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Professor Richard Thaler: Masters in Business (Audio) · Masters in Business

0:03
Speaker 1: This is Masters in Business with Barry Ridholts on Bloomberg Radio.
0:08
Speaker 1: On today's podcast, I once again have a very special guest.
0:14
Speaker 1: I know you guys are tired of hearing me say
0:16
Speaker 1: that week after week, but you know what this really
0:19
Speaker 1: is a very special guest, Professor Richard Taylor of the
0:23
Speaker 1: University of Chicago, perhaps best known as the father of
0:28
Speaker 1: behavioral economics. When you look at his body of work,
0:32
Speaker 1: when you look at the impact he's had, Professor Taylor
0:36
Speaker 1: on the perennial shortlist for a Nobel Prize in Economics,
0:41
Speaker 1: what um I think you'll find so fascinating about him
0:44
Speaker 1: is not just that he's incredibly intelligence and unbelievably knowledgeable
0:51
Speaker 1: about how human behavior in the world of economics differs
0:56
Speaker 1: so much from traditional economic theory. But you'll find he's
1:00
Speaker 1: somewhat uh, somewhat mischievous and and very amusing and not
1:05
Speaker 1: your typical dry academic and certainly not your typical dry economist.
1:13
Speaker 1: His background is is really the very very early days
1:17
Speaker 1: of behavioral economics. His early mentors were people like Danny
1:21
Speaker 1: Knoman and and a most diverse ky Uh. He's worked
1:25
Speaker 1: with Bob Schiller for many, many years, for twenty five years.
1:29
Speaker 1: They've been co chairs of an nb E er UM
1:34
Speaker 1: panel on behavioral economics, and just anybody who's been pursuing
1:40
Speaker 1: this field is certainly familiar with his work, starting with UM.
1:45
Speaker 1: A lot of anomalies that he's identified in the world
1:48
Speaker 1: of economics, including his book The Winner's Curse from so
1:51
Speaker 1: long ago. He did a book with Cass Sunstein Colts
1:54
Speaker 1: Nudge that's been very influential, and currently he's out promoting
1:59
Speaker 1: his latest book called Misbehaving, which really is a mix
2:04
Speaker 1: of his own autobiography, which of course paralleled the rise
2:09
Speaker 1: of behavioral economics over the past let's call it forty
2:11
Speaker 1: or fifty years, and a quick funny story. After we
2:15
Speaker 1: finished the interview, he had a head somewhere else downtown,
2:18
Speaker 1: and so I walked with him down to his hotel.
2:22
Speaker 1: We walked down Lexington Avenue, and let me tell you,
2:24
Speaker 1: walking through the streets of Manhattan with Richard Taylor is
2:29
Speaker 1: really quite fascinating because there's a running commentary on everything
2:33
Speaker 1: that's going on, and and it's quite amusing and quite interesting.
2:37
Speaker 1: And he said something that was really has stayed with me.
2:40
Speaker 1: It was very interesting. During the interview. You'll hear him
2:44
Speaker 1: discuss how traditional economic theory work works really well for
2:48
Speaker 1: the small, insignificant decisions we make over and over again.
2:53
Speaker 1: That we get good at what spaghetti source to buy
2:55
Speaker 1: in the supermarket, you know where to fill up our
2:57
Speaker 1: cars with gas, things like that that, let's be honest,
3:01
Speaker 1: in the scheme of things, are not very consequential. But
3:04
Speaker 1: he also talks about how the big decisions you make
3:08
Speaker 1: in life you don't get to make that often. You
3:11
Speaker 1: don't get to be that good at making the decisions
3:15
Speaker 1: that really matter, You don't have a lot of experience
3:17
Speaker 1: with them. His examples were, you choose what field you
3:21
Speaker 1: go into where you work saving for retirement, who and
3:27
Speaker 1: how often you get married, who you're gonna marry too,
3:30
Speaker 1: And I was who are gonna get married to? And
3:33
Speaker 1: how often you end up getting married or remarried, and
3:37
Speaker 1: and the big decisions, the ones that really impact your life,
3:41
Speaker 1: you do once or twice or maybe a handful of times.
