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Home » Opinion » China Knowledge
All-too-human side: Hope, fear, greed
May 4, 2009, Monday
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Print Edition
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TO explain the current economic crisis, the world of finance has a particular lexicon - including credit default swaps, mark-to-market and securitized subprime mortgages.
Psychologists, on the other hand, might use very different terms: hope, greed and fear.
The language of psychology helps to address the fact that behind every cut-and-dried statistic about falling home prices and other indicators of economic decline, lies an ever-shifting horde of homeowners, bankers, business owners, unwitting investors - in short, people.
And people often pay no heed to fine-tuned economic models by doing things that are not rational, not in their best interest, and justified not by numbers - but by emotion.
An interdisciplinary panel recently explored the psychological elements behind today's economy. They were speaking at a conference called, "Crisis of Confidence: The Recession and the Economy of Fear," sponsored by the University of Pennsylvania's Department of Psychiatry and the Psychoanalytic Center of Philadelphia.
The word "confidence" itself has a double edge to it, encompassing optimism on the one hand and delusion on the other.
And could there be a psychological tinge to economic vocabulary itself?
Psychological factors are at work behind the crisis, the panel agreed, although each focused on a different element: mania and over-optimism behind the housing bubble, a lack of self-control by consumers hooked on debt, and the shock and feelings of betrayal of many Americans who thought they were making safe investments, but now find themselves facing a frightening and uncertain future.
Like so many others in history, today's economic crisis began with a bubble, according to Wharton finance professor Richard Herring.
"Bubbles occur when people are willing to buy something simply because they believe they can sell it for a higher price. (Bubbles) often have an aspect of mania."
Property bubbles are nothing new, said Herring, who presented a chart of home prices during a 400-year period in Herengracht, a canal area in central Amsterdam, the Netherlands.
Over those centuries, real home prices increased annually by only 0.2 percent on average, "but in between, (they were) up 100 percent, down 50 percent. There was huge volatility."
Real estate booms and busts happen in very long cycles - on average about every 20 years. Consequently, when housing prices are going up, few remember that they ever went down. This was certainly the case in the recent crisis, since housing prices only went up between 1975 and 2006.
According to Herring, property markets are especially prone to booms and busts because of their nature: they have no central clearinghouse of information about prices, transaction costs are high and trading is infrequent, and the supply of property is relatively fixed in the short term.
Because the cycles are decades long, it is difficult to tell what a piece of property should be worth in the long run.
"We really don't know what the price should be, so it's always difficult to tell whether you are looking at a bubble or simply improving fundamentals of the economy."
Housing booms and busts are "almost always linked to the banking system," Herring added. "When something good happens in an economy, it tends to drive up real estate prices, and banks tend to lend to support that, because people now have collateral."
Optimism about rising prices feeds the frenzy, and as an increasing number of novice investors enter the market, prices and enthusiasm also increase.
"You get into this upward spiral that can take you a very long way for a very long time. You may ask where the supervisors and regulators are in all of this, and often, they tend to support it. They really like to see loans that are collateralized by real estate because it's tangible."
Call it "the fallacy of misplaced concreteness," Herring quipped, showing a slide of a half-built skyscraper from a recent property boom-gone-bust in Thailand, "but really it's the fallacy of misplaced concrete."
"I think we agree that over-optimism is perhaps a lot of what got us into this mess," said Wharton business and public policy professor Jeremy Tobacman, a panel participant. "There was rampant over-optimism about housing prices."
People often make poor economic choices because they are overly optimistic about what they will do in the future, Tobacman said.
One study of a health club found that members who worked out on average just four times a month chose to pay a monthly membership fee of US$85, even though the gym also offered a pay-as-you-go rate of US$10 per visit.
"When people are polled about their beliefs (as to) what they're going to do, there is a radical refusal to accept reality," said Tobacman. "Myopia may be willful in that we don't want to contemplate undesired outcomes."
Tobacman shared a quote from John Kenneth Galbraith's "The Great Crash," a history of the events leading up to the Great Depression: "The bankers were also a source of encouragement to those who wished to believe in the permanence of the boom. A great many of them abandoned their historic role as the guardians of the nation's fiscal pessimism and enjoyed a brief respite of optimism."
The explosion of consumer debt behind the crisis is also an issue of self-control, University of Pennsylvania psychology professor Angela Lee Duckworth noted.
For years, Americans have saved less and consumed more, Duckworth said.
Duckworth said: "It seems that my father was right during those conversations around the dinner table when he would say, 'Americans are living beyond their means.'"
