I was pretty excited about Thaler’s podcast because I’m reading his book right now. His writing is a lot more comprehensible than the audio file transcript. And I really hope those dirty words were transcription mistakes.
How is Apple’s speech-to-text conversion so terrible? Somehow it correctly spelled out Amos Tversky but has issues with econ. I can’t believe Siri hasn’t mistakenly directed me off a cliff yet.
Source: MiB: Richard Thaler on the Human Side of Economics –tbp
This is masters in business with Barry Ritholtz on Bloomberg Radio.
On today’s podcast I once again have a very special guest. I know you guys are tired of hearing me say that week after week. But you know what this really is a very special guest Professor Richard Thaler of the University of Chicago, perhaps best known as the father of behavioral economics. When you look at his body of work, when you look at the impact he’s had Professor Thaler on the perennial short list for a Nobel Prize in Economics what I think you’ll find so fascinating about him is not just that he’s incredibly intelligent and unbelievably knowledgeable about how human behavior in the world of economics differs so much from traditional economic theory but you’ll find he’s somewhat somewhat mischievous and very amusing and not your typical dry academic and certainly not a typical dry economist.
His background is is really very very early days of behavioral economics, his early mentors were people like Dan Kahneman and Amos Tversky. He’s worked with Bob Shiller for many many years for twenty five years they’ve been co-chairs of an N B E R panel on behavioral economics and just anybody who’s been pursuing this field is certainly familiar with his work starting with a lot of anomalies that he’s identified in the world of economics including his book The winner’s curse from so long ago.
he did a book with Cass Sunstein called Nudge that’s been very influential. And currently he’s out promoting his latest Book called misbehaving which really is a mix of his own autobiography which of course parallels the rise of behavioral economics over the past let’s call it forty or fifty years and a quick funny story after we finished the interview he had to head somewhere else downtown and so I walked with him down to his hotel. we walked down Lexington Avenue and let me tell you walking through the streets of Manhattan with Richard Thaler is really quite fascinating because there’s a running commentary on everything that’s going on and it’s quite amusing and quite interesting. And he said something that was really has stayed with me it was very interesting during the interview you’ll hear or hear him discuss how traditional economic theory works really well for the small insignificant decisions we make over and over again that we get good at what spaghetti sauce to buy in the supermarket you know where to fill up our cars with gas things like that, that let’s be honest in the scheme of things are not very consequential. But he also talks about how the big decisions you make in life you don’t get to make that often. you don’t get to be that good at making the decisions that really matter you don’t have a lot of experience with them. His examples were you choose what field you go into where you work saving for retirement who and how often you get married how who you’re going to marry to. And I was going to get married to and how often you end up getting married or remarried and the big decisions the ones that really impact your life you do once or twice or maybe a handful of times.
So you don’t get a lot of experience you don’t get a lot of skill at it. It’s something that you hopefully make a right decision and if you don’t the consequences are really significant. And so as we’re walking down Lexington Avenue in New York City. I start talking about that and I jokingly say to him, hey you know that thing about you know how many wives you have and the impact it has on your life is kind of interesting. My secret was to marry my second wife first, just skip the whole first marriage the whole disastrous first marriage go right to the second marriage. And he laughed and then he said something that has stayed with me since we did the interview. It’s really very very interesting he said. You can never be happier than your spouses. And look we’ve all heard the expression happy wife happy life.
But stop and think of it in that sort of behavioral terms that the ceiling on your own personal happiness is a function of whatever your spouse’s happiness is. And when you put it into that context it certainly makes it clear that hey if you make your significant other happy it’s going to come back and ultimately raise the ceiling for how happy you yourself can be. But lots of other comments and phrases like that where he’s just looking at it slightly askance slightly differently then you might consider. And it leads to a lot of insights. So I found him to be absolutely fascinating. I wish I could have kept him there for another hour without any further ado here is my conversation with Professor Richard Thaler.
This is masters in business with Barry Ritholtz on Bloomberg Radio. Once again I have a fantastic and special guest. His name is Dr Richard Thalar. He has been called the father of behavioral finance. And I’m just going to give a short version of your curriculum the bachelor’s degree from Case Western and then a master’s and Ph D. from the University of Rochester. Dr Thaler is the author of over fifty published papers and notable numerous books most notably the winner’s curse nudge and misbehaving. That’s a salary.
Welcome to Bloomberg.
Thanks very happy to be here.
I’m leaving out half of your C.V. will save that for for later. Tell us a little bit about your background how did you find your way to Academia
I went into academia because I didn’t think I was suitable for anything else. That’s literally true my father was an actuary and it was a great disappointment to him that I didn’t follow in his footsteps. But I saw him grew up in Jersey worked a Presidential I saw him taking the train in every day not to you not for me the world’s or subordinate so I could be MIA seemed like a good choice. And you know I was kind of good in math I’m kind of good in economics. So I went into economics so you start out as a was it a graduate school student at Stanford or right after being a graduate student. Yeah. After being graduates and teaching for a couple years the Stanford episode.
You had some really influential mentors.
