing.  On the contrary, it is a virtue.  The intellectual patron saint of free-market economics is Adam Smith, who argued that an “invisible hand” moves us toward mutually beneficial arrangements when everyone pursues his self-interest.  For example, if consumers freely compare different fruit vendors at the market place, they will choose the one who charges the lowest price, but the price will not fall below the farmer’s costs of production, or he will go out of business.

But there are a few problems with the Rational Man view.  One is that people often fail to act in ways that economists regard as perfectly rational.  For example, there is a laboratory game called the Ultimatum Game.  Imagine that an experimenter hands you $100 and instructs you to divide it between yourself and a stranger in the next room.  You can divide it any way you want, but there is one stipulation: If the bloke in the next room doesn’t like your offer, nobody gets anything.  What should you offer?

And if you happen to be the bloke on the receiving end of such an ultimatum, how low an offer should you accept?

Again, I hope you’ll read the whole thing and share your views.

The science fiction section at City Lights Bookstore

The science fiction section at City Lights Bookstore

Finally, check out this sociological/psychological essay at Salon, by Michael Lind: Tea Party radicalism is misunderstood: Meet the “Newest Right.” Again, I can’t really do the piece justice with an excerpt, but here’s a taste:

To judge from the commentary inspired by the shutdown, most progressives and centrists, and even many non-Tea Party conservatives, do not understand the radical force that has captured the Republican Party and paralyzed the federal government. Having grown up in what is rapidly becoming a Tea Party heartland–Texas–I think I do understand it. Allow me to clear away a few misconceptions about what really should be called, not the Tea Party Right, but the Newest Right.

The first misconception that is widespread in the commentariat is that the Newest Right can be thought of as being simply a group of “extremists” who happen to be further on the same political spectrum on which leftists, liberals, centrists and moderate conservatives find their places. But reducing politics to points on a single line is more confusing than enlightening. Most political movements result from the intersection of several axes—ideology, class, occupation, religion, ethnicity and region—of which abstract ideology is seldom the most important.

The second misconception is that the Newest Right or Tea Party Right is populist. The data, however, show that Tea Party activists and leaders on average are more affluent than the average American. The white working class often votes for the Newest Right, but then the white working class has voted for Republicans ever since Nixon. For all its Jacksonian populist rhetoric, the Newest Right is no more a rebellion of the white working class than was the original faux-populist Jacksonian movement, led by rich slaveowners like Andrew Jackson and agents of New York banks like Martin Van Buren.

The third misconception is that the Newest Right is irrational. The American center-left, whose white social base is among highly-educated, credentialed individuals like professors and professionals, repeatedly has committed political suicide by assuming that anyone who disagrees with its views is an ignorant “Neanderthal.” Progressive snobs to the contrary, the leaders of the Newest Right, including Harvard-educated Ted Cruz, like the leaders of any successful political movement, tend to be highly educated and well-off. The self-described members of the Tea Party tend to be more affluent and educated than the general public.

Read the rest at Salon.

I hope you’ll find something useful and/or enlightening among these psychological approaches to our current crazy political environment. Now what stories are you focusing on today. Please share your ideas and links in the comment thread.

Friday Reads: Sandy Aid, JFK, Real War on Women, and Fake War on Xmas

Good Morning!!

I hope everyone had a great day yesterday, regardless of how you spent your time.  My day was very quiet, because I had an upset stomach from some brussels sprouts I ate on Wednesday night.  My mom and I are going to have “thanksgiving” dinner at my sister’s place on Saturday, so we just hung out and relaxed.

It’s going to be a slow news day, obviously, but I’ll do my best to provide some interesting reading material.

The New York Times had a nice story about some help for Sandy victims that came from a surprising place–Rikers Island.

On the night that the storm roared into the city, Dora B. Schriro, the correction commissioner, slept on a couch in her office at the Rikers Island jail, bracing for flooding and reassuring inmates and employees that the island would weather the storm.

The next morning, the vast jailhouse complex was mostly unscathed, but Ms. Schriro was stunned by the devastation the storm had wrought elsewhere.