(Reproduced with permission from Knowledge@Wharton, http://knowledgeatwharton.com.cn. Trustees of the University of Pennsylvania. All rights reserved.)
Psychologists, on the other hand, might use very different terms: hope, greed and fear.
The language of psychology helps to address the fact that behind every cut-and-dried statistic about falling home prices and other indicators of economic decline, lies an ever-shifting horde of homeowners, bankers, business owners, unwitting investors - in short, people.
And people often pay no heed to fine-tuned economic models by doing things that are not rational, not in their best interest, and justified not by numbers - but by emotion.
An interdisciplinary panel recently explored the psychological elements behind today's economy. They were speaking at a conference called, "Crisis of Confidence: The Recession and the Economy of Fear," sponsored by the University of Pennsylvania's Department of Psychiatry and the Psychoanalytic Center of Philadelphia.
The word "confidence" itself has a double edge to it, encompassing optimism on the one hand and delusion on the other.
And could there be a psychological tinge to economic vocabulary itself?
Psychological factors are at work behind the crisis, the panel agreed, although each focused on a different element: mania and over-optimism behind the housing bubble, a lack of self-control by consumers hooked on debt, and the shock and feelings of betrayal of many Americans who thought they were making safe investments, but now find themselves facing a frightening and uncertain future.
Like so many others in history, today's economic crisis began with a bubble, according to Wharton finance professor Richard Herring.
"Bubbles occur when people are willing to buy something simply because they believe they can sell it for a higher price. (Bubbles) often have an aspect of mania."
Property bubbles are nothing new, said Herring, who presented a chart of home prices during a 400-year period in Herengracht, a canal area in central Amsterdam, the Netherlands.
Over those centuries, real home prices increased annually by only 0.2 percent on average, "but in between, (they were) up 100 percent, down 50 percent. There was huge volatility."
Real estate booms and busts happen in very long cycles - on average about every 20 years. Consequently, when housing prices are going up, few remember that they ever went down. This was certainly the case in the recent crisis, since housing prices only went up between 1975 and 2006.
According to Herring, property markets are especially prone to booms and busts because of their nature: they have no central clearinghouse of information about prices, transaction costs are high and trading is infrequent, and the supply of property is relatively fixed in the short term.
Because the cycles are decades long, it is difficult to tell what a piece of property should be worth in the long run.
"We really don't know what the price should be, so it's always difficult to tell whether you are looking at a bubble or simply improving fundamentals of the economy."
Housing booms and busts are "almost always linked to the banking system," Herring added. "When something good happens in an economy, it tends to drive up real estate prices, and banks tend to lend to support that, because people now have collateral."
Optimism about rising prices feeds the frenzy, and as an increasing number of novice investors enter the market, prices and enthusiasm also increase.
"You get into this upward spiral that can take you a very long way for a very long time. You may ask where the supervisors and regulators are in all of this, and often, they tend to support it. They really like to see loans that are collateralized by real estate because it's tangible."
Call it "the fallacy of misplaced concreteness," Herring quipped, showing a slide of a half-built skyscraper from a recent property boom-gone-bust in Thailand, "but really it's the fallacy of misplaced concrete."
"I think we agree that over-optimism is perhaps a lot of what got us into this mess," said Wharton business and public policy professor Jeremy Tobacman, a panel participant. "There was rampant over-optimism about housing prices."
People often make poor economic choices because they are overly optimistic about what they will do in the future, Tobacman said.
One study of a health club found that members who worked out on average just four times a month chose to pay a monthly membership fee of US$85, even though the gym also offered a pay-as-you-go rate of US$10 per visit.
"When people are polled about their beliefs (as to) what they're going to do, there is a radical refusal to accept reality," said Tobacman. "Myopia may be willful in that we don't want to contemplate undesired outcomes."
Tobacman shared a quote from John Kenneth Galbraith's "The Great Crash," a history of the events leading up to the Great Depression: "The bankers were also a source of encouragement to those who wished to believe in the permanence of the boom. A great many of them abandoned their historic role as the guardians of the nation's fiscal pessimism and enjoyed a brief respite of optimism."
The explosion of consumer debt behind the crisis is also an issue of self-control, University of Pennsylvania psychology professor Angela Lee Duckworth noted.
For years, Americans have saved less and consumed more, Duckworth said.
Duckworth said: "It seems that my father was right during those conversations around the dinner table when he would say, 'Americans are living beyond their means.'"
(Reproduced with permission from Knowledge@Wharton, http://knowledgeatwharton.com.cn. Trustees of the University of Pennsylvania. All rights reserved.)
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