I’m reading A Demon of Our Own Design, by Richard Bookstaber. He did not cause the major market meltdowns of the last two decades, but—as he puts it—“let’s just say I was in the neighborhood.”
More on that book another time. There is one fascinating passage about human behavior. Bookstaber noticed major league top Wall Street traders caught like a deer in the headlights on the wrong side of a bet about the outcome of a potential MCI/BT merger.
As the bet soured from a $100 million loss to worse, the team gathered to re-assess the situation. A half-dozen variables had moved against them since the last discussion a few weeks earlier. Yet, amazingly, the outcome of the meeting was to ratify the existing position. Bookstaber puts it:
Stavis and I joked after the meeting how miraculous it was that with all the dislocations in the market, with all the surprise events and changes in the fortunes of the trade, it turned out that the position we had on at the time of our meeting still just happened to be exactly the right amount.
It was a phenomenon that I found again and again and that seems to be an innate part of trader behavior: inertia against changing a losing position, and more specifically, inertia when faced with losses coming from unexpected corners. In experimental biology there is a term for this: experimental neurosis. An animal in the laboratory, beset by a strange environment and events that are outside of its past experience, will sometimes simply curl up in a ball and ignore all of the stimuli. Its reaction to the alien environment is to freeze in its tracks…this is not limited to the behavior of animals in the lab; it is a phenomenon that arises from the core of how we approach the world.
Now—contrast that with one of the great business stories of our time—Andy Grove and Intel’s exit from memory technology, as told by Richard Tedlow:
NB: How did Intel make that transition?
RT: They knew they had to get out of memories. Freud talks about a cognitive state he calls “knowing but not knowing,” which he defines as a state of rational apprehension that does not result in effective action. Intel was being clobbered by Japanese manufacturers. They knew something was happening, but they didn’t know how important it was. They were feverishly debating various ideas of how to respond.
Andy proposed a thought experiment to his then boss, Intel CEO Gordon Moore. “What would happen,” he asked, “if the board kicked us out and brought in new management?” Moore immediately replied, “They’d get us out of memories.” Andy looked at him and said, “Why don’t we walk through the door, come back, and do it ourselves?”
By creating a fantasized new management, he was able to escape from the legacy of Intel as the memory company. At least in part because of that moment, the United States today is the world’s leading manufacturer of microprocessors.
Grove probably would have gotten out of the MCI trade too. He had figured out how to beat the deer in the headlight phenomenon, the boiling frog problem, the sunk costs problem.
More broadly: he figured out how to change.
And it’s actually not complicated to understand. Here it is in conventional folk wisdom terms:
You can start your day over anytime you want
It’s never too late to have a happy childhood
This is the first day of the rest of your life.
The truly great decision-makers aren’t those schooled in hyper-quant theory.
They are those secure enough with themselves to remember what they learned in kindergarten.
Update: "Deer in the Headlights Decision Making" is a featured post at the Huffington Post. Trust Matters readers may want to check out the discussion there as well.