Search results for: Cognitive Dissonance

The Cognitive Dissonance is Strong in This One

Stick With Numbers When Judging Trump’s Rally
Anything else is just story-telling in the interest of scoring political points.
Bloomberg, October 20, 2017



Whenever I write about anything with even a vague political component, I always get the strangest correspondence. Much of it is unpublishable and sometimes amusing, and usually worthy of nothing more than a Twitter block. And yet these missives offer something useful about one of my favorite subjects: Why our brains are not wired for finance.

That was the case last week, when President Donald Trump tweeted the following : “It would be really nice if the Fake News Media would report the virtually unprecedented Stock Market growth since the election.”

That statement about the stock market can be easily checked. This has nothing to do with your party affiliation or political views; it is a very simple mathematical question. The statement is either true or false, and not subject to debate.

That is what I did in an article that examined the historical record (as did Bloomberg News). As it turned out, his statement was false. The Trump rally is OK, but it is nowhere near unprecedented.

 Some of the pushback from readers was — hmmm, how can I say this? Fake news.

I won’t mention anyone by name, but a few excerpts are worthy of discussion. They are wonderful examples of how we have trouble reconciling facts with our biases, and why partisans and investors alike are predestined to make certain mistakes over and over.

The emails, among other things, said my analysis of Trump’s claim was “disappointingly facile,” that I “ignored other economic indicators,” or that I was “overly focused on the numbers.” And my inclusion in the comparison of “international markets” was biased.

More specifically:

“You overlooked several points that would strengthen Trump’s case. FDR’s recovery had the advantage of rebounding from the Great Depression, and JFK also benefited from a rebound from a recession.”

This is an odd statement: I was discussing market performance, not an analysis of how different presidents did relative to the economy under their predecessor. This is a classic case of cognitive dissonance — the refusal to acknowledge a fact because it contradicts a strongly held belief or ideology. Oddly enough, it came from a professor of psychology at a well-regarded southern university.

There was more: “You refer to mean reversion, but they conveniently ignore how it may have benefited others on the list ahead of Trump.” Again, our task was not to rationalize the prior rallies or their causes, but instead to determine whether Trump’s claim was accurate.

More than one emailer pointed out that Trump’s rally is “unprecedented in terms of the timing of the rally relative to the duration of the economic expansion. The current expansion is 8 years old. It’s notable that only 2 economic expansions since the Great Depression were as long or longer than this one, and yet, the market shows no sign of slowing under Trump.” This may or may not be true, but certainly it isn’t what the president claimed. And as I have said before, all presidents get too much blame when markets or the economy heads south and too much credit when things go well.

Some people complained about comparing the U.S. markets to other countries. 1  This is a weird statement to make in 2017, when the rest of the world has become an ever-larger portion of both global output and total equity-market capitalization.

And yes, I “completely ignored other economic indicators, such as GDP and consumer confidence” because that was not what the president referred to in his tweet. I only examined the accuracy of the president’s assertion.

In other word, I looked at the issue quantitatively by relying on the mathematical performance returns, with as little subjective interpretation as possible. The approach many others seem to have taken is to consider Trump’s statement qualitatively, which entails relying on a selected set of facts to tell a story. There are many problems with that approach because it tends to give way to bias and subjectivity. Those who take this approach are trying to rationalize a political talking point of which president’s rally is better or worse; I was focused on objectively answering that question. And as if we needed further proof that bias is a powerful thing, some readers disputed the notion that quantitative analysis wasn’t more objective than qualitative analysis.

The real culprit here is evolution: Many of the common errors we see today are manifestations of survival strategies that were effective thousands of years ago but are much less useful today. The tendency to see patterns where none exist, to focus on negative (as opposed to positive) news; story-telling and groupthink — all are reflections of our primordial instincts. They were critical in helping out ancestors work within social groups on the savanna in an ever-changing, challenging environment.  But they serve no purpose in finance; indeed, these ingrained responses often lead to trouble.

Unlike political partisans who are focused only on the outcome of the next election, investors have money riding on the information they consume and use. That is why I prefer to stay with numbers rather than engage in story-telling.



