The Limits of Rational Trust: Part 2

Last week we talked about how rational trust, which is to say, being trustworthy because it can be shown that being trustworthy leads to more money or other benefits, can break down, either because a the person involved knew they wouldn’t be around for the long term, or because the reward for betraying a trust was so great that they could cash out.

Other failures of rational trust are:

  • When you’re not at the table, but on the table;
  • when the social mechanisms of reputation and deterrance break down;
  • when someone has a dominant strategy, something they can force on other people.

This post we’ll discuss not being at the table, and the breakdown of social mechanisms of trust.

Are you the roast beef being carved up?

It is rational to be trustworthy to people who are your customers because you want repeat business. But often even if you’re buying something, you aren’t the customer. So, for example, who are the customers for credit cards?

Here’s the odd thing about credit cards. Credit cards which charge merchants more, and that therefore also cost consumers more, since merchants have to pass those costs on, are the ones that are chosen by banks to be offered. Chosen by banks is the key phrase. Almost everyone gets their credit card through their bank. The banks control the pipeline, therefore the banks are the actual consumers. They, and the credit card companies are at the table, retailers and consumers are on the table. The real customer for credit cards isn’t consumers, and it isn’t businesses, who feel they must accept them or give up huge amounts of business, instead it is the banks. Since this is the case, it is rational to charge consumers and businesses more, not less, because the more you charge them, the more you can give to the real customer, the banks, who can deliver what amount to captive audiences.

Just because you’re buying something doesn’t mean you’re the customer, it just means you are paying.

Heads I win, tails you lose!

The next failure point of rational trust is when the social mechanisms for enforcement break down. If CEOs can materially misrepresent their company’s positions, and still be paid millions, if outright systemic fraud can occur throughout an industry, for example, mortgage origination and packaging during the housing bubble, and virtually no one is charged with a crime, and many of the companies which engaged in the fraud are bailed out at taxpayer expense, then why shouldn’t they engage in fraud?

Call it “heads I win, tails you lose”. If I know that I’ve done so much damage that the entire world’s economy is at risk, well, what’s to fear? On Wall Street they used to call this the “eat babies” scenario, which is to say, if the government didn’t step in, things would be so dire that everyone would be eating babies. Apocalytpically bad. Now, one can argue over whether failing to bail out Wall Street would have been so bad (I don’t think so), but it certainly seems the prime actors thought it would be, and unquestionably many actors at the Federal Reserve, Treasury and in power in DC thought it would be.

In capitalism, the joke runs, bankrupt companies go out of business. On Wall Street, they get bailed out. The political mechanism, which is ultimately a social mechanism, for enforcing law and basic capitalist principles broke down.

This has far less grandiose forms than the late financial crisis. It occurs any time when breaches of trust will not materially affect someone’s ability to continue to operate in business and to make money. If the social circle one moves in doesn’t care about breaches of trust or ethics, then it is rational not to care about either. Rational trust is about consequences, if the consequences are less than the benefits, why be trustworthy?

Next post: Dominant strategies, or “you’ll take this deal because you have no choice.”

If We’re So Rational, How Come We Don’t Believe It?

From Australia’s comes the story of how positive thinking can make things worse.   

REPEATING positive statements such as "I am a lovable person" or "I will succeed" makes some people feel worse about themselves instead of raising their self-esteem, a study says.

Positive self-statements make people who are already down on themselves feel worse rather than better, according to the study conducted by psychologists Joanne Wood and John Lee of the University of Waterloo and Elaine Perunovic of the University of New Brunswick.

For the study, the psychologists asked people with low self-esteem and people with high self-esteem to repeat the phrase: "I am a lovable person," and then measured participants’ moods and feelings about themselves. What they found is that individuals who started out with low self-esteem felt worse after repeating the positive self-statement.

Hmm.  So much for mantras, affirmations, cognitive therapy and NLP?  Now now, don’t bother writing in, the research also says those things can work in the context of a larger program.  But that just means it’s a helluva job to change our beliefs, no matter how irrationally we got there.  The head is a weak instrument with which to heal the heart.  Syllogisms are powerful only in computer programs.

Dan Ariely’s excellent book Predictably Irrational  uses an opening story/example  involving a nursing practice to show how people behave irrationally. 

Curiously, when he explained the irrationality of the practice to the nurses themselves, they agreed about the irrationality.  And then kept on doing it.

In the “same only different” vein, we have Tim Harford’s Logic of Life.  An economist, his purpose is similar to Ariely’s—to show that apparently emotionally driven patterns in life actually demonstrate very rational behavior, meaning they make perfect sense when explained in terms of the pursuit of self-interest.