So she decided to put her jail, and those who call it home, to work. Inmates did 6,600 pounds of laundry for people in emergency shelters. The jail supplied generators and gas to fuel them to neighborhoods in the dark, and donated long underwear usually given to inmates. And officers with medical training provided emergency care to victims.

“There was a lot of loss,” said Ms. Schriro, who personally pitched in at food lines on the Rockaway Peninsula, in Queens. “It was our responsibility and opportunity to jump in and help.”

I was disappointed that the story doesn’t say anything about how the inmates felt about all this.

Jail officials did not make inmates available for interviews about the role they played in helping storm victims, but Ms. Schriro said, “I’m confident they knew what they were doing.”

I’m not sure what to think about that.

Somewhat lost in the shuffle of yesterday’s holiday was the fact that it was also the 49th anniversary of the assassination of President John F. Kennedy. Journalist and assassination researcher Jefferson Morley wrote a piece about it at Huffington Post: JFK at 49: What We Know For Sure. Morley reports on new developments in the JFK story since the article he wrote in 2010 called The Kennedy Assassination: 47 Years Later, What Do We Really Know?

One nondevelopment is that “cultural elites” continue to deny any possibility that the official story of JFK’s murder could be flawed, despite new evidence that has been revealed in recent years. Morley writes that there is no real evidence of a CIA conspiracy to assassinate JFK, there is a great deal of evidence of “CIA negligence.” From the HuffPo link:

The truth is this: Lee Harvey Oswald was well known to a handful of top CIA officials shortly before JFK was killed.

Read this internal CIA cable (not declassified until 1993) and you will see that that accused assassin’s biography–his travels, politics, intentions, and state of mind–were known to top CIA officials as of October 10, 1963 six weeks before JFK went to Dallas for a political trip….

In the fall of 1963, Oswald, a 23-year old ex-Marine traveled from New Orleans to Mexico City. When he contacted the Soviet embassy to apply for a visa to travel to Cuba, a CIA surveillance team picked up his telephone calls. A tape recording indicated Oswald had been referred to a consular officer suspected of being a KGB assassination specialist.

Winston Scott, the respected chief of the CIA station in Mexico City, was concerned. He sent a query to CIA headquarters, asking who is this guy Oswald?

Oswald had been on the agency’s radar since 1959 when he defected to Russia, and they had a “fat file” on him; nevertheless, the CIA told Scott that Oswald had “matured” and there was nothing to worry about.

This optimistic assessment was personally read and endorsed by no less than five senior CIA officers. They are identified by name on the last page of the cable. Their names–Roman, Tom Karamessines, Bill Hood, John Whitten (identified by his pseudonym “Scelso”), and Betty Egeter–were kept from the American public for thirty years. Why? Because all five reported to deputy director Richard Helms or to Counterintelligence Chief James Angleton in late 1963. Because of “national security.”

Read much more at the HuffPo link. Not too many American still remember November 22, 1963 clearly, and as Morley says that dark day in Dallas “seems to be fading in America’s collective consciousness.”

It’s looking like once the final tallies from the presidential election are complete, Mitt Romney will have won about 47 percent of the vote.

The legacy of Mitt Romney’s presidential campaign will be marked with by the number 47. Not only the 47 percent of voters that he notoriously dismissed during a fundraising event, but also by the 47 percent of voters who chose to support him. Analysts predict that Romney will have won under 47.5 percent of the popular vote when the final tallies come in, compared to President Barack Obama’s 51 percent.

Romney characterized 47 percent of American voters as dependent on big government and therefore sympathetic to the Democratic platform. Instead, the election proved that the conservative Republican platform could not make a strong enough appeal to the demographics outside of its own traditional backing.

What could be more appropriate?

This one is for Dakinikat: Why Black Friday Is a Behavioral Economist’s Nightmare. At New York Magazine, Kevin Roose writes:

The big problem with Black Friday, from a behavioral economist’s perspective, is that every incentive a consumer could possibly have to participate — the promise of “doorbuster” deals on big-ticket items like TVs and computers, the opportunity to get all your holiday shopping done at once — is either largely illusory or outweighed by a disincentive on the other side. It’s a nationwide experiment in consumer irrationality, dressed up as a cheerful holiday add-on.