Yeah. I claim to have discovered Daniel Kahneman and missed a verse in the same sense in which Columbus discovered America. Right I mean it was here too as a surprise to the people who were living here at the time. Yeah. So kind of an adverse he came to as a surprise to economists right. So I came to be the first economist to discover them and I had been interested in weird stuff people do weird from the perspective of economists. So economists have this creature. They study that comes with the Latin term homo. Because I just like calling them economists economic man nomic man or we should say economic person
OK. Come on Barry we have to be in No twenty first century you work in an academic so you have to be more politically correct. Right so economic person but I call them econ and cons are as smart as the smartest economist or possibly even the smartest the smartest economist thinks he is which is much smarter which you are not smarter. Right which is really really smart. They have perfect willpower and never have to diet because they weigh exactly the right amount. No hangovers, saving for retirement, piece of cake. They calculate how much they need how much they’re going to earn on their investments. Implement. So needless to say
Oh one other thing they’re jerks so rational economic man will you know I left my cell phone outside the door to charge if an economy walked by he would take it.
So so let me throw a quote of yours to put this simply. Conventional economics assumes that people are highly rational in fact super rational and unemotional. They could calculate like a computer and have no self-control problems.
So so how does this manifest itself. This this obvious falshood about the way humans behave. How does this manifest itself in terms of the way economics progresses.
Well take the problem of saving for retirement. It’s one one of the biggest financial decisions that we have to make in our lifetime. One is how much education to get and what type of second is who to marry and how often.
Third is saving for retirement. Throw in buying a house and you’re pretty much of the big ones right. So you know that’s a piece of cake for economists and it used to be a piece of cake for my father’s generation because there were pensions and you would work at Prudential for your life and then they would give you an annuity and retiring was easy. You never had to think about you never had to think about anything. So then you know we invent the 401K. and now people have to figure out whether to join. How much to put in how to invest it and then how to draw it down which is a whole very hard I’ll probably do it anyway. And so the idea of this perfect person perfectly rational person making all the right choices on emotionally with good self-control and perfectly calculated to their needs that clearly doesn’t exist it clearly doesn’t exist and notice if the world was fill of full of people like that then the 401K. is an ambiguous Alee a big improvement because it’s portable and you can customize it and we all know what’s best for ourselves sure if we’re you cunts. (I don’t think he really said that)
The Dow by our numbers each year show that the average return over the course of thirty years has been about three percent for foreign investors. Yeah. And they have a great tendency to buy high and sell low. they massively got out of equities starting in about two thousand and six and flows didn’t turn positive until twenty thirteen during which time the market doubled. Why is it so challenging to get economists to actually understand. People don’t behave this way in the real world.
Well and let’s just say that one of the things that Hugh. Millions have trouble with is the economic concept of sunk costs. I was going through your list of mentors pretty much your early mentors or all almost all Nobel laureates. I’ve been lucky you know how to pick I’m definitely not a pick up.
So before the break we were discussing some costs and I had asked you why is it that a condom is just won’t recognize some of the reality of the way humans behave in the real world and your answer was. My answer was you know a bit cheeky as I tend to be which is that economists teach people they should ignore what they call sunk costs meaning if that dessert doesn’t taste very good you shouldn’t eat it just because you paid twenty bucks for it. And economists have trouble following their own advice and they have a lot invested in the rational economic model and we’re going to give it up without a fight.
Isn’t that the nature of so many ideologies that there’s all this time and effort. There’s this and down in the fact that it’s yours you’ve done you’ve done the work you’ve done the heavy lifting. Very difficult to just go this is wrong let me move on and find a new philosophy. Yeah that’s true and you know I often say that I don’t think in forty years I’ve changed anybody’s mind.
I disagree with that statement. I know you’ve said that but you’ve actually changed a lot of people’s, If not change their minds certainly change their perspectives and enlighten them somewhat.
Well but not and not economists. So I mean the field is growing. There are lots of great people in it but they’re young and so my strategy from the beginning was corrupt the youth. OK don’t try. You know there’s this old line Science marches funeral by funeral and a funeral at a time. Yeah and you know there’s no point in trying to convince those guys but young impressionable graduate students you know you can have your way with them.
That’s hilarious. So don’t even bother convincing the old fogies just go right for the kids. Yeah it’s a good long term strategy.
You know I was fine a long game. You have good impulse control. I have to work on that.
That’s really interesting so let’s move a little more specifically to the efficient market hypothesis. You once said I love a love a lot of your quotes. We don’t want to throw away the official market hypothesis. We just don’t want to believe it’s true. Explain what you mean by that.
Yeah. So all of behavioral economics and behavioral finance starts with rational models and they give us a benchmark and it wouldn’t really be possible to do behavioral economics without that rational benchmark. So you know the official market i Pods This is really has two components. One is that you can’t beat the market and the other is that prices are right that asset prices are equal to their intrinsic value. OK Now those are very useful starting points. No hypotheses right. And the beauty is that they’re testable. And so over long periods of time. Yeah well sometimes like let’s take the price is right.
OK Here’s an amusing story. There’s a closed and mutual fund which if listeners don’t know these are mutual funds that you have to buy and sell on exchanges which means that their prices can deviate from the value of the asset sale as opposed to traditional mutual funds where you can only sell at the end buy or sell at the end of the day and it reflects a calculation of everything that’s held within.
That that bucket.
Exactly. Now the fact that the prices sometimes differ from the value of the asset is already embarrassing but not as bad as the story I’m going to tell you. There’s a small closed end fund that happens to have the ticker symbol. CUBA – Cuba. Yeah. Now needless to say they don’t own any assets in Cuba because it’s against the law and B. there aren’t any. Nevertheless And for years it was selling at about a fifteen percent discount to its
President Obama made his announcement of his intention to ease relations with Cuba. The Cuba fund went to a seventy percent premium. The next day after the presidential announcement it was up almost to fifty percent a week later it was up seventy percent. How inefficient is that. Not efficient. And you know efficient market Defenders was that all of this is one little tiny example but there are hundreds of.
