Jonah Lehrer's book. How We Decide http://tinyurl.com/... has clarified my thinking about the bailout of financial companies and the why the approach of both the Bush and Obama administration have been a failure so far. It's not enough to shore up the industry. We must fundamentally change the assumptions that lay behind the failure and we should starting doing that now.
The book starts by challenging the ideal of the purely rational man set free from his nasty base emotions. The fact is the human beings cannot make a decision based on rational thought alone. People whose ability to feel emotion has been destroyed due to brain injuries or tumors lose the capacity to make a decision. Instead they become relentless information gatherers, performing endless comparisons between their choices but incapable of choosing. It seems we need emotions to motivate us into making that choice.
Conversely, people whose ability to weigh long-term consequences has been impaired tend to respond more to immediate gratification, leading them into long-term self-destructive behaviors. We clearly need both capacities to be effective decision makers.
Lehrer has some interesting illustrations about why intuition can lead to effective decision making in time-pressure situations such as a quarterback in the pocket looking for a receiver or the radar operator who correctly identified an incoming Scud missile even thought no one, including himself, could explain why he knew it wasn't a returning jet fighter. In both instances, experience allowed them to process subtle cues more quickly than rational thought processes could. The processing of these cues manifested itself as a gut instinct which they learned to act upon.
Emotions do have negative consequences in our decision making if we are not aware of what is behind the emotions. Sociologist have identified "Aversion to Loss" as a major factor in our decision making. In fact, people will make contrary choices when faced with the same decision depending on whether the choice is framed in terms of loss or not: "This operation has a 10% mortality rate" vs. "This operation has a 90% success rate."
Aversion to loss plays a big factor in why Americans don't save. Brain scans have shown that we respond with very different parts of our brain depending on whether we buy something with cash or a credit card. We experience paying for something with cash as a loss and are less likely to buy something on impulse. Buying something with a credit card, eliminates that sense of loss so that the part of the brain the responds to gratification is predominant.
Also at play is the strong biological response to gratification. Most people are aware of the value of delaying gratification for a longer term benefit, and in can resist an abstract enticement. But it takes a very disciplined person to resist that enticement if it is dangled right in front of them.
Companies are well aware of this phenomenon, which is why so many credit card companies and mortgage companies offer low introductory rates that then rose significantly some time in the future. As Oscar Wilde put it "I can resist anything except temptation."
At the same. these and other companies have been engaged in the same sort of poor decision making based on a short-term interest without regard to long term consequences. We have been asked to bail out companies whose reckless decision making has crippled the economy, brought long-established firms to their knees and brought many families to the edge of bankruptcy or worse. Yet, we are being asked to stay out of the running of these companies, out of the decision making process because business people know better. We must accept this on faith because the evidence belies this assertion.
We are being asked not to regulate executive pay because it will eliminate the incentives for executives to do well. However, the evidence points to the fact that these incentives lead to decisions based on short term gratification and not the long term benefit of the company or the economy. Whatever happened to the notion of moral hazard, the notion that you reaped what you sowed: good or bad. These market bulls have destroyed the china shop and we are being asked to restock the shop without any consequence to the bulls.
Many economists have offered the Swedish model as the correct approach to dealing with the banking crisis. Most discussions of the plan seem to dissolve into accusations of nationalization and socialism, purported fears of bank runs or explanations why the relative difference in sizes of our economies and the number and/or size of these banks makes the solution unworkable in the US.
The accusation of Socialism is nothing but fear-mongering by ideologues. Even nationalization is a inaccurate choice of words since it brings to mind the Government takeover of a whole industry rather than the temporary receivership of failing institutions. No one expects the banks to be in hands of the government longer than it is necessary to bring them bank to a sound footing. The banks would still be run by businessmen, but they would have true accountability to the government.
Under the Swedish plan, government takeover of a bank was voluntary. Once a bank was taken over by the government, their management was forced out. This provided a strong incentive for managers of other banks to find solutions to their problems and only the banks in the worst condition asked for government help. If a bank is strong enough to stay out of the bailout program, why would they face a run? The Swedish plan seems a much more rational choice than either handing over as much money as these institutions want or letting them collapse, consequences be damned.
All this pretense that these banks aren't insolvent just hampers the governments ability to deal with the problems. Yet the hope that the government will buy toxic assets just keeps delaying the day of reckoning and therefore the the day we can truly start solving this mess. All the banks know that the other banks are hurting but nobody knows for sure which ones are still solvent and ones which are empty shells. They all know that some form of market reform is coming but they don't know what it is and when it will arrive. Too much is still up in the air and no one is willing to make a move without a clearer picture.
I know the Obama administration is working on market reforms, but they should come sooner rather than later. The AIG bonus nonsense was only possible because of the pretense that it is a solvent institution. And all it did was to further distract the Obama administration from being able to focus on real solutions.