As Dan Ariely explains in his book, Predictably Irrational, “We all make the same types of mistakes over and over, because of the basic wiring of our brains.”

This applies to shopping on the other 364 days of the year, too. But on Black Friday, our rational decision-making faculties are at their weakest, just as stores are trying their hardest to maximize your mistakes.

Read about all the potential shopping booby traps at the link.

Here’s a horrifying update in the global war on women: Saudi Arabia implements electronic tracking system for women

RIYADH — Denied the right to travel without consent from their male guardians and banned from driving, women in Saudi Arabia are now monitored by an electronic system that tracks any cross-border movements.

Since last week, Saudi women’s male guardians began receiving text messages on their phones informing them when women under their custody leave the country, even if they are travelling together.

Manal al-Sherif, who became the symbol of a campaign launched last year urging Saudi women to defy a driving ban, began spreading the information on Twitter, after she was alerted by a couple.

The husband, who was travelling with his wife, received a text message from the immigration authorities informing him that his wife had left the international airport in Riyadh.

“The authorities are using technology to monitor women,” said columnist Badriya al-Bishr, who criticised the “state of slavery under which women are held” in the ultra-conservative kingdom.

Women still have a very very long way to go, as we have learned here in the supposedly “advanced” U.S. over the past few years.

But never mind the serious problems that face humanity, the wingnuts at Fox News are focused on the supposed “war on xmas.” From TPM:

In the days before Thanksgiving, Fox filled its shows with dire, sometimes terrifying segments about all the threats surrounding the merriest season of the year. There’s the eradication of free speech by atheist “loons,” the possibility of choking on our food, the diseases spread on airplanes, and the endless depression that comes from Christmas commercials.

If we even make it to Christmas, that is. Fox’s morning man Bill Hemmer charted the possibility that the “apocalypse” would arrive on Dec. 22, and just how sad it will be when we all get wiped out, leaving all those unopened presents under the tree.

Here’s a mash-up of Fox coverage of the “war,” courtesy of TPM.

That’s all I’ve got for now. I hope you found something to your liking. Now what’s on your reading list for today.

Markets (e.g. Herds of PEOPLE) aren’t very Rational a Lot of the Time

The Confidence Fairy is coming for your Savings!!!

One of the primary reasons I didn’t do an investments specialization for my PHD in financial economics is the overwhelming and pervasive group think on Rational Expectations or what’s called the Efficient Market Hypothesis. I’ve never really bought into this.  I think it is more an occasional circumstance or specific market behavior at that point when everything is going just dandy which is why I am more the sunspot equilibrium type.   I never found compelling reasons for the efficient markets view to be considered an overarching framework for all circumstances.  That kind of unorthodox outlook doesn’t buy you much print space in finance journals which means no tenure for you cupcake!!  (Although for some reason I can get it passed reviewers when it’s couched in the term “bubble” which is so very sunspot.)

Economists have become a little more accepting of the warts and  faults inherent in the hypothesis–notice it is still a hypothesis and not a theory–but finance people still have a tendency to worship at its alter.  Economists started out as philosopher social scientists–which is also why the big money is in finance–so they’re a little more open to the idea that markets aren’t all that efficient all the time.  I linked to the Wikipedia explanation of the idea for you which is adequate for our purposes.  The deal is when you build rational expectations into an economics model or investment model this is what you assume.

To assume rational expectations is to assume that agents‘ expectations may be individually wrong, but are correct on average. In other words, although the future is not fully predictable, agents’ expectations are assumed not to be systematically biased and use all relevant information in forming expectations of economic variables.

This basically rules out wrong group think that won’t deny “relevant information”.  If that was the case in reality, there would be no holocaust deniers, evolution deniers, climate change deniers, or flat earthers of substantial numbers to influence the average.  Basically, we’d have to accept the “average” rationality of today’s Republican Party and given the existence, electability and popularity  of Rick Santorum, Michelle Bachmann, and Ron Paul, I’ll rest my case and reject that. We have a major political party that’s basically a cult of irrationality these days.

