Arnold Kling  

Gullibility, Madoff, and Fiscal Stimulus

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Stephen Greenspan, a psychiatrist who lost money in the Bernard Madoff scam, writes,

Gullibility is a sub-type of foolish action, which might be termed "induced-social." It is induced because it always occurs in the presence of pressure or deception by one or more other people. Social foolishness can also take a non-induced form, as when someone tells a very inappropriate joke that causes a job interview or sales meeting to end unsuccessfully. Foolishness can also take a "practical" (physical) form, as when someone lights up a cigarette in a closed car with a gas can in the back seat and ends up incinerating himself. As noted, the same four factors can be used to explain all foolish acts, but in the remainder of this paper I shall use them to explain Ponzi schemes, particularly the Madoff debacle.

The four factors are situation, cognition, personality and emotion.

Just to be puckish, suppose that we think of financial bailouts and fiscal stimulus as a Madoff scheme, and we use these four factors to explain why we fall for it.

First, there is situation. Stock markets are tanking. Reports on employment, output, and inflation are disturbing. So we are ripe for a proposed solution. There is strong social pressure to go along with bailouts/stimulus, just as Greenspan felt strong social pressure to invest in a hedge fund that placed money with Madoff.

Cognition means using one's best judgment (or failing to do so). Here, Greenspan takes the view that he trusted others with greater financial expertise, and those experts let him down. Similarly, we are trusting expert macroeconomists to tell us that bailouts/stimulus are good.

Next, there is personality. Some people are perhaps are disposed to feel safer when government is doing more.

Finally, there is emotion. We certainly want to believe that the government parent can kiss all our boo-boos and make them better.

Overall, I'll admit that I did not find Greenspan's explanatory model for foolish decisions very helpful--I think it explains non-foolish decisions also. As to bailouts/stimulus, I actually think that the government's Madoff scheme may work over the next few years. However, in my view, the long-term risks, in terms of the liabilities being passed to our children and grandchildren, far exceed the benefits.

COMMENTS (12 to date)
dearieme writes:

But do you believe in "expert macroeconomists"? I think Santa Claus more likely, myself.

Les writes:

The parallel you draw between the Madoff Ponzi Scheme and the government bailouts is very instructive - and unfortunately it seems very apt.
Thanks for this distressingly accurate comparison.

Gary Rogers writes:

I think a lot can be summed up in "trusting the experts". Investors trusted Bernie Madoff, the rest of are trusting other Wall Street financial experts to take care of the huge pile of retirement money that is now invested and waiting for baby boomers to retire. It is an important point that even Alan Greenspan trusted others with more financial knowledge and was misled. When we are uncertain, we want experts to help. But, when the experts are wrong things can quickly go up in flames. When the government can take our money without permission and spend it on what the "experts" say, there is not much we can do about it.

Christopher Espinal writes:

All of you hate experts yet will resort to experts when you have to make decisions on things you don't entirely understand. Those "failed" macroeconomists are being asked to do the same exact thing - do what they are asked as experts.

Greg Ransom writes:

This is why the first ethical duty of every microeconomists is to let the general public know that their macroeconomic colleagues are outright pseudo-scientific frauds.

The macroeconomists are the Bernard Madoff's of the sciences.

>>Similarly, we are trusting expert macroeconomists to tell us that bailouts/stimulus are good.

Lorenz Gude writes:

Part of growing up is learning that just because you trust someone does not mean that they will treat you kindly. It doesn't even work reliably with parents who often abuse their kids one way or another. Trusting macroeconomists or investement advisers doesn't make them right or honest or competent. You can trust your doctor but in the end it wont save your life. It may even kill you prematurely. And it might make us feel better to blame Bush or Congress, but it wont make us less poor. I think it is cop it sweet time.

HatlessHessian writes:

So what do you do if you're one who wishes not to go along with the Treasury's FPS (Federal Ponzi Scheme)? Where can one opt-out of this monstrosity?