1. For example, “Greece’s market has NOT even remotely recovered from the losses since 2008,” one reader wrote.


Originally: Stick With Numbers When Judging Trump’s Rally


Exercises in Cognitive Dissonance

Yesterday, we looked at the question so many investors seem to have about President Trump. I tried to show why giving in to your assumptions and biases was problematic.

Today, Bloomberg has a fascinating study today tracking 8 voters from 4 swing states over the 7 months since the election. Despite the self-inflicted wounds, and the lack of legislative achievements, there are no signs of remorse. Instead, there is a doubling down of prior, emotionally-based beliefs, and a refusal to admit that perhaps the firebrand oversold his qualifications to lead the country.

The focus is not politics — rather, it is about human cognitive processes, bias, and what all if that could teach us about investor error.


click for interactive graphicscreen-shot-2017-05-17-at-6-41-30-am
Source: Bloomberg


The Latest Cognitive Dissonance: Weak Recovery is all Dodd Frank’s Fault

Don’t Blame Dodd-Frank for the Slow Recovery
The law isn’t perfect, but it hasn’t hurt small-business lending.
Bloomberg, October 7, 2015




Dodd-Frank has burdened small banks — and the businesses that rely on them — much more than large businesses that have access to capital markets. Is this why we’re experiencing the slowest recovery in two generations?


So asks Peter Wallison, a scholar at the American Enterprise Institute, a conservative think tank that advocates for free markets and views government regulation with suspicion.

Nonetheless, Wallison has raised a question worth asking — and answering — since he isn’t the only one who blames Dodd-Frank for the stubbornly slow recovery from the financial crisis. Just by way of background, Wallison was a member of the federal commission that studied the cause of the 2008 meltdown and was the lone member to lay almost all of the blame at the feet of the government-sponsored entities, Fannie Mae and Freddie Mac. Most scholars have concluded that the causes of the crisis were many — including deregulation of the sort Wallison has advocated — and his arguments have been widely disputed (see thisthis or this).

But leaving that aside, let’s spend a few minutes examining the assertion that Dodd-Frank, adopted in 2010 to lower the odds of another financial crisis, is responsible for the slow economic recovery.

Wallison’s argument goes like this: Dodd-Frank’s new and expanded compliance requirements, while manageable for big banks, are an intolerable burden for small banks, defined as those that aren’t among the U.S.’s 25 biggest lenders. In turn, these small banks are hobbled in their ability to lend to small businesses, which lack access to the capital markets that bigger companies can tap. Small businesses are a critical engine of economic growth and thus the shortage of credit for small and fast-growing companies explains why the economic recovery is so disappointing.

Just as an aside: Let’s not even bother with the part of Wallison’s argument where he cites a study by economists Michael Bordo and Joseph Haubrich claiming “deep contractions breed strong recoveries.” This directly flies in the face of a much more broadly researched set of studies by economists Carmen Reinhart and Kenneth Rogoff that reached the opposite conclusion — that recoveries from financial crises, and not just regular recessions, are agonizingly slow. Most of the economic community has endorsed the Reinhart & Rogoff perspective.

Also, we’ll skip the part where Wallison says “studies of Dodd-Frank’s effect have shown that the regulatory burdens imposed by that law have been particularly harsh for community banks.” Although he does make this claim, he doesn’t cite any studies backing it up and I know of no credible research that would support this assertion.

But let’s just stick with the core of Wallison’s argument: that Dodd-Frank has choked off lending by small banks to small businesses. This should be easy to verify. After all, the Federal Reserve keeps lots of data on commercial bank loans. If small-bank lending is in a funk it should show up in the numbers.

So please have a look at the chart below from the data service of Federal Reserve Bank of St. Louis. It shows that small banks, after seeing loan demand plummet following the 2008 financial crisis, now are sending so-called commercial and industrial lending — in other words, credit to small businesses — to record levels.

Furthermore, in the Fed’s most recent Senior Loan Officer Opinion Survey on Bank Lending Practices, loan officers noted: “Lending standards for smaller firms, with annual sales of less than $50 million, have been gradually loosening over the past few years, and in the current survey, the majority of domestic respondents that extend loans to such firms indicated that their standards were easier than or near the midpoints of the respective ranges over the past decade.”

In other words, lending to small businesses has been easing.