There are two really important real life phenomenon that make that assumption look really bad in finance research.  One is a little paradox called the Home Bias Puzzle where research has basically shown that most people will still buy investments from their own country despite the availability of better deals abroad. The second is momentum.  This is the pack animal behavior in the market where you see something hit the market and suddenly every one is moving that direction when it doesn’t make much sense on a fundamentals level.  This is when I sell all my stock holdings.  The little voice inside of me will go:  “wtf is this rally for?  The economy isn’t all that great!  I think I better get out of here before they realize they’re all on something!”  This is how I’ve managed to remove my “ass”ets and avoid the major crashes since way back in the 1980s.

Whenever you get a financial crises or financial bubbles, you tend to get the panicked cow phenomenon in that if one is spooked the rest chase wildly along.  They’ve even programed this behavior into their computers oddly enough. Oh, and btw, none of the strategies and no market guru like Cramer or Buffet or Jesus your neighborhood grocer could ever be right and beat the market consistently if the financial markets were truly rational and efficient.  That’s another story, just accept my word for it right now.

I took an Advanced Investments Seminar because I had to for my final elective having no other choice and was subjected the entire semester to the work of Eugene Fama whose big fat head will be in Denver with me next month.   Fama is considered the father of modern finance and efficient markets is his dogma. He’s one of the jerks that was drinking the two overly expensive bottles of wine with Paul Ryan that BB wrote about awhile back. The other jerk being his son in law John Cochrane whose asset pricing models always assume the same efficient markets hypothesis.  The two of them have dominated finance for decades now and in my mind it’s held the entire field back and caused much damage in the real world. I had to recreate the research in many of Fama’s seminal papers and the most noticeable lunacy to me was how his data sets back then always skipped the Great Depression Era. His data sets usually involved equity market indices like the Dow Jones average during periods that excluded financial panics.  That never struck me as honest, but then, I’m not one of the Finance gods–there really are no goddesses–and so I don’t really get a say.

Again, I don’t want to teach this stuff so I generally avoid classes where the textbooks ooze it. I  inherited the sincerity gene from my father which causes me to go apostate on my students which may help their critical thinking skills but won’t further the ass-kissing group think skills required in today’s finance jobs. Also, I’m late to academic life and spent the 80s doing hedging, forecasting interest rates, pricing financial assets and liabilities, and generally surrounded by rational senior management thoughts  like:  “Gee, we’ll get bigger if we do this merger and I’ll get a bonus!  Who cares if it drags our income and balance sheet into the depths of hell?” I can also give you examples from the 90s too.  Irrational market decisions ooze from marketing divisions and departments daily.

So, behavioral finance and economics looks at the herd mentality that was originally identified as “animal spirits” by J.M. Keynes during the time period and stock market behavior that Eugene Fama likes to systematically ignore.  Keynes didn’t have the luxury of skipping over the data of the Great Depression. The kind of apostate philosophy that drives me actually has a label and basically looks at decision making under risky and generally unpredictable situations.  In a lot of cases, people don’t make decisions in these circumstances rationally.   BB and I have been having some phone conversations about the topic because as a psychologist, she’s very interested in human behavior.  Human behavior very much causes people to do different things under times of risk.  Let’s face it, people and hence markets aren’t very rational a lot of the time when they’re panicked about losing their jobs, their businesses, their homes, and their savings. They’re a lot more efficient, rational decision makers when circumstances are not risky and unpredictable or when the biggest decision variables are messy and not well understood. Then, there’s the existence of powerful “deciders” who think their egos have a better understanding of alchemy than their necromancers and are on the look out for narratives to reinforce their beliefs.  Remember the word narrative because it plays a big role here in where I’m going and where Robert J. Shiller went.