3:46
Speaker 1: So you don't get a lot of experience, you don't
3:47
Speaker 1: get a lot of skill at it. It's something that
3:50
Speaker 1: you hopefully make a right decision, and if you don't,
3:54
Speaker 1: the consequences are really significant. And so as we're walking
3:58
Speaker 1: down Lexington Avenue in New York City. I start talking
4:01
Speaker 1: about that, and I jokingly say to him, Hey, you
4:03
Speaker 1: know that thing about you know how many wives you
4:06
Speaker 1: have and the impact it has on on your life
4:09
Speaker 1: is is kind of interesting. My secret was to marry
4:12
Speaker 1: my second wife first. Just skip the whole first marriage,
4:15
Speaker 1: the whole disastrous first marriage, go right to the second marriage.
4:18
Speaker 1: And he laughed, and then he said something that has
4:21
Speaker 1: stayed with me since we did the interview. It's really very,
4:25
Speaker 1: very interesting. He said, you can never be happier then
4:30
Speaker 1: your spouses. And look, we've all heard the expression happy wife,
4:34
Speaker 1: happy life, but stop and think of it in that
4:37
Speaker 1: sort of behavioral terms, that the ceiling on your own
4:41
Speaker 1: personal happiness is a function of whatever your spouses happiness is.
4:46
Speaker 1: And when you put it into that context, it certainly
4:49
Speaker 1: makes it clear that, hey, if you make your significant
4:51
Speaker 1: other happy, it's going to come back and ultimately raise
4:55
Speaker 1: the ceiling for how happy you yourself can be. But
4:58
Speaker 1: lots of other comments and phrases like that, where he's
5:02
Speaker 1: just looking at it slightly a scan, slightly differently then
5:07
Speaker 1: you might consider, and it leads to a lot of insights.
5:10
Speaker 1: So I found him to be absolutely fascinating. I wish
5:13
Speaker 1: I could have kept him there for another hour. Um,
5:16
Speaker 1: without any further ado, here is my conversation with Professor
5:20
Speaker 1: Richard Taylor. This is Master's in Business with Barry Ridholts
5:28
Speaker 1: on Bloomberg Radio. Once again, I have a fantastic and
5:32
Speaker 1: special guest. His name is Dr Richard Thaller. He has
5:36
Speaker 1: been called the father of behavioral finance. And I'm just
5:40
Speaker 1: gonna give a short version of your curriculum. Vite bachelor's
5:44
Speaker 1: degree from Case Western and then a master's and PhD
5:48
Speaker 1: from the University of Rochester. Dr Thaller is the author
5:51
Speaker 1: of over fifty published papers and notable numerous books, most
5:55
Speaker 1: notably The Winner's Curse, Nudge and Misbehaving for Fessa Faler.
6:00
Speaker 1: Welcome to Bloomberg, Thanks Berry, happy to be here. I'm
6:04
Speaker 1: leaving out half of your CV, will save that for
6:07
Speaker 1: for for later. Tell us a little bit about your background.