That’s right. And we study these little examples I call them the fruit flies of finance. Yeah. Because no one can possibly defend this. It’s still several months later selling forty percent above really above net asset value here. But I don’t know where we’re opening relations with Cuba. Why could you why are you so negative on a closed end fund called Cuba.
Yeah yeah because it has nothing whatsoever to do with Cuba.
Yeah well I notice that their their holdings are public information. Yeah. And you can buy those stocks on your own for a hundred dollars. Why would you pay one hundred forty. That’s unbelievable. Well markets are not perfectly efficient. Their kindness or to eventually will get around to it efficient well.
Maybe so here’s what I would say. The part that you can’t beat the market is approximately true. Some people can on rare occasion – Good luck picking them in advance.
That’s right. Look I mean what we know is most active managers underperform and that’s kind of the best evidence in favour of the official market opens and that’s before fees cost taxes time depends on how you do it but they’re certainly certainly not beating the market after fees. But although it’s the best evidence for the efficient market I bought this is it’s also the most evidence against because whereas most of the money in active funds.
Yeah Vanguard has grown a lot. They’re the exception. You know it and they will kill a third of their three trillion dollars is still actively managed right. So. So I think it’s approximately right. And listeners would be well advised to just say I can’t do it. Is it just inherent in human behavior that we’re going to get booms and busts markets are going to rally and crash and that’s just the way it’s going to be I think we’re subject of that risk. But I think there are things we can do to mitigate it.
And let’s talk a little bit about choice architecture and knowledge which refers obviously to the book you wrote with Cass Sunstein.
Yes So the idea of nudge is that because we’re dealing with humans rather than any kinds that you sometimes need help. And can we think of ways to help them that don’t force anybody to join. So that was that can feet of the book. Another word you’re not mandating anything all man made. No bands how much can you do with those restrictions. So just you just kind of just nudging is the right choice.
There’s an interesting little. All bit of behavioural engineering which is and I see it here in New York I come up out of a subway to get to my office because it’s the fastest way to get around town and it’s a double escalator. I mean this thing just goes on forever. And about half the people stands on the escalator and have people walk. But sometimes you get people who don’t understand the social norms and they stand on the left side instead of standing on the right side. I’m in an airport or somewhere in maybe it was Brussels and I see this escalator and on the right hand side are two feet on each step two to two on the left hand side is alternates left and right foot. And I made it clear oh this is the walking path. And that whole issue you never ran into the person to understand the social etiquette. And if you’re standing slow traffic moved to the right. It was amazing it was so simple and very effective yet you know people have lots of misconceptions about nudge. One is that it has to be sneaky. These notice these things are the opposite of right in your face.
Right. Look my favorite nudge one that I claim I saved my life many times is in London at street corners there’s a sign that your feet look right now because the cars are coming from the wrong direction. If you’re from Europe or American right and so you know many years of looking for cars coming from your left all of a sudden boom. So you know there’s something sneaky about that. It’s right that nobody tells you you have to look at it but several double decker buses haven’t hit me because of that look right. You know a couple years ago I wrote this thing for tourists coming to New York City. And one of the things was there are many want to. They streets but the bicyclists don’t have any obligation apparently to follow that. So when you step off the curb look left and right to make sure you don’t. And let me tell you how many times I’ve just missed the bicyclists because I happen to look right it’s the same it’s the same exact thing. So this really is kind of consistent with the philosophy at the University of Chicago which is really known as a a libertarian a sort of right leaning philosophical efficient market hypothesis place.
Are you considered a bit of a heretic there because you really don’t fit the mold of of Chicago economy.
Yeah I think heretic would be one of the more polite to have been called. You know we called our philosophy libertarian paternalism libertarian paternalism the way many of the Libertarians were mad that we stole their word and that everybody hates paternalist they think of the journalist as Ralph Nader. So but what we need by Libertarian we use it as an adjective and by paternalism we mean helping people achieve their goals like not getting run over by a bus. So if we can do that without forcing anybody to do anything why wouldn’t we be known as the father of behavioral economics.
I’m about halfway through the book and I found it to be both informative and amusing which is an unusual combination So let’s talk a little bit about theory induced blindness. I know you’re going to be seeing your mentor Daniel Kahneman and you mentioned that’s a quote of his he called Theory induced blindness the refusal to see facts when it disagrees with a theory or ideology. Some people call that cognitive dissonance is.
He difference between this is a different concept so the idea is that if you have a certain lens that you look at things through then you’re going to see everything to be consistent with your point of view. And so you know it’s like that people have various views about the economy from the left and from the right. And every you know every time there’s a bit of news they’ll find a way of inter-breeding that piece of news as just confirming what they’ve always thought. Where I see that every day is the bull bear debate that takes place in the media and print and no matter what’s the data point is the bulls who are long equities and explain why this is good for the markets and the bears just tried out a counterargument. This is proof that we’re all going to die. It’s amazing with the same data points out people just focus on right. What justifies and how much of that is selective perception and how much of that is just you know we see that which agrees with us. Yeah yeah. Psychologists call this confirmation by yes. So we go out and looking for evidence that supports our point of view. I mean what theory should show should be one hundred percent of them are trading at or pretty close to intrinsic value. That’s right. So the fact that you find in one that’s fifteen percent below one day and seventy percent above that really shows that hey that’s theory is a little bit or that it’s what we call an anomaly mental accounting.
What is mental accounting.