So, this background chat brings me to the topic of this blog post which is a project syndicate article by Robert J. Shiller who is a very well respected economist and dabbles in behavioral economics. He is well known for the Case-Shiller index which measures activity in the housing market in some key markets. (BTW, Case is a big sunspot equilibrium sort as is Douglas Diamond who the Republicans ran out of the District earlier this year.)  I’ve taught out of his textbooks.  He teaches at Yale and co-authored a book with Nobel Prize winning George “market for lemons” Akerlof called “Animal Spirits: How Human Psychology Drives the Economy and Why It Matters for Global Capitalism.”.  His voice is important in this day and age of people chasing confidence fairies and reacting to events here and in Europe rather irrationally which frequently happens during periods of great uncertainty and increased risk.

I’m consistently amazed at the success of the narrative that Republicans have managed to push into the national psyche that we’re over taxed and that our national debt is horrendous as its never been before and that our children and grand children will be crushed by it.  You even hear President Obama spew the stuff and he should know better given his ability to access any of the aforementioned economists by phone easily.  As I’ve said before with the use of data and nifty graphs,  the debt was far worse after World War 2, the tax rates far higher and none of us or the US economy was the worse for it.  Really, would you have rather they not borrowed money to fight World War 2 and lived with those results instead? We had nothing but debt when started out as a country and also after the Civil War.  As long as you have lots of really high quality assets and people and the power to tax and print money, it’s NO BIG DEAL! Greece does not have Bill Gates and Microsoft continually pumping out huge amounts of value. We have him and lots more like them!  People have been reacting to ideological nonsense and narratives.  We have a failure of governance and policy because of this. That’s hardly rational.  It’s also causing bad effects in our home prices, the value of our savings, and our ability get and keep jobs.

So, here’s Shiller writing on “The Great Debt Scare” about how this ideological nonsense has shaken consumer confidence in both Europe and the U.S. causing a “perverse dynamic” that has been discouraging consumption and investment which has brought about economic weakness.  What this basically shows is that the psychology of self-fulfilling prophecies is alive and well in financial markets. Rational Markets my swamp people ass!

We now have a daily index for the US, the Gallup Economic Confidence Index, so we can pinpoint changes in confidence over time. The Gallup Index dropped sharply between the first week of July and the first week of August – the period when US political leaders worried everyone that they would be unable to raise the federal government’s debt ceiling and prevent the US from defaulting on August 2. The story played out in the news media every day. August 2 came and went, with no default, but, three days later, a Friday, Standard & Poor’s lowered its rating on long-term US debt from AAA to AA+. The following Monday, the S&P 500 dropped almost 7%.

Apparently, the specter of government deadlock causing a humiliating default suddenly made the US resemble the European countries that really are teetering on the brink. Europe’s story became America’s story.

There is something—most likely hard wired–in people that creates highly irrational narratives ( we call them frames) to justify stuff that occurs even in the face of incredible evidence against the frame. It’s why there are so many evolution and climate change deniers. The narrative makes them feel better than the reality.  We all edit out the data coming from those periods of intense irrationality–like Fama did with the Great Depression–to justify our pet juicy rationalizations.  It’s like the post-trauma narrative you create to justify something you did when your lizard brain kicked in. Republican and so called conservative operatives seem to thrive on spinning lizard brain activity into parable like narratives to hone their advantage.

Changes in public confidence are built upon such narratives, because the human mind is very receptive to them, particularly human-interest stories. The story of a possible US default is resonant in precisely this way, implicating as it does America’s sense of pride, fragile world dominance, and political upheavals.

Indeed, this is arguably a more captivating story than was the most intense moment of the financial crisis, in 2008, when Lehman Brothers collapsed. The drop in the Gallup Economic Confidence Index was sharper in July 2011 than it was in 2008, although the index has not yet fallen to a lower level than it reached then.

So, what do these current confidence surveys tell us according to Shiller?

The timing and substance of these consumer-survey results suggest that our fundamental outlook about the economy, at the level of the average person, is closely bound up with stories of excessive borrowing, loss of governmental and personal responsibility, and a sense that matters are beyond control. That kind of loss of confidence may well last for years.

That said, the economic outlook can never be fully analyzed with conventional statistical models, for it may hinge on something that such models do not include: our finding some way to replace one narrative – currently a tale of out-of-control debt – with a more inspiring story.

