Wednesday, 20 August 2008

Robert Shiller on bubble psychology

Robert Shiller has a short book out on the sub-prime crisis and how to respond to it. I'll bung up a review once I've read it. He's big on the importance of psychology and in particular the idea of contagion as reasons behind the current mess. Below is a good bit on the late 1990s stockmarket bubble (about which he has obviously written a great deal):

That boom inolved a transformation of people's thinking about their role in the economy. The idea developed that we ought to expect to make a lot of money investing. The transformation went well beyond opinions about particular investment strategies to alter the very self-esteem mechanism that supports our egos. The Protestant work ethic that had underlain the national psyche for so long underwent a makeover. To a substantial extent, we no longer admired those who were merely hard workers. To be truly revered one had to be a smart investor as well.

It is the change in thinking about ourselves that is the deepest cause of the bubble, and maybe the slowest to unravel after the bubble comes to an end. George Akerlof and Rachel Kranton have shown persuasively that economic theorists must take as fundamental that people care more about who they are and how they are viewed than the kind of food they are eating or car they are driving. A life as an investor has become more than a means to an end, it is an end in itself.

The first para in particular rings very true with me, having seen a few people get carried away in the TMT surge. I also agree that speculative booms must have an impact on how we see ouselves and others. I tried to argue previously that I think financialisation has had a cultural impact, but I think Shiller in more accurate in describing it as a psychological one. When everyone else seems to be making money out of shares/houses/tulips there must be a very strong pull to join in.

2 comments:

Nick Drew said...

clearly an interesting and highly pertinent theme: a couple of points

- in addition to the recent vogue for speculation, we are all actually driven to take more personal responsibility for investing, given Brown's decade of assault on pensions

- the Parable of the Talents ! - shows that there is a longstanding tradition of approval for those who know how to make a turn from (prudent) investment, and disapproval - rather strong disapproval, actually, if you care to read it again - for those who do not put money to work: the foolish servant didn't squander the money, he just didn't do anything with it & simply kept it safe, and still he got it in the neck

how well-equipped folks are to shine in the investment lark is of course another matter altogether ... and as the conclusion of the Parable goes:

to him that hath, shall be given: and to him that hath not, even that which he hath shall be taken away

ain't that the brutal truth ? and it's 2000 years old

Tom Powdrill said...

Hi Nick

I'll have to agree to disagree with you about Labour's record on pensions ;-)

I do wonder where the move to put ever more responsibility on individuals to invest for themselves will take us. The evidence suggests that professionals get it wrong quite a bit and in my experience pension fund trustees often struggle even when they have a bank of advisers to support them.

So I think the design of default funds in money purchase schemes is one of the most important issues in pensions (since, hopefully?, most people will end up in the default rather than attempting to do it all themselves).

Funnily enough I came across the Parable of the Talents a few years back in a book by US corp governance activist Bob Monks.