Saving the economy from our brains

By J Saft
February 6, 2009

James Saft Great Debate – James Saft is a Reuters columnist. The opinions expressed are his own –

Our brains are wired for bubbles, it would appear, and regulation and tight external controls are the only way to save ourselves from ourselves.

Bankers, traders and investors effectively became addicted to the pleasure that comes from making money, while at the same time increasingly losing touch with just how much risk they were taking.

The result was a bubble in risk taking, debt and many financial assets and the inevitable crash and complete pull back in activity.

“The finance industry was adapting to the level of risk,” said Gregory Berns, a professor of neuroeconomics at Emory University in Atlanta who uses brain scanning technologies to try and decode the decision-making systems of the brain.

“It is an insidious process, you are not aware of it. You are addicted to returns, you are addicted to risk, you are addicted to cocaine — it’s all the same as far the brain goes.”

Berns, who says that the brain has no mechanism for being satisfied, compares the process of becoming adjusted to new stimulus such as making money or taking risks to the eyes adjusting to the light; while at first it seems bright, your brain adjusts and you no longer perceive the light as bright, the money as enough, the risk as high.

So in order to get the same buzz from making money you have to up the stimulus, doing more of what it was that brought in the money in the first place. At the same time your perception of risk becomes less sharp.

So with the same regret that a recovered alcoholic looks back on driving after seven martinis, we all now look back on an investment bank with a 40-1 leverage ratio.

Seemed like a good idea at the time, but an addiction like any other. Berns, an outsider to finance, looks at other addictions and concludes that what’s most likely to succeed is a system of controls imposed from outside, namely government regulation.

“It needs an imposition from outside; addicts have a difficult time self-treating, it needs structure.”
But that of course is complicated by the fact that what government and the rest of us want the banking industry to do is not go off risk cold turkey but to control the amount of risk it takes so that enough credit is created to allow the economy to grow. So it’s a bit like a 12-step addiction program that meets in a bar and in which the object is not sobriety but being just pleasantly tipsy. It’s a hard ask.

SOMEONE TO WATCH OVER ME

People who are against government regulation will say: why do we think governments are going to be better at figuring out what is risky? But if you look at it from the point of view both of compensation and conflicts of interests, and of brain chemistry and psychology, you will see that is not the point.

Governments are probably marginally more hopeless than bankers or the markets at figuring out what is what in the beginning, just as the guy in the risk department at Big Bank plc knows a lot less about the derivative market than the physics PhD he has to oversee. But the person with the most to gain from the activity is the person most likely to have his opinions distorted over time. The important thing is to be beholden to someone with oversight and power who will check your natural tendency to get carried away.

We simply need outside controls, both in terms of company controls and government controls, to help stop us from deluding ourselves.

James Montier, a strategist at Societe Generalein London and an expert in behavioral finance, says that our beliefs about our abilities and future behavior is often profoundly out of step with reality.

People believe they will act in one way when contemplating an emergency, for example, and then act in quite a different one in the heat of the moment. The solution is harder rules and more process, just as data has shown that even the most experienced surgeons have better outcomes if they use something as simple as a checklist.

“What it drives you to is the primary role that process has to play in investment,” Montier said.
“You can’t control return, can’t control risk; all we can control is how you approach investment.”

The fact is that controls are needed. Parts of the system like hedge funds which have no call on state insurance if their bets go bad would be well advised to put in their own controls. Those parts which we all seem to be insuring need to have those controls imposed from on high.

Those controls will be circumvented and worn away by future successes, but that is no reason not to try.

– At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. For previous columns by James Saft, click here. .  –

36 comments

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The problem with regulation is that it never identifies the latest risk – only the previous one. The nature of the particular risk changes and so does the perception of it – by regulators as well as traders. There is a mechanism that deals with imbalances unimagined by traders or regulators. It is called the market. As we are finding out, it works – maybe not as quickly as we might like, but really, really well.

Posted by John Melrose | Report as abusive

I agree rules are important but what have we seen in this crises? Even with a lot of rules around the people who had to act on these rules looked the other way and as such deluded the public into unsafe investments.So, the cry by Henry Kissenger for a new world order is a cry for the U.S.A. to regain power on an other way.Not the lacking of rules made this crises possible as we have seen in Europe for instance where every country needed an other crises anti-dope. Far from being one Europe better is to be united as separate sovereign countries in talkings but not in building up a to big to handle very corrupting massive molog institute which the powermad very much like to see.

