Business Blog: Hoover’s Business Insight Zone

One of my long-term interests centers on how we decide, and in particular the sorts of neurological or psychological biases that affect our processes of making decisions. So you can understand my interest in this IndexUniverse interview with Jason Zweig, author of the recently released Your Money & Your Brain: How the New Science of Neuroeconomics Can Help Make You Rich. A couple of tidbits:

Straight From The Source: Jason Zweig

. . . The brain has been built to make basic decisions about risk and reward. We don’t have financial circuitry in the brain. We haven’t evolved to make decisions specifically about money. That’s one of the really interesting things about neuroeconomics: It shows very clearly that when you make a decision about a profit, it’s processed in the same part of your brain that processes everything else that feels rewarding, like chocolate cake, Cheetos and drugs, sex and rock ‘n roll. When you make a decision about risk and losing money, that’s handled by the same kind of circuitry that responds when you face physical risk and mortal danger. There’s not much difference in the brain between having a rattlesnake slither across your living room carpet and having some stock you own go down 40 or 50 percent. Basically it’s the same response, which is, “I’m in trouble; how do I get out of here alive?” It’s very fast. It’s incredibly rapid.

. . . The really surprising thing is how little we know about how we think. J.P. Morgan once said that every man has two reasons for everything he does: the reason he states and the real reason. I think he meant something a little different by it, but what a neuropsychologist or a neuroeconomist would say is that most of us don’t even know why we do things ourselves, and we can often be in the grip of unconscious emotion or unconscious biases, feelings and inclinations that are in our mind but we have no awareness of. By definition, this is one of the hardest ideas you can ever get someone to admit.

It’s a very interesting read. Check it out.

The interview also puts me in mind of a lecture by Charlie Munger (vice chairman of Berkshire Hathaway). In the lecture, Munger details a variety of heuristic biases that tend to lead investors astray.

The Psychology of Human Misjudgment

…What happens when these standard psychological tendencies combine? What happens when the situation, or the artful manipulation of man, causes several of these tendencies to operate o­n a person toward the same end at the same time?

The clear answer is the combination greatly increases power to change behavior, compared to the power of merely o­ne tendency acting alone. Examples are:

- Tupperware parties. Tupperware’s now made billions of dollars out of a few manipulative psychological tricks. [...]

- The system of Alcoholics Anonymous: a 50% no-drinking rate outcome when everything else fails? It’s a very clever system that uses four or five psychological systems at o­nce toward, I might say, a very good end.

- The Milgr[a]m experiment. It’s been widely interpreted as mere obedience, but the truth of the matter is that the experimenter who got the students to give the heavy shocks in Milgrim, he explained why. It was a false explanation. “We need this to look for scientific truth,” and so o­n. That greatly changed the behavior of the people. And number two, he worked them up: tiny shock, a little larger, a little larger. So commitment and consistency tendency and the contrast principle were both working in favor of this behavior. So again, it’s four different psychological tendencies. When you get these lollapalooza effects you will almost always find four or five of these things working together.

Particularly interesting to me is this “lollapalooza effect,” through which various biases are piled atop one another, leading us badly astray. It happens all the time, and it can lead astray even the most brilliant and principled among us.

Though I’m not sure exactly where to start untangling the current mess in the credit markets, my hunch is that using Munger’s rubric would uncover multiple overlapping biases that have led large sets of investors astray. Food for thought, anyway.