Mental accounting is the one. Think of it as the financial accounting of people and economists tell us that money is fungible. If you want to impress people at a cocktail party use fungible it just means there’s no law.
But of course people put labels on stuff. You go to the casino you can see this. A guy wins some money early in the new plan with house money. Exactly that’s the expression Yeah playing with the house money. What does that mean. The casino is called the house so it’s like you’re playing with their money. Well suppose you won five hundred dollars you put in your right pocket. You brought five hundred dollars to gamble us in your left pocket. Both of them will buy something pretty nice if you get it home but the one the house money easy come easy go and it’s entertainment. You’re just putting in a different right option. So you know that sounds like small potatoes.
But during the 1990s technology bubble Oh sure. During that boom everybody thought they were playing with the house money. And for one gain best years were just increasing and increasing their equity exposure. And at the time I said one of two things is true. Either they understood that equities outperform bonds or they think stock prices only go up those things that give us an answer is a crash. Fortunately we got a crash and we got an answer.
You know I’ve had this conversation with people that this was early in my career and I remember getting the calls from people who were significantly older than me saying hey I got a ton of profit some rolling a little money out into real estate I’m taking up that vacation house or I’m trading up to a bigger property. But they were really the exception you it was rational it made sense. I think most people wish they could go back and buy real estate in 1995 prices. That said you really didn’t see a whole lot of it. And any time people sold at least in the until two thousand they seem to have regretted that. All decision.
Yeah. Because you know everything was upside down during that period. The most the most exciting value. You know it was in the lawyer did with nearly Yeah but it did poorly that they all value investors were getting crushed and you had to just be patient. But meanwhile your neighbors were getting rich. It was hard to do so. So why don’t why is it this mental accounting
Why do we love bargains so much you tell one of the anomaly stories about when J.C. Penney’s decided to get rid of the fake prices with the artificial markdowns and just have one price and it was a disaster. Yet people like deals even if they know it’s nonsense and you know even rich guys like deals. You know plenty rich guys travelling in December to get their one K. you know to get more miles. And so only at the next break point and get all these free miles right. That and you know you go to Costco the big discount retailer you see a parking lot full of fancy Mercedes S.U.V.s with my wife pointed out we went to Target a few weekends ago and there is this Rolls Royce race in the parking lot yeah which is a three hundred fifty thousand dollars car at Target. I guess he needed a lot of time. Yeah yeah. I used to tease my father who was driving around in a fancy B.M.W. looking for the cheapest price for gas. And I said you know Dad how much gas you use using to find the cheapest price. But he had to find the cheapest.
So you had mentioned casinos earlier Twain once called Gambling a tax on the stupid. Do you agree or disagree with that.
You know I think it’s Mostly right. Why do we why do people love gamblers like the thrill. You know and there are some things like horse racing would be unbelievably boring if you didn’t have some action right. And of course the betting is irrational because the rate of return is minus seventeen percent per twenty minutes because that’s the take. Right. So it’s funny you say that. So I’m on a cruise with my my wife and we’re walking through the casino to get to the other side of the ship and we just walk by one of the tables and I notice because I have a bit of a I have a I head for math I say to her. Notice that this pace two to one but you have three chances to lose and that pays three to one and you have four chances to lose and it was a roulette table. And I go look at all the odds the odds are relatively bad relative to the risk. And she teaches fashion illustration and design so she’s a visual person and she says I don’t know about that but they certainly seem to be sweeping up a whole lot more chips and they’re handing out each each roll. And I’m like oh well that’s the other way to to look at it. And yet people sit at the tables and play for hours and hours.
So I’ll give you my favorite recent mental accounting story which is in the early days of the financial crisis the price of gasoline fell by fifty percent. What did people do. Remember everybody was belt tightening on all fronts except one people were splurging on premium gas on premium gas premium gas because they have a gas budget and they have been paying one hundred bucks a week to fill up the tank and now it was only fifty. And they’re thinking oh well guess is cheap. All right I’ll splurge by premium every once in awhile. What what of the fact that unless you have an engine designed for premium gas that extra octane just goes out the tailpipe you know. There’s a lot of money left in the gas budget. So just buy premium gas just so you know it’s completely stupid. But you know what can you do.
So let’s talk a little bit about self-control that’s another chapter in the book that’s another one of your favorite topics. People really seem to lack all manner of self-control. How does that manifest itself economically.
Well you know we talked about saving actually United States not an especially high saving area you know we went through a decade where we had negative saving rates. And you know this is the place the domain where behavioral economists have had their biggest impact and we’ve managed to change the way most for one game plans work with two small changes but on one automatic enrollment so you start a new job at a company that has a 401K. and you’re automatically enrolled. Right. Unless you opt out you have to fill out a form not to join. And that raised enrollment in the first year from about fifty percent to eighty five percent. Huge huge difference and a completely trivial change. And what was even the last thirty seconds what was the other the other one is what I call save more tomorrow which is get people to agree to increase their saving rates every time they get a raise. And that has an impact and therefore they’re contributing more.
You know we’ve been speaking with Professor Richard Thaler of the University of Chicago author of the book misbehaving the history and making of behavioral economics. If you enjoy these conversations be sure and check out our continuing chat which you can find on bloomberg dot com and on Apple’s iTunes Check out my daily column on Bloomberg View dot com and follow me on Twitter @ritholtz.
I’m Barry Ritholtz You’ve been listening. A master’s in business on Bloomberg Radio.