Madoff's failure wasn't hard to anticipate, even for those who subscribe to efficient market hypothesis and ignore behavioral finance dynamics. Either model shows that Madoff claimed to be making profits off of noise - a nice analog to perpetual motion machines and static electricity power generation plants. It's amusing stuff for a poorly conceived screenplay, but not something real-world people believe in absent pathological difficulties (e.g. greed).

When Enron tanked, a mutual fund manager friend of mine was approached by a friend of the family who had worked for Enron and at age 58, was facing a calamity. He asked how he could recover his savings in "faster and certain" investments in order to retire at 65 as originally planned. 80% of his retirement was in Enron stock since it was doing so good, and the other 10% was in highly diversified holdings like MCI Worldcom and Level3 Communications. He now had close to zero for retirement.

My friend attempted to explain risk/return relationships as well as "if something was a sure high return, everyone would jump into it and drive its return down to the risk-free rate" market dynamic explanation, but his efforts were futile. There's a mindset that predominates this nation now that outcomes can and must be guaranteed. Free healthcare, no business failure, guaranteed college educations, two cars, three HDTVs and a console gaming system are all rights. Retirement with great wages and medical care (and next-to-free drugs, thank you Pres. Bush) are all constitutional assurances.

As reality doesn't work that way, the majority is in for a hard shock, especially when those like me (and others here) will refuse to extend any more of our hard-earned funds for this delusion. It's time for tough love.

Davey Crickett writes:

Hatless Hessian:
All good until the last paragraph.

"...refuse to extend any more of our hard-earned funds for this delusion."

Exactly how do we do that? Especially when it's a "majority" that suffers from the delusion? The govt will simply take from us whatever it needs to buy the votes of the majority.

George writes:

I propose one way that consumers can slow down the nationalization of the economy: Angry consumers could boycott any company that received a federal bailout. If there was a large cost associated with federal government financing, companies would work harder to avoid the bailout stigma. In addition, a consumer bailout boycott could speed up the liquitation of failed companies feeding off the government.

What is missing is an efficient way for angry consumers to identify companies receiving a bailout. I know about GM, Chrysler, and the largest banks, but what financial institutions avoided the bailout? Who deserves our business?

Edward writes:

Pardon me. Not all macroeconomists were for this deal. Me, for instance.

I have taught this subject and studied it for more than 30 years. I could see that the approach of this administration and congress were completely boneheaded. I told everyone who would listen, including my representatives in congress that the original and following bailouts were doomed to not accomplish their goals.

There were even a number of us who signed an open letter to the administration and congress asking them not to do this thing. All to no apparent avail.

So, don't tar us all with the same brush as that used to paint those who have never left the Keynesian camp that sees large multipliers attached to every dollar of federal expenditure.

Anyone ever ask why there is not a tax rate cut that would produce a $1 trillion dollar tax saving for the economy?

Dan Weber writes:

I propose one way that consumers can slow down the nationalization of the economy: Angry consumers could boycott any company that received a federal bailout.

What about the banks that got "investment" against their will?

jimbo writes:

" However, in my view, the long-term risks, in terms of the liabilities being passed to our children and grandchildren, far exceed the benefits."

I do have to ask, Mr. Kling, because you seem like a reasonably intelligent guy: do you actually believe this nonsense, or are you just telling a "noble lie" in order to justify some other policy?

How, exactly, are these "liabilities" to be "passed on"? Are they going to build cars and houses, pack them into time machines, and ship them back here? Are we using the same magical machines to ship our stuff back to 1945 to help pay for the war? Current production can either be used in the present or used in the future - it can never be used by the past. Our children and grandchildren will be able to fully consume their production (which will be greater than ours, unless technological progress suddenly grinds to a halt and productivity never increases), no matter what the notional values of financial assets and debts are. I mean, really: how could it be otherwise?

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