Posted by Youri Carma | Report as abusive

People have known this in generations past and understood that boundaries had to placed on public officials. I would think that CEOs of public companies also need to be held to some boundaries because of the amount of damage they can do to society.From Wikepedia:”The concept of the public trust relates back to the origins of democratic government and its seminal idea that within the public lies the true power and future of a society; therefore, whatever trust the public places in its officials must be respected.One of the reasons that bribery is regarded as a notorious evil is that it contributes to a culture of corruption in which the public trust is eroded.A famous example of the betrayal of public trust is in the story of Julius Caesar, who was killed by Roman senators who believed they had to act drastically to preserve the republic against his alleged monarchical ambitions.”

Posted by Linda | Report as abusive

Exactly!!! There’s really no logical reason to buy stocks these days, but every time that there is a glimmer of hope (usually news containing the words “stimulus” and/or “bailout”), there’s a “sucker’s rally”. The reason? Nostalgia. Remember those good old coupon-clipping days. Oh what fun it was to review the evening stock market results and calculate the increase in your personal wealth. All this reminds me of a poem by Edgar Alan Poe:”When will is see my lost Lenore?Quoth the raven, “Never more”.

‘Those who do not know history are condemned to repeat it!We’ll have another ‘bubble,’ in another fifty or sixty years. Such is the nature of our dual existence, as all things come and go in cycles. One extreme seeking its opposite (enantiodromia).We had a ‘liberal’ cycle with FDR.Then Reagan came along and we’ve had a disastrous ‘conservative’ cycle.Back and forth we go, as we never learn!

There are many stories and dimensional views about the present crisis. But if we look at it seriously, IT IS A HUMAN LUST FOR MONEY. For last one and half decades globally every institutes is busy making their money double with each passing year. The new generation of MBA’s saying ‘in business every thing is possible’ and keep applying extra aggressive tactics to achieve their motives, now entire world is paying the price.

Posted by Al Baloushi | Report as abusive

I don’t get why some people just don’t “get it” and still want to say that “the market works” and there shouldn’t be regulations governing HOW it works. Kind of like saying there shouldn’t be speed limits or safety standards: if someone goes too fast, their auto will simply blow a tire, blow an engine, spin wildly out of control and kill 30 members of a boy scout group on a bus, or some other event that ends up slowing the driver down. Any damage caused is irrelevant, since the driver did end up slowing down, didn’t he? If I put my money in a bank, I want to get it back. The only way that’s going to happen is if there are rules about how that money is to be handled in the meantime. In this case they weren’t remotely adequate, and the US has completely blown their credibility as a financially responsible nation. Their days of importance are numbered.

Posted by Rufus | Report as abusive

“Berns, who says the brain has no mechanism for being satisfied…”The brain does have a mechanism for being satisfied. It’s located in the mind. It’s called gratitude. Gratitude, being of the mind, is a stronger emotion than lust, which is limited to the brain. Addictions, whether uncontrolled risk taking, or anything else, are uncontrolled lusts. Gratitude trumps lust. One cannot experience anger, or any number of lusts, while experiencing real individual gratitude. Addiction wisdom teaches us to access individual gratitude to control our lust. Religious wisdom teaches us to access individual gratitude through prayer. Folk wisdom teaches us to access individual gratitude by counting our blessings. When the mind accesses gratitude, it overcomes the brains lust. But there is no wisdom that teaches institutional access to gratitude. No wisdom that allows it because institutions function mindlessly to be successfull. The basic amorality of the institutional growth philosophy: Only responsible to the stockholders, must have growth, nothing else counts or matters, is a group think philosophy, precluding individual think. Institutions exploit individuals; first and foremost those individuals who work for institutional growth, who must adopt the amoral institutional philosophy to succeed. The true conflict we face today is resolving the institutional philosophy of success with the individual philosophy of success. World wide, individual taxpayers are being asked to fund financial institution losses. At some point soon we must face the fact that institutions must be allowed to fail, just like individuals. The whole institutional mindset must fail, in the form of the institution, before we will have an opportunity to change it for the better.

Posted by Peter | Report as abusive

The most important thing you as an individual can do to improve the current financial climate in your neighborhood is take all your money out of the multinational bank you currently use and put it in your local credit union. Period. It’s the one act available to all of us that puts us back in local control of our money.