6:10
Speaker 1: How did you find your way to academia. I went
6:15
Speaker 1: into academia because I didn't think I was suitable for
6:18
Speaker 1: anything else. That's literally true. My father was an actuary,
6:23
Speaker 1: and it was a great disappointment to him that I
6:25
Speaker 1: didn't follow into his footsteps. But I saw him. I
6:30
Speaker 1: grew up in Jersey, worked at Prudential. I saw him
6:33
Speaker 1: taking the training every day and not for you, not
6:36
Speaker 1: for me, and I'm the world's were subordinate. So academia
6:42
Speaker 1: seemed like a good choice. And you know, I was
6:46
Speaker 1: kind of good in math and kind of good in economics,
6:49
Speaker 1: so I went into economics. So you start out as
6:54
Speaker 1: a was it a graduate school student at Stanford or
6:57
Speaker 1: right after being a graduate student? Uh? Yeah, after being
7:01
Speaker 1: graduate student and uh and teaching for a couple of
7:05
Speaker 1: years is the Stanford episode. Um, you had some really
7:11
Speaker 1: influential mentors. Yeah. I I claimed to have discovered Daniel
7:17
Speaker 1: Kneman and Amos Tversky in the same sense in which
7:21
Speaker 1: Columbus discovered America. I mean it was here. Came to
7:25
Speaker 1: as a surprise to the people who were living here
7:27
Speaker 1: at the time. Yeah, so uh, Conlimen Diversky came to
7:33
Speaker 1: as a surprise to economists. So I claimed to be
7:38
Speaker 1: the first economists who have discovered them. And I had
7:41
Speaker 1: been interested in weird stuff. People do weird from the
7:48
Speaker 1: perspective of economists. So economists have this creature they study
7:57
Speaker 1: that comes with the Latin term homo econonomicus. I just
8:01
Speaker 1: like calling them econs economic man, economic man, or we
8:05
Speaker 1: should say economic person. Come on, Barry, we have to
8:09
Speaker 1: be you know century. You work in academia, so you
8:12
Speaker 1: have to be more politically career. Yeah right, so economic person,
8:16
Speaker 1: but I call him econs. And econs are as smart
8:21
Speaker 1: as the smartest economist, or possibly even as smart as
8:25
Speaker 1: the smartest economist thinks he is, which is much smarter,
8:29
Speaker 1: which is right, which is really really smart. Um. They
8:34
Speaker 1: have perfect willpower, never have to die because they weigh
8:38
Speaker 1: exactly the right amount. No hangovers, uh saving for retirement,
8:44
Speaker 1: piece of cake. They calculate how much they need, how
8:48
Speaker 1: much they're gonna earn on their investments, implement so needlessness.
8:54
Speaker 1: Oh one other thing, they're jerks. So these uh rational
9:00
Speaker 1: economic man. Will you know I left my cell phone
9:06
Speaker 1: outside the door to charge. If an econ walked by,
9:09
Speaker 1: he would take it. He would take it. So so
9:11
Speaker 1: let me throw a quote of yours to put this succinctly.
9:16
Speaker 1: Conventional economics assumes that people are highly rational, in fact,
9:21
Speaker 1: superrational and unemotional. They could calculate like a computer and
9:26
Speaker 1: have no self control problems. So so how does this
9:29
Speaker 1: manifest itself. This this obvious falsehood about the way humans behave.
9:35
Speaker 1: How does this manifest itself in terms of the way
9:38
Speaker 1: economics progresses. Well, take the problem of saving for retirement.
9:44
Speaker 1: It's one one of the biggest financial decisions that we
9:49
Speaker 1: have to make in our lifetime. One is how much
9:53
Speaker 1: education to get and what type, second is who to
9:56
Speaker 1: marry and how often, And the third is saving for retirement,
10:02
Speaker 1: throwing buying a house, and you pretty much have the
10:04
Speaker 1: big ones. So you know, that's a piece of cake
10:09
Speaker 1: for econs. And it used to be a piece of
10:12
Speaker 1: cake for my father's generation because there were pensions and
10:16
Speaker 1: you would work at prudential for your life and then
10:21
Speaker 1: they would give you an annuity, and retiring was easy.
10:25
Speaker 1: You never had to think about anything. So then you know,
10:29
Speaker 1: we invent the four one K and now people have
10:33
Speaker 1: to figure out whether to join, how much to put in,
10:37
Speaker 1: how to invest it, and then how to draw it down,
10:42
Speaker 1: which is very hard. And so the idea of this
10:47
Speaker 1: perfect per perfectly rational person making all the right choices, unemotionally,
10:53
Speaker 1: with good self control and perfectly calculated to their needs,
10:58
Speaker 1: that clearly doesn't exist. It clearly doesn't exist. And notice
11:02
Speaker 1: if the world was full of full of people like that.
