Sunday, August 21, 2011

A very interesting article on financial “irrationality”

I read quite a few articles on the economy and the economic crisis. Most of them seem soberly written, and pretend to be analyzing the situation in informed, rational ways. And most of them show little understanding of why we are in an economic abyss and do not seem to be able to predict the future accurately. These articles perhaps seem convincing because they are, on the surface at least, apparently rationally written.

Only very, very few acknowledge the irrationality of the system. How could a system, devised by whizz-kid mathematicians employed by major banks and financial institutions be so irrational? After all, before they answer your questions, these kids grab the slide ruler or its modern equivalent to give you a precise, rational, answer.

An excellent article by Danny Schecter is a refreshing departure, because it acknowledges explicitly that the financial system is driven by greed and fear and arrogance. Greed and fear are emotional states that are difficult to analyze rationally. As I have argued here before, greed and its pursuit are very likely accompanied by de-activation of large parts of the brain, and specifically the parts concerned with judgment. Hence the actions and decisions taken by those in this state – especially when the prize is untold riches – is considered irrational, at least when analyzed by people who are not themselves in that state.

But is it really irrational? Yes, if you judge it by the standards of rational judgment. But I think that emotional behaviour has its own logic and rationality, which we commonly fail to understand, precisely because we analyze it with our rational brains.

But no, they are not irrational, if judged by other standards. Would one financial wizard, consumed by greed, consider it irrational when another financial wizard, equally consumed by greed, sells sub-prime mortgages to make fat profits? In the greed world, there is nothing irrational about that. And recent history proves it. Those actions evidently received wholesale approval. Nor was this approval restricted to the financial wizards. Those who bought the mortgages were probably equally consumed by the dream of rich profits, with minimal outlay.

If you think about it, there is nothing really irrational when someone consumed by greed behaves in unethical ways provided that he is rewarded, at least periodically. And of course, he would do it again and again, even after he fails, because in greedy states the cognitive, judgmental parts of the brain are inactive.

This is not unlike the brain system regulating romantic relationships. In phases of intense, passionate love, it appears as if large parts of the brain are inactive. Hence lovers often behave as if they have taken leave of their senses. But in fact, their conduct makes biological sense.

Neurobiologists have for a long time emphasized brain activity when we undertake particular tasks or are in particular states. Perhaps the time has come to give equal emphasis to brain de-activation when we undertake particular tasks or are in particular states.


Stephanie said...

Mmmm. Interesting in so many ways. Do you know Aristotle? Seneca? - I'm sure you do.....There's a pocket-sized translation (I know you probably read him in Greek) "Life is long if you know how to live it" which has transformed the mental life of my 18-year-old son, immersed as he is, willy-nilly, in the teen world of trainers & Blackberrys, brand-names and online games. He's found a new, wise friend talking to him from the mists of antiquity....

S.Z. said...

Delighted to learn that the wisdom of antiquity has intruded so early on!
But you flatter me: I wish I could read in the original Greek (I mean ancient Greek), but I cannot. I gather that Plato, especially, is far better in the original, rather than the modern, Greek