Finance Isn’t as Amoral as It Seems (Part 2): Robert Shiller

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Illustration by Paul Windle

Many people assume there is something sleazy about the business of finance, or the people who practice it. This impression is probably behind the commonly voiced opinion that it is a shame so many young people today are going into finance-related occupations, when they could be doing something more high- minded in other fields.

It’s true that many people in business do seem to feel rewarded, for the short run at least, in putting salesmanship ahead of purpose and in cutting legal corners. They seem too focused on money to have moral purpose in their business affairs.

Yet if one lives in the real world, one has to work with, or even for, such people. They are a reality, and it makes sense to try to understand them -- to see if they are as simply sleazy as people think.

Positions in certain finance-related fields often offer more than the usual temptation to be less than honest -- because finance is a profession that offers, at least to the lucky few, astronomically high incomes. On occasion, we may even ask: Why would anyone with a sense of personal morality go into finance?

Deliberate Deception

Finance may seem corrupt also because the management of information is central to success in the field. And to make the best deal in a financial transaction, there is always the temptation to withhold information. Deliberate financial deception wounds the victim’s ego; people feel foolish to have been duped.

Casinos reveal how it’s possible to exploit people’s recurring errors in judgment. Consider how much people act to avoid losses, even small ones, as research by psychologists Daniel Kahneman and Amos Tversky has shown. If offered an asymmetrical bet on a coin toss -- to win $20 if it comes up heads, or lose $10 if it comes up tails -- most people will turn it down. How is it then that casinos are able to induce many people to make investments (in the form of bets) -- and do it so much that, by the law of averages, losses are a virtual certainty?

Part of the answer has to do with the casino, which is designed to encourage risk-taking. Alcohol is served. And the setting cultivates the notion that all the casino’s customers are rich and successful. This confuses some, causing them to lose sight of their repeated losses at the tables. When people are in a place where they can see others making large bets, their own potential losses seem less salient.

By replicating some of these features in their laboratory, the psychologists Joseph Simmons and Nathan Novemsky found that they do, in fact, encourage risk- taking.

Left to unregulated market forces, many brokerage services would closely resemble casinos. We know this from observing the nature of securities establishments before regulation was effective. The “bucket shops” of the late 19th and early 20th centuries, where customers bet on commodities and prices, allowed patrons to make many very small bets, in a social atmosphere and while watching others bet. One patron of a bucket shop in the financial district of New York in 1879 said it reminded him of “a horse-pool room,” a place where people engaged in an early form of pari-mutuel betting.

Cognitive Dissonance

When someone participates in a business that seems in any way sleazy, that person may experience the discomfort of what psychologists call “cognitive dissonance.” To maintain self-esteem in such circumstances, people may revise their beliefs. Hypocrisy is one manifestation of this; a person espouses opinions mainly out of convenience and to justify certain actions, while often at some level actually believing them. Social psychologists have shown how cognitive dissonance leads with some regularity to moral lapses -- or, at times, to what we might call “sleaziness.”

Recently, the neuroscientist Vincent van Veen and his colleagues used functional magnetic-resonance imaging to monitor brain activity in experimental subjects as they were encouraged to lie about their true beliefs. The researchers found that the lying stimulated certain regions of the brain, the dorsal anterior cingulate cortex and the anterior insula. Some subjects showed more stimulation in these regions than did others. Importantly, those with more activity in these brain regions showed a stronger tendency to change their actual beliefs to be consonant with the beliefs the researchers led them to espouse. We thus have some evidence that a physical structure in the brain is associated with cognitive dissonance, and that this appears to be part of a neural mechanism that produces the phenomenon.

If hypocrisy is thus built into the brain, then there is a potential for human error that can be of great economic significance. A whole economic system can take as given certain assumptions -- for example, the belief, held during the years before the current financial crisis, that home prices never fall. To doubt it would have caused cognitive dissonance for millions of people who either invested in real estate or were otherwise involved in a system that was overselling it.