11:06
Speaker 1: Then the four O one K is unambiguously a big
11:09
Speaker 1: improvement because it's portable and you can customize it, and
11:15
Speaker 1: we all know what's best for ourselves if we're econs.
11:20
Speaker 1: The the the dal Bar numbers each year show that
11:24
Speaker 1: the average return over the course of thirty years has
11:28
Speaker 1: been about three for four O one K investors. Yeah,
11:31
Speaker 1: and they have a great tendency to buy high and
11:33
Speaker 1: sell low. They massively got out of equities, uh, starting
11:39
Speaker 1: in about two thousand six, and flows didn't turn positive
11:44
Speaker 1: until during which time the market had doubled. Why is
11:48
Speaker 1: it so challenging to get economists to actually understand people
11:54
Speaker 1: don't behave this way in the real world. Well, let's
11:57
Speaker 1: just say that one of the things that you have
12:01
Speaker 1: trouble with is the economic concept of sunk costs. I
12:05
Speaker 1: was going through your list of mentors. Pretty much your
12:08
Speaker 1: early mentors are all almost all nobile laureates. I've been lucky.
12:15
Speaker 1: You know how to pick them. Yeah, you definitely know
12:17
Speaker 1: how to pick them. So before the break, we were
12:19
Speaker 1: discussing sunk costs, and I had asked you, why is
12:23
Speaker 1: it that economists just won't recognize some of the reality
12:28
Speaker 1: of the way humans behave in the real world. And
12:31
Speaker 1: and your answer was My answer was, uh, you know,
12:36
Speaker 1: a bit cheeky as I tend to be, which is
12:39
Speaker 1: that economists teach people that they should ignore what they
12:42
Speaker 1: call sunk costs, meaning if that dessert doesn't taste very good,
12:47
Speaker 1: you should need it just because you paid twenty bucks
12:50
Speaker 1: for it. And economists have trouble following their own advice,
12:55
Speaker 1: and they had a lot invested in the rational economic
12:58
Speaker 1: model and weren't gonna give it up without a fight.
13:02
Speaker 1: Isn't that the nature of so many ideologies that there's
13:06
Speaker 1: all this time and effort, there's this endownment effect that
13:09
Speaker 1: it's yours, you've done, You've done the work, you've done
13:12
Speaker 1: the heavy lifting. Very difficult to just oh this is wrong,
13:15
Speaker 1: let me move on and find a new philosophy. Yeah,
13:18
Speaker 1: that's true. And you know I often say that I
13:22
Speaker 1: don't think in forty years I've changed in anybody's mind.
13:26
Speaker 1: I disagree with that statement. I know you've said that,
13:28
Speaker 1: but you've actually changed a lot of people's If not
13:32
Speaker 1: change their minds, certainly change their perspectives and enlighten them somewhat. Well,
13:36
Speaker 1: but not not economists. So, I mean, the field is growing,
13:43
Speaker 1: and uh, there are lots of great people in it,
13:45
Speaker 1: but they're young, and so my strategy from the beginning
13:50
Speaker 1: was corrupt the youth. Don't try to you know, there's
13:54
Speaker 1: this old line science much on funeral by funeral and
13:58
Speaker 1: funeral at a time, and uh, you know, there's no
14:02
Speaker 1: point in trying to convince those guys. But young impressionable
14:07
Speaker 1: graduate students, you know, you can have your way with them.
14:11
Speaker 1: That's hilarious. So don't even bother convincing the old fogies.