There are many reasons to criticize Dodd-Frank — it is too long, too complex, difficult to implement and probably doesn’t do enough to deal with the monumental problem of too-big-to-fail banks. But the claim that it has choked off credit to small businesses as the reason for the slow economic recovery just isn’t supported by the facts.


Originally: Don’t Blame Dodd-Frank for the Slow Recovery



Gramm’s Unrepentant Cognitive Dissonance



Some people look at subprime lending and see evil. I look at subprime lending and I see the American dream in action. My mother lived it as a result of a finance company making a mortgage loan that a bank would not make.

–former U.S. Senator Phil Gramm

Many elected or appointed officials have a specific belief system that they may act upon in the implementation of policies. When the policies that flow from those beliefs go terribly wrong, it is natural to want to learn why. As is so often the case, that underlying ideology is usually a good place to begin looking.

In the aftermath of the great credit crisis, we have seen all manner of contrition from responsible parties. Most notably, Alan Greenspanadmitted errorsaying as much in Congressional testimony. Greenspan was unintentionally ironic when he answered a question about whether ideology led him down the wrong path when it came to preventing irresponsible lending practices in subprime mortgages: “Yes, I’ve found a flaw. I don’t know how significant or permanent it is. But I’ve been very distressed by that fact.”

Other contributors to the crisis have been similarly humbled. In “Bailout Nation,” I held former President Bill Clinton, and his two Treasury secretaries, Robert Rubin and Larry Summers, responsible for signing the ruinous Commodity Futures Modernization Act that exempted derivatives from regulation and oversight. The CFMA was passed as part of a larger bill by unanimous consent, and that Clinton signed on Dec. 21, 2000. Clinton joined Greenspan in admitting his contribution to the credit crisis, as well as saying the advice he received from his Treasury secretaries — Rubin and Summers — was wrong.

The CFMA removed the standard regulations that all other financial instruments follow: reserve requirements, counter-party disclosures and exchange listings.

Bloomberg reported that Clinton said his advisers argued that derivatives didn’t need transparency because they were “expensive and sophisticated and only a handful of people will buy them and they don’t need any extra protection. The flaw in that argument was that first of all, sometimes people with a lot of money make stupid decisions and make it without transparency.”

Even the American Enterprise Institute changed the name of its “Financial Deregulation Project” to the more benign “program on financial policy studies.” That is as close to an apology as we can expect for its part in pushing for market deregulation.

The exception to any post-crisis self-reflection is former Senator Phil Gramm. Although he was one of the chief architects of the radical gutting of financial regulations and oversight rules during the two decades that preceded the financial crisis, the former senator remains a stubborn believer that banks and markets can regulate themselves.

Perhaps more than anyone else, Gramm drove the legislation that allowed banks to get much bigger and derivatives to run wild. His name is on the law — the Gramm-Leach-Bliley Act of 1999 — that overturned the Glass-Steagall Act, a Depression-era law that forced commercial banks to get out of the risky investment-banking business.

How responsible was Gramm for the financial crisis? Consider the following from the New York Times in 2008:

In one remarkable stretch from 1999 to 2001, he pushed laws and promoted policies that he says unshackled businesses from needless restraints but his critics charge significantly contributed to the financial crisis that has rattled the nation.

He led the effort to block measures curtailing deceptive or predatory lending, which was just beginning to result in a jump in home foreclosures that would undermine the financial markets. He advanced legislation that fractured oversight of Wall Street while knocking down Depression-era barriers that restricted the rise and reach of financial conglomerates.

And he pushed through a provision that ensured virtually no regulation of the complex financial instruments known as derivatives, including credit swaps, contracts that would encourage risky investment practices at Wall Street’s most venerable institutions and spread the risks, like a virus, around the world.

The causes of the crisis are complex and developed over many years. But if you want to hold a single elected official responsible for the collapse of American International Group — if any one event could have taken down the entire financial system, that was it — it would have to be Gramm.

Today, we will see the former Senate deregulator in chief defend his actions in testimony before the House Financial Services Committee. Don’t expect a Greenspan-like moment of self-criticism.



Originally published as: The Few Who Won’t Say `Sorry’ for Financial Crisis



Cognitive Dissonance Is Hurting Your Returns

Regular readers know I enjoy discussing behavioral aspects of investing. The reasons for this are twofold: First, we can’t control the markets, but we can control our own reactions to it (at least we can try). And second, many studies have shown that investors suffer from a behavior gap between what they should garner in returns and what they actually get.