Hi this is Barry Ritholtz You’re listening to a masters in business on Bloomberg Radio this is our podcast portion where only you folks lucky enough to go to Sound Cloud or Bloomberg dot com or iTunes and I have to tell you if you’re listening to this you already have found the podcast portion and we just kind of take our ear pieces out and relax and have some fun.
I didn’t get to mention some of your curriculum of the day and I know you said it’s way too long but you do something with Professor Bob Shiller That’s kind of interesting. You guys are the you’re the co-director of the behavioral economics project at the National Bureau of Economic Research. Professor Shiller is your co-director is that right.
You know we’ve been doing this for I think I’m over twenty five years really so here’s what I find fascinating and there are amazing parallels. So Bob Shiller is also a behavioralist he thinks people make mistakes markets get crazy We have bubbles we have crashes. One of his very best friends is Wharton professor Jeremy Siegel couldn’t be more opposite philosophically than then Professor Shiller. He stocks for the long run we can never you know what’s not worry about this if you’re thinking long term you have to be long equities.
Bob is you know things look a little pricey here is my Shiller cape and then I look at you and your University of Chicago you’re the father of behavioral economics and your golf buddy is Eugene Fama who couldn’t be more opposite in terms of philosophy then you are. How did that relationship develop.
You know when I first arrived at the University of Chicago a reporter asked. Couple of distinguished financial economists why they had allowed this to happen. This heretic to shield one I’ll make you read the book to find out who said he didn’t block it because each generation has to make their own mistakes.
That’s hilarious. A very warm welcome to a new colleague. Gene said oh we are them because we wanted him. We wanted him nearby so we could keep an eye on him. That’s very funny also. Yeah so but a little nicer right. And I had a little tongue in cheek a little you know yeah I have to looking if they’re exactly exactly and you know Jean. what Jean says is and I agree with this that he and I agree about almost all the facts we disagree about the interpretations.
Yeah but you agree that there are bubbles. He sort of has ducked that question what is a bubble. What’s a bubble right. Look. But what’s his real objection is that we can’t predict when a bubble is going to end which is true. OK And you know a lot of us had a pretty good run a lot of it. No no no. Look Bob is my buddy for twenty five years. But he was warning. When did he give the speech to Alan Greenspan ninety six around four years early but he wasn’t saying it’s a bubble get out he was saying hey things of it on well you know but kind of what we’ve been hearing that you have by doing is about like ninety eight.
Yeah you know it was as hair was on fire and you know 2000 you know. So my selective perception and confirmation bias is that I only saw the 2001 and. Well I don’t remember the ninety six. He’s the one who planted irrational exuberance and exactly and there and then Greenspan gave him that phrase which Bob never used and the S. and he turned it into a bestselling book which happened to come out in two thousand which was lucky.
Good timing good timing while he was very dead on with the housing. Again you know again he started warning that house prices are going to look in pretty scary especially in places like Vegas and Scottsdale but they kept going up for a couple more nights. So so Gene’s right that calling tops and bottoms. There’s nobody is good at that. And now I think it was pretty obvious in both of those cases that there was a bubble going on but you know I thought it was ridiculously priced in 1998 and you know some people would argue it was.
Yeah and by that I had a guy in my class I was teaching a Ph D. class and behavioral finance and I said Amazon who buys this and there’s a guy who raises his hand and he bought it at the I.P.O. Well come on and he says still on it still holding on to this is ninety eight so isn’t that old and so he’s still holding on to all that I don’t know I don’t know but. So each week in class you know I’m teasing him about this and each week in class he’s getting richer tips because you know at the end of the quarter I gave him an A. I said What the hell. Who knows what I mean you know people forget that in 1998 the Nasdaq was up eighty. Five percent and in ninety nine it more than doubled was up more than a hundred percent. And that’s just you could throw a dart at any tech stock and you’re making crazy money of course you subsequently ended up with an eighty percent not too far off from the ’29 crash an eighty percent subsequent debacle starting in March two thousand.
But Amazon is one of the survivors it yells the American money the example I always give people when they say Imagine if you bought the I.P.O. of Amazon or or apple and my answer is always how many of the original I.P.O. holders valuable do you think are still long Apple that that people buy it and they can. They’re afraid of oh my God I’m a loser we’ll talk a little bit about Prospect Theory and about why people seem to hate losses so much more than they like gains in a little while.
But how many people who bought Apple even fifteen years ago are still long today. Yeah well it’s very hard. People have a tendency to get rid of their winners too quickly and to hold on to their losers too long and that’s the exact opposite I started as a trader in this business. It’s the exact opposite you have to let the runners winners run you gotta let them run and but and you’ve got to be willing to admit you made a mistake and you started to get into law also version lots of evidence shows that losses hurt about twice as much as games feel good.
So I have to ask why. I have my own pet theory which is very esoteric I’m really curious as to why you think why that is that losses hurt. I think we’re just hard wired that way. Amos Tversky one of my psychology mentors had a joke that there once were species that didn’t exist but loss aversion and they’re now extinct. It so. If you are right near subsistence it makes really good sense to be lost a verse right now for those of us who if we lose two thousand dollars we’re not going to fail to make our mortgage payment or stop eating. No longer you know that the evolutionary cycle is very slow and so it made sense to be loss averse when losing something meant you starve to death. Right but but now you know people do stupid things like buy extended warranties right. Twenty seven billion dollars a year. That’s an industry and most of it is for stuff that is just to those of all.