Harford has his own curious moment.  He shows how juvenile delinquents’ criminal behavior demonstrate rational decision-making based on the relative severity of juvenile vs. adult laws.  So much for adolescent impulsive crime, he says.  Higher penalties actually do deter criminals.  The data show it.

As Harford puts it, “the policy recommendations that emerged from…the theory and data are strikingly clear and precise…Unfortunately, politicians prefer simple ideological answers.”

Well, duh!

I think both these books are superb—great reads, and very insightful.  I’m not making a fundamental critique of them at all, I agree with them.  I’m just high-spotting a side moment in each book.

But what moments!  Here are two deservedly respected experts on the subject of how apparently irrational behavior actually makes sense.  Yet each of them is flummoxed when faced with people who nod their heads at the experts’ logic—and then proceed to completely ignore it!

Hey guys–aren’t those the folks you wrote the books about?  So–why are you flummoxed?  And where’s the explanation?

I think Ariely and Harford are quite right—as far as they go.  But I think there’s also something still out there, beyond explaining the perversely expressed logic of self-interest.

It’s the reason it takes a couple of generations to work out family neuroses. It’s the reason dieting is so hard, prejudice is so persistent, and why more people trusted Madoff than the IRS.

And it’s the reason mere affirmations can backfire.  Maturity comes upon us at the pace of molasses.  Change is a bitch.

Marketing Science is Great in Theory…

Lately I’ve been struck several times by the huge gap between what we might call management science, and the reality of what really happens in the world of management.

  • Corporate training people plan multi-stage programs for the maximal developmental impact; the programs more often than not get cut off in mid-program.
  • CEOs pronounce intentions; the tea leaves are read, rightly or wrongly, and the reactions are very often deep cynicism or blind faith—not much in the rational middle area.

This runs deeper than just events overtaking plans. This pattern of the irrelevance of theory in the real world of practice is rooted far more deeply—in the human psyche.

Consider the latest on Barnard Madoff and Susan Boyle.

Madoff Less Sociopath, More Common Crook?

Fortune Magazine  tells How Bernie Did It. Many things are astonishing about Madoff. One I figured out ahead of the crowd—the fact that his “investments” were pure vaporware.

But I mistook the scale of his crime for the scale of his mental bentness. I was hardly alone in thinking him a sociopath. Now, I think, he’s just more of a common crook.

In a recorded phone call Madoff made to Fairfield Greenwich’s representatives just before an SEC visit, Madoff began with these words: “Obviously, first of all, this conversation never took place…okay?”

These are Tony Soprano lines—not mentally ill or deluded, just garden variety sleazy crook talk. This fosters distrust based not on mental stability, but on the much more familiar grounds of low integrity.

Madoff went on to remind Fairfield of their cover story, that Madoff only executed strategies formulated by Fairfield. He then essentially told Fairfield he would send Fairfield’s revised strategy on to them, contradicting himself in an almost Kafkaesque way.

Madoff successfully threatened Fairfield with taking away their golden goose–and Fairfield groveled and apologized for daring to let their customers withdraw funds! Finally, it appears Fairfield left their own money in too.

And so–Fairfield claims they were bamboozled along with all the rest. And they appear to mean it.

How is it that can you be complicit with a crook, take massive ill-gotten gains, grovel to a blackmailer, then get ripped off–and then feel righteously indignant about it?

This is the same mindset that says ‘no convict is guilty,’ at least according to the inmates. Which begs the question: What’s the difference between Fairfield Greenwhich and the Craigslist Killer’s fiance’?  (answer–the fiance is less into denial).

The best logic of the best court system can’t lay a finger on the self-judgment of those being judged. Our ability to rationalize overwhelms our capacity to be rational.

Susan Boyle: Irrational Reactions

The NYTimes today has the last (please) word on the Susan Boyle phenomenon, and it is again about how “rational thought” is an oxymoron. Let’s look at what we all thought. We thought:

-she’s a frump; no, wait, she’s an angel
-Simon Cowell judged a book by its cover; me, I just changed my mind based on new data
-people use stereotypes all the time, except for me of course

Susan Boyle proves people are prejudiced. But people won’t change. “Proof” is pitifully weak when up against assumptions.

In business, I often think of Indiana Jones’ encounter with the intricately practiced Arabian master of the sword, threatening to bring years of skill and practice to bear on Indiana in the form of whirling cold steel.  Jones responds with a disgusted eye-roll—and a point blank shot from his .45.

Theory is the sword—so often outclassed by the blunt force of emotion, a far more powerful driver of human behavior.

Management theories that don’t take human reality into account are so much whistling in the wind.

Deer in the Headlights Decison-Making

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.

He expands:

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.

Damn right.

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.