Of all of the failings of human wetware, the one I find most intriguing is cognitive dissonance. You can find technical definitions at Changing Minds, The Skeptics Dictionary or any number of other reference books.

In the context of economics and investing, my preferred definition is as follows: Cognitive dissonance occurs in the mind of an individual when a theoretical belief system is confronted by factual evidence demonstrating outcomes contrary to what theories dictate should occur.

Stated more plainly, when facts conflict with beliefs people find ways to ignore those facts, rationalizing them in a way that allows the disproven ideas to survive. John Kenneth Galbraith famously referenced cognitive dissonance before it was even called that, stating “Faced with the choice between changing one’s mind and proving that there is no need to do so, almost everyone gets busy on the proof.”

I was reminded of this recently courtesy of several seemingly disparate but cognitively-related articles. The New York Times discussed the idea in “When Beliefs and Facts Collide”; my colleague Michael Batnick focused on cognitive dissonance and investing in “Climate Change and the Efficient Market Hypothesis.”

Consider the following: Much of what we do is predicated upon a specific abstract belief system. Investors and traders hold and act on a tremendous range of philosophies — from value investing to market timing, stock selection, momentum trading, chart reading, etc. All of these have their positives and negatives, but none of them excel all of the time in all markets. Hence, we are often confronted with data that conflicts with the basic philosophy that we use to govern how we deploy our capital.

The important aspect of this is how we respond to this conflict. We can rationalize the data, or we can accept the facts and make changes to our beliefs.

Examples are many and varied: Deep value investors who buy depressed stocks without regard to other risk factors, only too see them fall another 50 percent; buy-and-hold investors who get demolished in a bear market, only to sell out at the bottom; radical deregulation resulting in bad outcomes rather than the free market nirvana its believers espoused; Austrian economists warning of imminent hyperinflation and the collapse of the fiat dollar that never arrives.

Rather than question the theory, the person suffering from cognitive dissonance ignores the facts in front of their very eyes and instead devises rationales for why any specific expected outcome never occurred. The blame is laid elsewhere, never on their disproven thesis.

Perhaps my favorite example came about after housing-market collapse. It wasn’t the wildly irresponsible behavior of non-bank lenders and junk mortgages securitized and rated AAA that caused the problems. Rather, it had to be something else, and if we can find a government entity to blame, so much the better. Watching the endless attempts to throw something against the barn door to see what might stick would have been amusing if it were not so sad: It was the Community Reinvestment Act! No wait, it was the FHA’s VA loans. No, it was Fannie and Freddie!

The grim reality was much more complex. Many factors deserve blame, ranging from ultra-low interest rates, falling real incomes and a mad scramble for yield. These combined with the deregulation of the past decades created a unique set of circumstances that allowed traditional lending standards to fall by the wayside. You know how all of that ended.

Refusing to acknowledge the complicated reality once it conflicts with your belief system is a classic example of cognitive dissonance. If you can’t face the reality of the housing collapse, cook up some story that explains what happened consistent with your ideology. That it might be very easily debunked is beside the point.

We see this manifested in many ways in investing and trading. There is a fine line between having confidence in your methodologies and living in your own private fantasy world.

Like it or not, this is the human condition. Recognizing it at least gives us a chance to avoid getting caught in its pernicious grasp.

In investing, just because you have human failings doesn’t mean you have to act upon them.

Ash Donaldson on Cognitive Dissonance (TEDxCanberra)

Multiple-TED attendee and human factors expert, Ash Donaldson, wants us to better understand why we believe what we do. In this talk, Ash explains how our minds build belief and then breaks it down, showing us how and why humans are fooled into believing that things like Power Bands, anti-aging treatments and supplements actually work. Along the way, he tells us how as a trainee pilot he managed to nearly get himself killed by allowing his beliefs to rule logic and provable fact.

