I am intrigued by the issue of how our own cognitive foibles impacts our decision making processes as investors. Our behaviors have evolved for other reasons (primarily survival); Regular readers know I am especially interested in how our wetware fails us when applied to making risk decisions in capital markets.
It is exceedingly difficult to avoid these kinds of biases and cognitive errors in your own behavior, which is why smart investors develop rule based decision-making to help overcome these issues.
It is, however, a rather simple task to identify cognitive errors in other people. I find myself constantly playing pop cognitive therapist as I watch massive rationalizations occur. I see them deployed to explain why stocks are rallying, or why the economy hasn’t collapsed yet, or why a fit of under reported inflation will soon lead to $7000 gold (ignore the falling prices for now).
Probably the greatest example of bias is seen as some try to explain why the financial crisis occurred. Post bailout, the flailing, cognitive dissonance has been astounding. It is the underlying cause of the Big Lie.
I was reminded of this while reading a Real Time Economics post on Why Canada Can Avoid Banking Crises and U.S. Can’t. It discusses a new paper (and forthcoming book) by Charles Calomaris and Stephen Haber. The thesis is that Canada has a French legal history, which created a “highly-centralized federal government which controlled economic policy making and had built-in buffers for banker interests against populist forces” as the primary reason for its stability in banking.
Calomaris is an economics professor at Columbia University. My experience with him is he’s a really nice, really smart guy. At a conference somewhere in the Caribbean (I think Cayman Island), we had dinner with the wives after our respective presentations. I am often interested in what his thinking is about economic topics.
But it is his other role, as Co-Chair of AEI’s Financial Deregulation Project with Peter Wallison that raises questions in my mind.
Back to Canada: The legal backdrop is a fascinating concept, one I want to explore further. But I cannot help but wonder if this line of thinking came about to avoid the obvious issues in the US, namely, the crisis was driven in large part by the radical deregulation.
In Canada for example, there are other factors beyond the French legal history worthy of discussion. Note that in Canada, bankers cannot lobby regulators. Unlike the US, their Supreme Court does not think corporations are people. In Canada, money is not speech. There are explicit limitations on Corporate political donations. And where as we have a revolving door between government service and the private sector, the restrictions are much greater in Canada. All of this adds up to a much more intensely regulated banking system than in the America.
Which makes me wonder how this will get treated in their book.
It also raises important questions regarding academic objectivity. If your starting premise is that the financial system needs to be deregulated, how objective can any of your subsequent academic research be? If you spend time co-chairing AEI’s financial deregulation project, how much of your thought process is in part a rationalization of your own role in creating the crisis? (I’ll let someone else look into the issue of academic research being funded by deep-pocketed ideological Think Tanks). If your starting premise is deeply, fundamentally flawed, what happens to the academic theories built on top of that foundation?
By all means, we should be looking at all of the factors that drove the credit bubble and collapse. We just need to be especially aware of the framework our own biases create when we do so . . .
Why is AEI Scrubbing Wallison’s Name From AEI’s Financial Deregulation Project? (December 15th, 2010)
Why Canada Can Avoid Banking Crises and U.S. Can’t
Real Time Economics, April 9, 2013