Posted by Peter | Report as abusive

The West has put too much confidence in the unbridled market economy not taking into account the fact that man is intrisincally greedy and self centred. I sure is addititive making money especially when it not yours and the so called gurus of finance have been given too much leeway to come up with products which are so complex that nobody seems to understand how they work and is sold just because they are marketed by so called reputable firms backed by rating agencies.

Posted by Regeev Govindan | Report as abusive

governments get elected by providing the populace with the things they want, and get punished for telling the american public they can’t have what they want. It should come as no surprise therefore that bubbles are encouraged at the expense of long term stability. I’d advise almost everyone to read what marc faber has to tell you. governments can intervene to prop up the economy only if they also work to minimize bubbles in a counter cyclical behavior. Until we are willing to accept this we have to realize washington will do everything in its power to get reelected ensuring the problem is delayed for a time further down the road for someone else to deal with. This is the nature of human behavior and to expect otherwise is foolish.

Posted by dcb | Report as abusive

We are looking for a scapgoat and we have found all of them who were greedy enough to cut the same branch they were sitting on.They all are Bernard Madoff of the world and some did out of greed mostly other people’s money and also they were selected group of one or two racial backgrounds,Enough said.peace to everybody in mind and soul.

Posted by vj | Report as abusive

There are many culprits in this fiesta of idiocy. A society driven by instant gratification and by rag-to-riches myths is as much at fault as a bunch of bankers trying to make billions out of millions. The latter are virtually criminal (and as a journalist I actually heard bankers congratulating themselves for making 300 % on some schemes, while paying out 10 or 12 %. Still: bacteria require a nourishing medium to proliferate. Society’s collective ethical compass was dumped by Ronald Reagan. Let us hope that we can recover it.

Posted by Talleyrand | Report as abusive

Mr. Saft. What rot!Governments set fiscal policy. Central banks set monetary policy. They collectively decide whether or not they are going to run debts and deficits that need to be financed. And they control both the cost and quantity of money via interest rates. Although it is hard for central banks to control both at the same time. Excess money supply creation means that money has to be invested somewhere even if the rates of return do not justify the risk being taken.Low real interest rates, in many cases zero or negative, encourage risk taking as borrowed money is essentially free. But governments love it when banks, investors and traders make money because then they get their cut via taxes. Taxes that can then be shared with voters to ensure that governments made up of politicians get re-elected.Balance budgets and pay down debt, while keeping real interest rates neutral and currencies at their trade-weight adjusted value, and you go a long ways to making financial systems both more robust and stable.We are in the worst credit crisis and financial meltdown in generations. Quite frankly I am getting quite tired of Monday morning quarterbacks – financial journalists such as yourself – constantly banging on about how banks, traders and investors created this mess when really their true cause were the build-up of global financial imbalances caused by excessive money supply creation and the rapid expansion of credit as well as central bank manipulation of currencies to remain export competitive.Why it is so annoying is because the only difference between a recession and a depression is the policy response to such a crisis. If you do not understand the causes of the crisis you cannot formulate a responsible public policy response. Seriously Reuters needs to find some financial reporters that understand both macro-economics AND finance. Opinions alone just do not cut it. I am not addicted to risk. I am allergic to mediocracy.

Posted by MrBill, Eurasia | Report as abusive

The comments regarding the misguided corporate philospohy that forces individuals to step in line or get out of the way is the sad truth of todays society. There is no room for even a slight doubt or failure. Once you show a weakness there will be a punishment, company or individual level. No room for high moral standards. I get sick hearing CEO’s preach the crap about leadership, mentoring, team building etc. It seems the bigger the failure the meager the consequences provided you are high up in the hierarchy. So what does a regular guy do – carry on being exploited simply because you’re doomed otherwise. In that environment fraud, risk-taking, deceit will flourish.

Posted by Franz Kafka | Report as abusive

The previous comment re. credit unions is spot on. Banksters are bankrupting the system and the global economy. The effect of the gradual befogged the windshield: Ample warnings were out there for a very long time. Here in the US, a common, longstanding comment is: Where do you put it? … Under the mattress isn’t good enough. When I moved here from Toronto two decades ago, I found the fear and cynicism over the safety of one’s assets quite shocking.

Posted by Lynn Cee | Report as abusive