Kyle Bass: The Cognitive Dissonance of It All

The Cognitive Dissonance of It All
By John Mauldin
March 6, 2011


I get a lot of client letters from various managers and funds, as you might imagine. I read more than I should. But one that shows up every quarter or so makes me stop what I am doing and sit down and read. It is the quarterly letter from Hayman Advisors, based here in Dallas. They are macro guys (which I guess is part of the magnetic attraction for me), and they really put some thought into their craft and have some of the best sources anywhere. So today we take a look at their latest letter, where they cover a wide variety of topics, with cutting-edge analysis and sharp insight. I really like these guys, and suggest you take the time to read the entire letter.

Today (Tuesday) is the day I want you to start buying Endgame. The early reviews on Amazon are quite gratifying – writing a book is damn hard work, so when people say nice things it just feels good. Have a great week! Now let’s jump into the Hayman client letter.

John Mauldin, Editor
Outside the Box

The Cognitive Dissonance of It All

“Men, it has been well said, think in herds; it will be seen that they go mad in herds, while they only recover their senses slowly, and one by one.”

– Charles Mackay, Extraordinary Popular Delusions and the Madness of Crowds

Dear Investors:

We continue to be very concerned about systemic risk in the global economy. Thus far, the systemic risk that was prevalent in the global credit markets in 2007 and 2008 has not subsided; rather, it has simply been transferred from the private sector to the public sector. We are currently in the midst of a cyclical upswing driven by the most aggressively procyclical fiscal and monetary policies the world has ever seen. Investors around the world are engaging in an acute and severe cognitive dissonance. They acknowledge that excessive leverage created an asset bubble of generational proportions, but they do everything possible to prevent rational deleveraging. Interestingly, equities continue to march higher in the face of European sovereign spreads remaining near their widest levels since the crisis began. It is eerily similar to July 2007, when equities continued higher as credit markets began to collapse. This letter outlines the major systemic fault lines which we believe all investors should consider. Specifically, we address the following:

• Who Is Mixing the Kool-Aid? (Know Your Central Bankers)

• The Zero-Interest-Rate-Policy Trap

• The Keynesian Endpoint – Where Deficit Spending and Fiscal Stimulus Break Down

• Japan – What Other Macro Players Have Missed and the Coming of “X-Day”

• Will Germany Go All-In, or Is the Price Too High?

• An Update on Iceland and Greece

• Does Debt Matter?

While good investment opportunities still exist, investors need to exercise caution and particular care with respect to investment decisions. We expect that 2011 will be yet another very interesting year.

In 2010, our core portfolio of investments in US mortgages, bank debt, high-yield debt, corporate debt, and equities generated our positive returns while our “tail” positions in Europe contributed nominally in the positive direction and our Japanese investments were nominally negative. We believe this rebound in equities and commodities is mostly a product of “goosing” by the Fed’s printing press and are not enthusiastic about investing too far out on the risk spectrum. We continue to have a portfolio of short duration credit along with moderate equity exposure and large notional tail positions in the event of sovereign defaults.

Who Is Mixing the Kool-Aid?

Unfortunately, “academic” has become a synonym for “central banker.” These days it takes a particular personality type to emerge as the highest financial controller in a modern economy, and too few have real financial market or commercial experience. Roget’s Thesaurus has not yet adopted this use, but the practical reality is sad and true. We have attached a brief personal work history of the US Fed governors to further illustrate this point. So few central bankers around the world have ever run a business – yet so much financial trust is vested with them. In discussing the sovereign debt problems many countries currently face, the academic elite tend to arrive quickly at the proverbial fork in the road (inflation versus default) and choose inflation because they perceive it to be less painful and less noticeable while pushing the harder decision further down the road. Greenspan dropped rates to 1% and traded the dot com bust for the housing boom. He knew that the road over the next 10 years was going to be fraught with so much danger that he handed the reins over to Bernanke and quit. Central bankers tend to believe that inflation and default are mutually exclusive outcomes and that they have been anointed with the power to choose one path that is separate and exclusive of the other. Unfortunately, when countries are as indebted as they are today, these choices become synonymous with one another – one actually causes the other.