Consider, too, the European bank regulators’ decision years ago to put zero capital requirements on euro- denominated government debt. At the time, an end to the euro was unthinkable; to recognize a risk of failure would have created dissonance. So European regulators adopted what in retrospect seems an irrational stance -- that euro- denominated debt was completely safe -- setting the scene for a potential disaster in the banking sector.

Truth Seekers

This kind of thinking is perennial and fundamental. But the finance professions also attract people who are relatively invulnerable to cognitive dissonance: traders or investment managers who delight in the truth that is ultimately revealed in the market. Troubled by hypocrisy, they seek vindication not by sounding right but by being proved right. Many financial theorists have tried to represent people as merely profit maximizers, perfectly selfish and perfectly rational. But people really do care about their own self-esteem, and profit maximization is at best only a part of that.

The practice of finance doesn’t universally incline its practitioners to sleazy behavior. It also rewards people with a certain kind of moral purpose -- one that may be visible to outsiders only intermittently. Day to day, it is hard to see the moral purpose inherent in helping one’s clients, and so it is easy to conclude that such moral purpose doesn’t even exist among people in finance. However, most people naturally project such purpose onto their daily routine. Most of us instinctively want to be helpful and good, within limits, to those around us.

The moral calculus of accumulating large sums of money over a lifetime can be extremely opaque. Most of us never have a true reckoning of our own moral purpose, let alone the moral purposes of others.

John D. Rockefeller Sr., himself the son of a small- time huckster and bigamist, was, in his business life, a ruthless, take-no-prisoners aggressor. Ida Tarbell made a scandal of his business practices in her 1904 book “The History of the Standard Oil Company.” But in his later life, Rockefeller became a philanthropist in the mold of Andrew Carnegie, establishing the Rockefeller Foundation, the University of Chicago and Rockefeller University. His son John D. Rockefeller Jr. continued the family philanthropy and, in turn, trained his six children in the ways of public service. One of them, Nelson Rockefeller, became vice president of the U.S., and the fourth generation includes John D. Rockefeller IV, who has been a U.S. senator from West Virginia for more than a quarter of a century.

Charitable Impulse

What ultimately motivated the Rockefellers? Was it mere ego gratification and the desire for a family dynasty? Or did their philanthropy serve some deeper moral purpose? Most likely, it is a little of both. Even if wealthy people plan to give away all their money and possessions eventually, no one else knows their ultimate intentions, and thus others are naturally suspicious of them. Such suspicion may express itself in a tendency to brand all of the rich as sleazy. Yet quantitative research suggests that negative stereotypes of top businesspeople aren’t universal.

In 1990, Maxim Boycko, a Russian economist; Vladimir Korobov, a Ukrainian economist; and I did conducted a survey on American (specifically New Yorkers’) and Russian (Muscovites’) attitudes toward business. We asked, “Do you think that those who try to make a lot of money will often turn out to be not very honest people?” In both countries many people answered yes. But more felt that way in Russia: 59 percent, compared with only 39 percent of the New Yorkers.

We then asked a more personal question: “Do you think that it is likely to be difficult to make friends with people who have their own business (individual or small corporation) and are trying to make a profit?” In Moscow, 51 percent of the respondents said yes, compared with only 20 percent in New York.

The further success of financial capitalism once again depends on people adopting a more nuanced view of human nature as it is expressed in a financial environment. In an economic system that is essentially good overall, we have to accept that there will be some less-than-high-minded behavior.

(Robert Shiller is a professor of economics at Yale University, where he teaches financial markets in the Open Yale Courses program. He is the author of “Irrational Exuberance” and “The Subprime Solution.” This is the second in a series of four excerpts from his new book, “Finance and the Good Society,” to be published April 4 by Princeton University Press. The opinions expressed are his own. Read Part 1, Part 3 and Part 4.)

Read more opinion online from Bloomberg View.

To contact the writer of this article: Robert Shiller at Robert.Shiller@yale.edu

To contact the editor responsible for this article: Mary Duenwald at mduenwald@bloomberg.net

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