14:15
Speaker 1: Just go right for the kids. Yeah, it's a it's
14:18
Speaker 1: a good long term strategy. Yeah, you know, I was
14:21
Speaker 1: playing a long game. You have good impulse control. I
14:24
Speaker 1: have to work on that. That's really interesting. So let's
14:28
Speaker 1: move a little more specifically to the efficient market hypothesis. Um,
14:33
Speaker 1: you once said, I love I love a lot of
14:35
Speaker 1: your quotes. We don't want to throw away the efficient
14:38
Speaker 1: market hypothesis. We just don't want to believe it's true.
14:41
Speaker 1: Explain what you mean by that. Yeah, So all of
14:45
Speaker 1: behavioral economics and behavioral finance starts with rational models, and
14:51
Speaker 1: they give us a benchmark, and it really wouldn't really
14:54
Speaker 1: be possible to do behavioral economics without that rational benchmark. So,
15:01
Speaker 1: you know, the official market hypothesis really has two components.
15:05
Speaker 1: One is that you can't beat the market, and the
15:07
Speaker 1: other is that prices are right, that asset prices are
15:11
Speaker 1: equal to their intrinsic value. Now, those are very useful
15:17
Speaker 1: starting points, no hypotheses, right, and the beauty is that
15:23
Speaker 1: they're testable and so over long periods of time. And yeah,
15:29
Speaker 1: well sometimes, like let's take the prices right. Here's an
15:33
Speaker 1: amusing story. There's a closed and mutual fund, which, if
15:40
Speaker 1: listeners don't know, these are mutual funds that you have
15:43
Speaker 1: to buy and sell on exchanges, which means that their
15:47
Speaker 1: prices can deviate from the value of the assets they own,
15:51
Speaker 1: as opposed to traditional mutual funds where you can only
15:54
Speaker 1: sell at the end buy or sell at the end
15:55
Speaker 1: of the day, and it reflects a calculation of everything
15:58
Speaker 1: that's held with that that bucket exactly. Now, the fact
16:03
Speaker 1: that the prices sometimes differ from the value of the
16:06
Speaker 1: assets is already embarrassing, but not as bad as the story.
16:09
Speaker 1: I'm gonna tell you. There's a small closed end fund
16:14
Speaker 1: that happens to have the ticker symbol. See you be
16:17
Speaker 1: a Cuba Yeah. Now, needless to say, they don't own
16:22
Speaker 1: any assets in Cuba because A it's against the law
16:27
Speaker 1: and B there aren't any right. Nevertheless, and for years
16:31
Speaker 1: it was selling at about a fifteen percent discount to
16:35
Speaker 1: its event President Obama made his announcement of his intention
16:40
Speaker 1: to ease relations with Cuba, the Cuba Fund went to
16:46
Speaker 1: a seventy premium. The next day after the presidential announcement,
16:51
Speaker 1: it was up almost fifty. A week later it was up.
16:56
Speaker 1: How inefficient is that? Not efficient? And you know efficient
17:01
Speaker 1: market defenders was like, oh, look, this is one little,
17:04
Speaker 1: tiny example, but there are hundreds of the right and
17:07
Speaker 1: we study these little examples. I call them the fruit
17:10
Speaker 1: flies of finance because no one can possibly defend this.
17:16
Speaker 1: It's still several months later, selling above really above net
17:23
Speaker 1: asset value here. But Jobo, we're opening relations with Cuba.
17:28
Speaker 1: Why could you? Why are you so negative on a
17:30
Speaker 1: closed and fun called Cuba just because it does nothing
17:33
Speaker 1: whatsoever to do with Cuba? Yeah? Well, and noticed that
17:36
Speaker 1: they're they're holdings are public information. Yeah, and you can
17:41
Speaker 1: buy those stocks on your own for a hundred dollars.
17:46
Speaker 1: Why would you pay a hundred and forty that's unbelievable. Well,
17:50
Speaker 1: markets are not perfectly efficients, they're kind of sort of
17:55
Speaker 1: eventually will get around to it efficient. Well maybe maybe.
