On Irrationality

Maybe a post is warranted just to add a marker for the times we live in. This one is about being brought to ones knees after soaring. The first time it hit me hard, or rather the second time (who can forget Orenthal J. Simpson) was when I saw Marion Jones’s tear stained face at a press conference where she admitted she had used performance enhancing drugs during all her Olympic appearances and wins. She lost all her medals, got six months in prison and is bankrupt. I was saddened to hear of her fate. She had reached the highest heights as athlete extraordinaire. The saddest thing is that people believe she would have done equally well without these drugs.

Now there’s Eliot Spitzer, his fall from grace is stunning. His conduct appeared to be exemplary as he brought several corrupt individuals and corporations to their knees as New York’s Attorney General. He leveraged that success to become New York State’s governor. No one could have imagined that his fall from grace would be so sudden and so stunning when he got caught in a federal investigation that linked him to a prostitution ring and a 22 year old prostitute. Last week he was seen apologizing for having violated the trust of his family, as his wife stood next to him (it’s always fascinating to see the wives standing by looking supportive, what’s really going through their minds?). What struck me as ironic is that he apologized for having let his family down – how could such an intelligent man have forgotten that his actions would result in him letting his family down, while he was indulging in them? He must have thought about it, but it just wasn’t enough to override the power of the self-destruct button. The button we all seem to cherish. The button, the imp that tells us to take anything as far as we can, see how much we can get away with before things really start going south. Now radio and TV stations are discussing his behavior in surprise, in “What was he thinking?” terms. Someone said it was to do with the corruption that power brings. I tend to doubt that explanation. I don’t think Spitzer went through a thought stream, at the peak of power that went somewhat like this: “I am so powerful now, I could go out and pay for sex and no one would be the wiser”. I very much doubt that. The absolute corruption that ostensibly comes from power is nothing more than a cliché.

And now there’s Bear Stearns, and 85 year old company that had survived so many recessions, so many economic cycles only to be wiped out last week from having made questionable investments in subprime loans. They were just bought by JP Morgan, as if at a garage sale, for $2 per share. It is a company that employed financial geniuses from institutions with stellar reputations and yet the long term decisions they made brought them to this sad turn of events.

We know nothing lasts forever, not power, not success, not fame, not youth – it doesn’t take too many years of living to realize that it’s all ephemeral and that our actions have inevitable consequences. If we don’t have sub par IQs we should be aware of the consequences of every one of our actions. But this is perhaps a lesson that we all choose to ignore.

I have often said that comfort and security is not what we seek as humans. We are programmed for chaos. As an economics major the idea of seeking equilibrium was always reinforced in our studies. Every chapter in every textbook required us to learn and master the ways in which equilibrium was attained. The other underlying statement that laced all this learning was that of rationality; how a rational person would behave.

This has come under closer scrutiny since the Nobel Prize was awarded to Daniel Kahneman and Vernon Smith in 2002; they challenged this key assumption and incorporated insights from psychology into economics. An entire discipline now comes into question because the idea of a “rational person” ceases to exist.

The state of equilibrium was supposed to come about through rational behavior from rational human beings. If we would rather behave irrationally, it goes without saying that we never reach equilibrium and chaos rules; as it has over thousands of years; it’s obvious in every one of our actions, collective and individual. At the risk of sounding terribly repetitive – we are programmed for self-destruction.

If underlying irrationality is assumed then new theories can be constructed in an attempt to predict what’s rendered unpredictable, or can it? That works very well with another thing I often say about expectations – “Expectations Be Gone!” We build expectations when we assume things will behave rationally- A will happen, followed by B etc. But it doesn’t work that way. Things don’t happen as we think they will; we have no gauge for irrationality or for what seems irrational from our perspective.

Should all of us be writing macros that incorporate irrational behavior into outcomes that would affect our lives and our relationships with others?

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