Yeah I forgot what even the last washing machine we just bought a washing machine. We moved in September November or October we bought a washer and dryer and they were nice but they weren’t you know crazy expensive and they stuck pitching in the washer. I’m going to throw that breaks you going to fix and if you know fix it I’m thrown away and I’m buying a new one. I’m not going to. Why do I need to spend more money on the possibility of this breaking. You know what people have to think about is they’re making money selling you that policy right. And the salesman at those especially is making money and that means you’re losing money. They’re making more money. In college I worked part time in an electronics store and they would make more money on the extended warranties then they would make on the products.
So here’s an example of mental accounting. What people should do is say every time somebody offers me an extended warranty I’m going to take that money and put it into a special sale. Right and then any time and then goes to a repair fund. Yeah I had a I had a friend that at Cornell who had here was his mental accounting trick at the beginning of the year. He would set aside money for the United Way say five grand is going to give them anything bad happens to them. He did ducked it. From what he’s going to give to the United Way right now. So he was totally insured so he had an insurance policy and at the end if he had a good year United Way got five grand. Yeah that’s funny you know speeding to get no problem comes out of United Way
You know one year the roof blew off is very close you know in North Carolina and I told them Look you the reason why you were covered is you’re too cheap to give United Way enough money to cover the roof right. That’s unbelievable. So in other words he didn’t have the homeowners and journo you have insurance but you know he didn’t have insurance for the doctor bill. That’s that’s pretty fast. Mental accounting insurance.
So let me keep working my way so might My pet theory on on why people hate losses more than they like gains gains represent a temporary increase in your standard of living. Stamper ery Yeah and we all know you behaviorists have taught us hey you go out and buy a bigger car a bigger house or a nicer television or whatever. And six months later that just becomes your benchmark your frame of reference and whatever benefits accrue to that for the most part don’t really most people don’t feel
I’m an exception with cars and I could tell you my wife’s car every time I drive this. We’ve had this for two years. It’s an utter thrill. The car I forced her to get. It’s just this little rocket ship and it’s a deal. Other than getting pulled of speeding tickets it’s a delight and I’m aware as I’m doing this I’m like you know it’s two years and I just the thrill is not yet gone but I know that it’s about six months for for most people or most things. And so you’re on to a basic fact of life which is that we adapt to our surroundings and to the upside and the downside
Yeah I mean look when you’re a grad student you don’t feel poor because you’re living with a bunch of other grad student right. And you know you’ve all got second hand furniture and macaroni and cheese and you know it’s temporary and now you know if we had to go back to live in like oh yeah but you know we were happy then you’re sure. So you know that. And so that’s the first basic fact of human nature and then the second is that improvements make us happy but that governments make us miserable.
Right. So I know you also version. So so the loss aversion thesis. So not only are the gains temporary but and this sort of traces back to what you said about people on the edge when you lose money in that mental accounting that we do with that loss of the average salary in the United States is about fifty thousand dollars you lose a thousand dollars. That means that a week of your life is gone and you have nothing to show for it. You work that week you got a thousand you lose it. That’s a significant loss. It’s a permanent loss versus the benefits a temporary. Hey here’s a thousand dollars you could buy some nice stuff you could do things but it’s only temporary. And that’s the only way I’ve been able to rationalize why we despise the losses so much more than we enjoy the game you know.
I’m not much for evolutionary stories but this one. Is just we’re just hard wired. And maybe in another fifty thousand years we will get over it but not anytime soon. There’s a book I almost done reading that actually put it down to start yours called last apes standing and it looks at the past ten million years and that there were approximately thirty species of either human like or near human and how the the way they’ve evolved led to some to thrive and some to not make it. And we happen to be the last state standing and it’s a lot of the decision making that that we see today a lot of these what you mention is hardwired. Well sometimes it is a hard wiring to send you down the wrong path.
Right. Hey you ain’t around anymore. Well you know we got hard wired to win that battle with the others. Sapiens and it came you know there were pros and cons we are bad backs so you know that’ll teach you to walk upright right YOU hundred thousand years just to say the least. Let’s talk a little about the winner’s curse we kind of skipped over that earlier. What exactly is the winner Scott’s idea of the winner’s curse this was discovered actually by a couple of engineers at Arco Arkell
is Arco all the oil company almost all Atlanta Richmond.
Yeah exactly. Land Richfield Richfield right. So what. Here’s what they discovered they discovered that when they were bidding for oil leases. Every time they want to lease there was less oil in the ground than they expected. Not every time but on average now they had pretty good geologists and they couldn’t figure out why they were so unlucky. And then they had the Internet. Well there’s a reason. One the auction. They too much. We paid too much
So the lesson is the more bidders there are the more likely it is that if you win the auction you lost. That’s really interesting so if there is something that you want that you’re bidding at auction for you should be at a moderate price and either you get lucky and you pay that under price or if you get enthusiastic and bid too much that’s that’s a losing situation and a lot of options have a way people get carried away. They certainly do. The only way to rationally participate in the auction is to submit your bid and be done with.
Yeah and walk away. So figure out the intrinsic value apply a reasonable discount some of that in writing and find out the next day did I win or not right. Because if you go in person you’re doomed. A friend of mine dragged me to an antique watch auction that took place in uptown and men an hour from where we are yet still uptown from here and I looked at all these and they come out with the white gloves and they bring this watch is four thousand dollars and this watch is ninety thousand dollars and this watch is five hundred that it’s was just insane that’s a whole different universe of collectibles. And I watched online the auction go off and there were some things I thought were really interesting and I hadn’t the slightest idea of. I would love to pay you know steal that for twenty percent below. But auctions are pretty good at getting people at the very least to bid fair value and most of the time to bid above and there’s they have a cost on top of it. Well that’s right but a colleague of mine that Chicago Booth called Devon pope has studied the auctioneers. Turns out that there are some there are good and bad auctioneers. Not surprising but again in a world of recounts that wouldn’t be true because who would all be up to our reservation price and stop.