ZIRP (Zero Interest Rate Policy) Is a TRAP

As developed Western economies bounce along the zero lower bound (ZLB), few participants realize or acknowledge that ZIRP is an inescapable trap. When a heavily indebted nation pursues the ZLB to avoid painful restructuring within its debt markets (household, corporate, and/or government debt), the ZLB facilitates a pursuit of aggressive Keynesianism that only perpetuates the reliance on ZIRP. The only meaningful reduction of debt throughout this crisis has been the forced deleveraging of the household sector in the US through foreclosure. Total credit market debt has increased throughout the crisis by the transfer of private debt to the public balance sheet while running double-digit fiscal deficits. In fact, this is an explicit part of a central banker’s playbook that presupposes that net credit expansion is a necessary precondition for growth. However, the problem of over indebtedness that is ameliorated by ZIRP is only made worse the longer a sovereign stays at the ZLB – with ever greater consequences when short rates eventually (and inevitably) return to a normalized level.

Consider the United States’ balance sheet. The United States is rapidly approaching the Congressionally mandated debt ceiling, which was most recently raised in February 2010 to $14.2 trillion dollars (including $4.6 trillion held by Social Security and other government trust funds). Every one percentage point move in the weighted-average cost of capital will end up costing $142 billion annually in interest alone. Assuming anything but an inverted curve, a move back to 5% short rates will increase annual US interest expense by almost $700 billion annually against current US government revenues of $2.228 trillion (CBO FY 2011 forecast). Even if US government revenues were to reach their prior peak of $2.568 trillion (FY 2007), the impact of a rise in interest rates is still staggering. It is plain and simple; the US cannot afford to leave the ZLB – certainly not once it accumulates a further $9 trillion in debt over the next 10 years (which will increase the annual interest bill by an additional $90 billion per 1%). If US rates do start moving, it will most likely be for the wrong (and most dire) reasons. Academic “research” on this subject is best defined as alchemy masquerading as hard science. The only historical observation of a debt-driven ZIRP has been Japan, and the true consequences have yet to be felt. Never before have so many developed western economies been in the same ZLB boat at the same time. Bernanke, our current “Wizard of Oz”, offered this little tidbit of conjecture in a piece he co-authored in 2004 which was appropriately titled “Monetary Policy Alternatives at the Zero Bound: An Empirical Assessment”. He clearly did not want to call this paper a “Hypothetical Assessment” (as it really was).

Despite our relatively encouraging findings concerning the potential efficacy of non‐standard policies at the zero bound, caution remains appropriate in making policy prescriptions. Although it appears that nonstandard policy measures may affect asset prices and yields and, consequently, aggregate demand, considerable uncertainty remains about the size and reliability of these effects under the circumstances prevailing near the zero bound. The conservative approach — maintaining a sufficient inflation buffer and applying preemptive easing as necessary to minimize the risk of hitting the zero bound — still seems to us to be sensible. However, such policies cannot ensure that the zero bound will never be met, so that additional refining of our understanding of the potential usefulness of nonstandard policies for escaping the zero bound should remain a high priority for macroeconomists.

–Bernanke, Reinhart, and Sack, 2004. (Emphasis Added) It is telling that he uses the verb “escaping” in that final sentence – instinctively he knows the ZLB is dangerous.


Vocabulary Problem: Cognitive Dissonance

Paul Krugman asks:

Unusually, I’m having a vocabulary problem. There has to be some word for the kind of person who considers his mild discomfort the equivalent of torture, crippling injury, or death for other people. But I can’t think of it. What brings this to mind is this from Alberto Gonzales: I consider myself a casualty, one of the many casualties of the war on terror.

The answer to this query is one of my favorite phrases, pulled from psychiatry and often applied to investing. But its just as valid in the legal and political realm.

I typically use it to describe absurd and perplexing statements made sincerely.

The phrase is Cognitive Dissonance.

You can find technical definitions at Changing Minds, Wikipedia, and The Skeptics Dictionary. The way I use it somewhat modifies the classic definition, when applied to an economic or investing context (but it works just as well for politics).

Cognitive Dissonance occurs in the mind of an individual when a theoretical belief system is confronted by factual evidence demonstrating outcomes contrary to what theories dictate should occur.

Examples are many and varied: Deep value investors buying beaten up stocks with no regard to other risk factors, only too see them fall another 50%. Buy & Hold investors getting utterly demolished this year; Radical deregulation resulting in market mayhem being denied by its advocates as a root cause, especially with derivatives. Rather than question the theory — be they Investing or Economic — the person suffering from Cognitive Dissonance ignores the facts in front of their eyes or devises rationales for why the undesired outcome occurred, blaming other factors (but not their thesis).