18:00
Speaker 1: So here's what I would say. The part that you
18:02
Speaker 1: can't beat the market is approximately true. Some people can
18:07
Speaker 1: on rare occasion. Good luck picking them in advance. That's right.
18:11
Speaker 1: And look, I mean what we know is most active
18:14
Speaker 1: managers underperformed, and that's kind of the best evidence in
18:20
Speaker 1: favor of the efficient market hypothesis. And that's before fees, cost,
18:25
Speaker 1: taxes time. Yeah, it depends on how you do it,
18:27
Speaker 1: but there's certainly they're certainly not beating the market after fees.
18:32
Speaker 1: But although it's the best evidence for the efficient market hypothesis,
18:36
Speaker 1: it's also the most evidence against because where is most
18:40
Speaker 1: of the money inactive funds? Yeah? Van Guard has grown
18:44
Speaker 1: a lot that exception. Yeah, and there's still a third
18:47
Speaker 1: of their three trillion dollars is still actively managed. So
18:53
Speaker 1: so I think it's approximately right, And listeners would be
18:57
Speaker 1: well advised to just say I can't do it. Is
19:00
Speaker 1: it just inherent in human behavior that we're going to
19:04
Speaker 1: get booms and bus markets are gonna rally and crash,
19:07
Speaker 1: and that's just the way it's gonna be. I think
19:10
Speaker 1: we're subject to that risk, but I think there are
19:13
Speaker 1: things we could do to mitigate it. And let's talk
19:15
Speaker 1: a little bit about choice, architecture and nudge, which refers
19:20
Speaker 1: obviously to the book you wrote with Cassnstein. Yes, so
19:26
Speaker 1: the idea of nudge is that because we're dealing with
19:30
Speaker 1: humans rather than e cons, they sometimes need help, and
19:35
Speaker 1: can we think of ways to help them that don't
19:39
Speaker 1: force anybody to do anything. So that was the conceit
19:42
Speaker 1: of the book. In other words, you're not mandating anything,
19:45
Speaker 1: do it, no bands, how much can you do with
19:50
Speaker 1: those restrictions, So you're just you're just kind of just
19:53
Speaker 1: kind of nudging is the right words, just kind of
19:56
Speaker 1: nudging them into the right choice. There's an interesting little
20:00
Speaker 1: little bit of behavioral engineering, which is and I see
20:04
Speaker 1: it here in New York. I come up out of
20:05
Speaker 1: a subway to get to my office because it's the
20:08
Speaker 1: fastest way to get around town. And it's a double escalator.
20:13
Speaker 1: I mean, this thing just goes on forever, and about
20:16
Speaker 1: half the people stand on the escalator and half people walk.
20:20
Speaker 1: But sometimes you get people who don't understand the social
20:23
Speaker 1: norms and they stand on the left side instead of
20:26
Speaker 1: standing on the right side. I'm in an airport or
20:29
Speaker 1: somewhere in maybe it was Brussels, and I see this
20:34
Speaker 1: escalator and on the right hand side are two ft
20:38
Speaker 1: on each step two to two. On the left hand
20:41
Speaker 1: side is alternates left and right. And it made it clear, oh,
20:45
Speaker 1: this is the walking half and that whole issue. You
20:49
Speaker 1: never ran into the person who don't understand the social etiquette.
20:53
Speaker 1: And if you're standing slow traffic moved to the right.
20:56
Speaker 1: It was amazing and it was so simple and very effective.