So what is it that the good auctioneers are getting people to do that the better not.
Yeah I don’t remember the other now getting about four of us that really just but all I wrote all the headline of the is there are different just like there are good baseball pitchers and bad ones. There are good auctioneers and bad ones and the only reason that would only be surprising if you’re an economist. Right because they shouldn’t be there should be only good to so much money and you know it sure is a huge incentive to get a good option here right. If you’re the one having the OP You know if you’ve ever gone to like a charity auction and if there’s a good auctioneer they raise a lot of money really. Then you know they just they just have their ways of get emotionally excited they get into entirely and the right has that right and then know that there is a good trick which is they’ll have two people bidding on like a weekend some villa in Italy and one bids twenty grand then the other wins it at twenty one and the twenty guy and Guy finally says own on call and then he says OK I have about the second week and then he sells the second week to that twenty gram guy. That’s amazing and so yeah there’s a lot of skill in that.
So let’s talk a bit about these biases that are so challenging to overcome. Why is it that a we just creatures of habit is the way we’re wired. Why do people find these inherent issues so challenging to to circumvent.
You know again I mean it’s you know it’s. Like asking why we have bad backs you know or why why we can’t run as fast as her same bolt were built that way and you know in many domains we recognize it. So you know if my wife sends me to the store to pick up some groceries if there are more than two items I need a list. You know I you know I understand my memory. My wife hasn’t figured that out yet. You know she’s like where’s the juice you know.
You know so we all understand at some level you know we set all our clocks if we have to get up early in the morning. And so we’re not perfect and it’s just silly to think that we are perfect. And you know as you mentioned earlier in the show. There’s nothing wrong with theories that assume everyone’s perfect. The only thing that’s wrong is believing that those theories are true.
So you know Greenspan was convinced there couldn’t be a technology bubble because acid prices are equal to their intrinsic value. The rational of course. And you know meanwhile companies are selling for one hundred times sales and they’re computing that because there are no profits. And you know we’re all looking at this and saying this is completely crazy. But then the market goes up another fifty percent and you start to wonder maybe this time is different. One of my missing Well yeah. Yeah I’m not seeing that thing well although he did do a mea culpa post financials and I did do a miracle.
That’s right. And I believe that reputation would have prevented banks from doing the really dumb things they did. You know what bank is going to risk a one hundred fifty eight year. As Lehman Brothers invest Arens and everybody else did and now they’re no longer. Yeah and I think a lot of that a lot of the companies is something I talk about in the book is you know economists have a theory of the agency theory about principles of age I’m sure. And the idea is usually that principle is the owner. So the shareholders the shareholders are you know Bloomberg it would be Mr Bloomberg right so he would be the principal and then you know he’s got guys like you working for him and or shirking that it was kind of the usual idea is that things go wrong because the age and the employee isn’t doing their job right.
I think in a lot of cases it’s what I call a dumb principle Prop eight. So you know let’s take the banks that were paying mortgage brokers two grand a pop to sell mortgages without any documentation. Now I’m not blaming the mortgage broker. That’s what he’s getting paid to do. I’ll take it a step further. Those mortgages had a warranty on them that was often ninety days three months. So you’re selling the thirty year mortgage you’ve basically told this mortgage broker go find me someone who’s going to lease make the first three right first three out of three hundred sixty payments.
Yeah yeah. Crazy right. So you know on principle dumb principle and you know I think in a lot of cases you know if we think of the big catastrophes like Barings and Barclays and. What we had. Or CEO’s who didn’t understand What The people that were working for them were doing. That’s a dumb principle. Yeah to dumb principle that’s fascinating.
So we’ve talked about finance we’ve talked about how irrational people can be in the markets. Let’s talk about fairness with people and fairness games where people are willing to give a benefit to themselves even if they think something is because they think something is not fair.
Yeah a classic experiment is something called the ultimatum game. So let’s say the experimenter gives me one hundred dollars and he tells me to make you an offer of some share of the hundred. And the rules are either you take it and you get what I offer you or you say no in which case we both get nothing. So it’s it’s an all or nothing ultimatum. And that’s why it’s called the ultimatum game. Now let’s suppose I offer you two dollars out of my hundred. Well I don’t need two dollars. You’re keeping ninety eight that with you go jump.
Right. So what we find is in that game if you offer less than about twenty percent you’re likely to get turned down. That’s amazing. And why is that cost to this person making that decision it’s free money. It’s free money. It’s but you know they say The hell with you. I mean that’s not fair.
You know my friend Dan Kahneman and I did a study way back in one 1984 85. What pisses people off. Eight. Well the more polite term was what people think is fair. Right. And we had an example. There’s a blizzard the hardware store has been selling snow shovels for fifteen dollars. There’s they raise the price to twenty dollars The morning after a blizzard. Is that fair. Well people hated it right. You know they all hate it. Price gouging.
Yeah right exactly. Now think about Hoover. Right they do. Surge price surge pricing now at some level surge pricing makes total sense. You know greater demand finite supply prices we’re all used to the fact that if you want to buy an airline ticket at Christmas and a hotel room in Aspen you’re going to pay more than two weeks earlier. They they even call that hey it’s high season and it’s prime season. Right. But you do it in a blizzard you’re going to make people that get you well your gadget you’re now Jake ing advance think that the very word gouging the literal means poke a hole and that’s the way people feel.