So after our lizard brain causes fight or flight, the Captain Picard part of our brain tells us to make our narratives so. What we are building into our psyche is not any kind of analysis based on rational views of historical data, economic theory, or for that matter, common sense.  What we are building into our psyche is a narrative that isn’t very rational and that’s impacting our behavior and the behavior of markets.  Now, if we could just stop the press from reinforcing all the irrational crap out and about these days maybe we could sit down, take a few deep breaths, and peel back the layers of skin on the onion of those destructive narratives.  Think about it. Yes, the Garden of Eden story is a great narrative, but what explains the carbon dating data on rocks, the dinosaur bones, and the vast existence of several varieties of protohumans’ remains better?  Dinosaurs and Neanderthals in the Garden of Eden with Adam and Eve (not Steve or Lilith) or the Big Bang THEORY and the THEORY of evolution?  What explains the financial crisis and the fallout better?  The narrative that it’s too much government debt, too high taxes, and too much  regulation that were all at much lower levels now than after the World War 2 economic boom or excessive speculation in the markets and exotic, difficult to price, unregulated derivatives, NINJA loans, government encouragement of monopoly and oligopoly power, and  fiscal policy known to suppress economic growth? Your choice.  Theory or comforting bed time tale.

Irrational numbers

maskI’ve sat in two doctoral level investment classes for my degree. It’s not one of my fields because I just don’t want to take the derivatives seminar.  I actually have a lot of disdain for the field now that I’ve done the proofs on the major models.  My ex husband worked 20 years for an insurance company in their investment department doing the real thing.  It was one of the reasons I actually left him.  I find the entire field pretty insufferable.  Unfortunately, it’s also one of the highest paying fields you can have as an academic.  It’s much easier to get big publications in Finance than Economics. That’s basically because there really isn’t an awful lot of theory in finance.  It’s mostly data mining looking for some kind of theory.   As you can  probably tell by now, I’m not really popular with the Investment professors.  They don’t understand me primarily because I’m not out to make money. (Well, that and I refuse to call Eugene Fama God)  My research is always based on contrariness about the current asset pricing models we teach.  I especially disdain the ones that we teach to MBAs and Finance majors.

A lot of Finance is based on two assumptions that I can’t buy. One is that the market follows a random walk.  (This is Fama’s big contribution for which he expects to get a Nobel, but hasn’t managed to date.)  A lot of time is spent looking at the equity markets saying you can’t beat the market or really forecast it because it’s a completely random series.  The second is that the investor is a rational being.  Most of the field total ignores the old Keynesian idea of ‘animal spirits’.  That’s the idea that the market can get a herd mentality and spook at various events and move like a bunch of scared cows.

There’s a field in Finance that’s beginning to get a little bit of respect but still is considered a little out there. That’s probably, why it’s the only parts of Finance and Investment theory that intrigues me.  It’s called Behavioral Finance.  It looks for anomalies in the market and tries to find the reasons for them based more on human psychology rather than trying to just call them odd events.  That’s why I was happy to read this account,  Irrational everything,  written by Guy Rolnik on  Prof. Daniel Kahneman.  Kahneman’s a collector of stories of irrational behavior when it comes to people and finance decisions.  His voice would really add some flavor to the current collapse of modern finance.  Here’s a non finance example that just tickles me every time I read it.

But the story Kahneman recalls when asked about the economic models at the root of the current financial crisis is actually taken from history, not an experiment. It concerns a group of Swiss soldiers who set out on a long navigation exercise in the Alps. The weather was severe and they got lost. After several days, with their desperation mounting, one of the men suddenly realized he had a map of the region.

They followed the map and managed to reach a town. When they returned to base and their commanding officer asked how they had made their way back, they replied, “We suddenly found a map.” The officer looked at the map and said, “You found a map, all right, but it’s not of the Alps, it’s of the Pyrenees.”

According to Kahneman, the moral of the story is that some of our economic models, perhaps those of the investment world, are worthless. But individual investors need security – maps of the Pyrenees – even if they are, in effect, worthless.

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