A few recent classic examples:

• Blaming the housing boom and bust on the Community Reinvestment Act of 1977 rather than an abdication of lending standards (See various posts);

• Phil Gramm denying deregulation had anything to do with the current crisis; (See A DeRegulator Unswayed)

• Blaming the population for being too gloomy (June 08), rather than questioning whether the low unemployment and inflation data where problematic (Are We Too Gloomy?)

• Amity Schlaes false definition of recession to maker the claim there was no economic contraction; (See Amity Shlaes Does Not Know What a Recession Is)

There’s more but you get the idea.

Cognitive Dissonance can lead to a politician appearing out of touch; recall John McCain’s The Fundamental’s of the Economy are Strong quote, which certainly did not help his campaign.

In investing, it can be downright deadly. Those who bought the Home Builders in 2005 had to ignore rising rates AND prices, inventory build and stagnant income. The purchasers of Banks in 2007 or Brokers in 2008 engaged in a similar risk denying approach.

There are many other forms of Cognitive Dissonance in investing and economics, it is one of those psychological factors that astute investors and traders must constantly be on the look out for. Those who are brutally honest with themselves and engage in a degree of introspection should be able to avoid its most pernicious effects.


The Psychology Behind Common Investor Mistakes (July 2005)

Recessions Often Begin With Positive GDP Data (May 2008)

Who is Right: Professionals or the Populace ? (June 2008)

Pervasive Pollyannas of Prosperity (June 2008)

Hank Paulson’s Cognitive Dissonance

"The Paulson plan belongs in a fictional world where financial institutions
do a good job in regulating and monitoring themselves. Unfortunately, that’s not
the world we live in."

Why the Paulson Plan is DOA


So says Michael Mandel of Businessweek. In addition to the quote above, he goes further, calling the Treasury Secretary to task:

"In the middle of perhaps the greatest financial upheaval since the Great
Depression, Treasury Secretary Hank Paulson is proposing a change in financial
regulations which basically amounts to a big wink to Wall Street. His plan will
go nowhere, both for political and practical reasons. In fact, it does not even
meet the minimum standard of improving transparency, which would reduce the
possibility of a similar crisis in the future…

The most striking thing about the current problems is just how much money the
banks and the investment banks have lost. They apparently had no idea of how
risky their own exposure was. The supposedly smart guys were simply stupid."

I concur with Mandel: In order to avoid these issues in the future,
depository banks and investment banks need full and transparent
reporting of their holdings. No more side pockets, off-the-book SIVs, or buried
derivatives exposures. In fact, they should also clearly report the potential losses they have on their books via exposure to leveraged and risky
counter-parties as well.

How did this all come about? Over the past 25 years or so, we have migrated from a world that was excessively regulated to a new world that was excessively deregulated. The initial problems were too much complexity,  high costs, and time consuming bureaucracy. That’s been replaced with an equally problematic situation: No adult supervision in places where the children require  adult supervision.      

Less financial supervision? More self-regulation? What hallucinogenics were taken prior to making those recommendations?

Bankers are not the folks who should be garnering less transparency, and less onerous regulatory requirements. Only a clueless ideologue would even dare suggest as much. Unfortunately, we have a clueless idealogue running the Treasury department. When confronted with what can only be described as insurmountable evidence that self-regulation has failed miserably, our man at Treasury proposes more self-regulation.

Riddle me this, Batman: If these finance wizards were any good at the job of self-regulation, would we even be having discussions as to how to resolve a global credit crisis? 

If you are wondering how certain people can fail to understand this, the simple answer is cognitive dissonance. If Paulson were to confront reality — lack of supervision is how banks got themselves in this mess in the first place — his entire world view would crumble. Thus, the problem is not one of lack of supervision, its  an issue of efficiency! Hence, we get these absurd attempts to make the lack of regulatory supervision "more efficient."

The Paulson plan isn’t about avoiding future meltdowns in the financial system — its about allowing Hank Paulson (and others) to cling to their now disproven deregulatory fantasies . . .



Why the Paulson Plan is DOA 
Michael Mandel
Economics Unbound, March 30  2008