So my opinion about Uber is that they should cap the surge and to reduce animists and right and maintain a reputation. Yeah and it makes sense because they’re fighting a political battle in every city as to whether they can operate and whether they can go to the airport. They can’t afford to be making people mad at least not in the beginning. And you know there’s it never makes sense to make people mad. I mean if you’re in this for the long run the most businesses have learned this.
So after a hurricane down in Florida the cheapest place to buy plywood Wal-Mart is Wal-Mart. In Florida they’re notorious for anticipating weather and shipping X. Whatever it is actually ply whatever is needed after and it generates a lot of goodwill a lot of goodwill. Now there will also be a guy in Atlanta who will load up his truck with plywood sell it off the back of the truck right for a market price. Both Wal-Mart and that guy are being rational. Wal-Mart’s playing the long game and that guy is just doing a one off. Right it’s not my reputation that my business in Florida I’m selling this plywood and going back to Atlanta right.
So you know we’ve all had the experience in New York. It’s raining. Can you disappear so cabs disappear. Some guy in a black car pulls up twenty bucks twenty bucks right. And you know you pay unless you want to get what you want to get wet. But if if a cab driver pulled up and let’s say it’s a six dollars fare normally and he says it’s raining it’ll be twenty bucks you’re going to ride down is going to be very very unhappy. Right but you put up with it from over because it’s a different choice. It’s a third option. It’s a third option but I think they could they could do better.
So let me ask you some of my favorite questions that that I ask all of my guests these are these are some regular ones. Let’s start with an easy one. What are some of your favorite books and they can but don’t have to be economic books what books do you really have you really enjoyed.
Maybe my favorite book of all time is catch twenty two. I love Joseph Heller. That book was just I really got your college in just that some catch that gets money. It’s a fantastic catch.
Here’s a weird thing. It’s not on Kindle. That’s funny because it’s high priced I’ve been I’ve been meaning to really read it. It’s read it sold something like twenty million Curry’s right. I wonder theist. Eight has not is the reason why it was published pre candle so there’s no obligation to write about that right
if you like if you like hell are you a Vonnegut fan at all. Yeah I love so fantastic catch. So the two big ones Slaughterhouse Five always comes up every time. Catch twenty two comes up but few of his other ones would just catch cradle is just so yeah you know there’s a book that that many people know that I read because I was there about called Galapagos I think that’s the title. Maybe it’s not the title but it’s a book that takes place there. And I bought a good book a violent book off the Galapagos book that’s in the back of my head.
Douglas Adams who wrote The Hitchhikers Guide to Galaxy he did a book called Last Chance to See and he talked about by the way you want to go see this is not going to be here for another hundred years. If you want to go see this go take a look if you want to go see that go go take a look.
So here’s another book and this is a book I went back and really read while I was writing my book and it’s Richard Feynman’s Surely you must be joking Mr feynman and yet that it’s an ordeal now also you can get the versions of him narrating some of his speeches and so really tough. Yeah his stuff is wonderful.
So in some ways writing this book was my final act of misbehaving. You know the title technically refers to the fact that people misbehave according to economists right. But the second meaning is that by pointing that out during my career I was misbehaving. Well you didn’t conform to what right ones they were expecting you. Two to conform to. And then the third act was writing the book the way I did because my publisher assured me that there’s no market for a book like this right. They’re very bad at predicting these sorts yes.
Yeah but that’s true in television and film right. You know that’s the famous William Goldman line nobody knows anything. Talking about Hollywood that they would make these if it was up to them they would just make sequels of what was originally successful. But you got at least try something to see what’s going to be success so fireman’s book a you know you’ve read it. It’s a bunch of stories and some of them are very funny. He’s a funny guy and but there’s no physics. So the book I wanted to write is as it would be if I had tried to explain physics on Apple.
That makes but I don’t know whether you think I have that but that was what I was trying to do.
So let me ask you the my next question is what sort of advice would you give to a young economics student or a millennial either just entering grad school or just starting their career today.
Find your own problems or work your own problems. Don’t. Don’t be or advisors a research assistant and it may cost you a year. Because it’s the easy thing to do is do a variation on your adviser’s life work and that you and good standing for the rest well you know I think you know the my book starts out with this story about Daniel Kahneman having it in your view with Roger Lowenstein.
When Genius there I love another grad and I just had lunch with a not so long so insightful Roger.
Yeah he’s a great guy.
So the story is that Roger was writing a piece about me for the New York Times magazine you were in the room while while Danny was actually having the conversation. So then he said you want to stay for this. And I said sure and then he starts explaining to Roger sailors’ best quality what really makes him special is that he’s lazy and I’m waving my hands in the air and shaking my head and saying you know come on. I admit to being lazy but is it my best quality. And Tammy still sticks to that story.
I love that that’s a great story.
Professor Thaler thank you so much for being so generous with your time. We’re going to wrap right here I know you have a place to go to from here and I will see you on the radio tomorrow.
For those of you are listening we’ve been having a conversation with Professor Richard Thaler of the University of Chicago. Be sure and check out some of our other pod cast you can look it inch up orange down and end up checking them out. Check out Professor sailors’ Twitter handle at our underscore Thaler at Twitter. I’m Barry Ritholtz You’ve been listening to masters in business on Bloomberg Radio.