20:59
Speaker 1: You know, people have lots of misconceptions about nudge. One
21:04
Speaker 1: is that it has to be sneaky. These notice these
21:08
Speaker 1: things are the opposite of right. Look. My favorite nudge,
21:12
Speaker 1: one that I claim has saved my life many times,
21:16
Speaker 1: is in London at street corners, there's a sign at
21:20
Speaker 1: your feet look right because the cars are coming from
21:25
Speaker 1: the wrong direction if you're from Europe or America, and
21:30
Speaker 1: so you know, many years of looking for cars coming
21:35
Speaker 1: from your left, all of a sudden boom, so you
21:39
Speaker 1: know there's nothing sneaky about that. Nobody tells you you
21:44
Speaker 1: have to look at it, but several double decker busses
21:48
Speaker 1: haven't hit me because of that look right. So, you know,
21:52
Speaker 1: a couple of years ago, I wrote this thing for
21:55
Speaker 1: tourists coming to New York City, and one of the
21:57
Speaker 1: things was there are many one way streets, but the
22:01
Speaker 1: bicyclists don't have h any obligation apparently to follow that.
22:06
Speaker 1: So when you step off the curb, look left and
22:09
Speaker 1: right to make sure you don't. And let me tell
22:11
Speaker 1: you how many times I've just missed the bicyclists because
22:14
Speaker 1: I happen to look right. It's the same, it's the
22:17
Speaker 1: same exact thing. So this really is kind of consistent
22:21
Speaker 1: with the philosophy at the University of Chicago, which is
22:25
Speaker 1: really known as a libertarian, a sort of right leaning
22:29
Speaker 1: philosophical um efficient market hypothesis place. Are you considered a
22:36
Speaker 1: bit of a heretic there because you really don't fit
22:39
Speaker 1: the mold of of Chicago economists. I think heretic would
22:43
Speaker 1: be one of the more polite terms that I've been called. Uh,
22:48
Speaker 1: you know, we called our philosophy libertarian paternalism. Libertarian paternalism.
22:56
Speaker 1: The libertarians were mad that we stole their word, and
23:00
Speaker 1: everybody hates paternalists. They just think of paternalists as Ralph Nader. So,
23:06
Speaker 1: but what we've by libertarian, we use it as an adjective,
23:11
Speaker 1: and by paternalism we mean helping people achieve their goals,
23:16
Speaker 1: like not getting run over by a bus. So if
23:20
Speaker 1: we can do that without forcing anybody to do anything,
23:23
Speaker 1: why wouldn't we known as the father of behavioral economics.
23:27
Speaker 1: I'm about halfway through the book and I found it
23:29
Speaker 1: to be both informative and amusing, which is an unusual combination.
23:36
Speaker 1: So let's talk a little bit about theory induced blindness.
23:40
Speaker 1: I know you're gonna be seeing your mentor um Daniel Kneman,
23:45
Speaker 1: and you mentioned um. That's a quote of his. He
23:49
Speaker 1: called theory induced blindness the refusal to see facts when
23:53
Speaker 1: it disagrees with a theory or ideology. Some people call
23:57
Speaker 1: that cognitive dissidence. Is there any difference between No, I
24:01
Speaker 1: think I think this is a different concept. So the
24:04
Speaker 1: idea is that if you have a certain lens that
24:07
Speaker 1: you look at things through, then you're gonna see everything
24:13
Speaker 1: to be consistent with your point of view. And so,
24:17
Speaker 1: you know, it's like people have various views about the
24:21
Speaker 1: economy from the left and from the right, and every
24:26
Speaker 1: you know, every time there's a bit of news, they'll
24:29
Speaker 1: find a way of interpreting that piece of news as
24:33
Speaker 1: just confirming what they've always thought. Where I see that
24:36
Speaker 1: every day is the bullbear debate that takes place in
24:39
Speaker 1: the media and in print, And no matter what the
24:43
Speaker 1: data point is, the bulls who are long equities are
24:46
Speaker 1: gonna explain why this is good for the markets, and
24:49
Speaker 1: the bears just try out a counter argument, this is
24:53
Speaker 1: proof that we're all going to die. It's amazing with
24:56
Speaker 1: the same data points, how people just focus on what
25:00
Speaker 1: justifies Now how much of that is selective perception and
25:03
Speaker 1: how much of that is just you know, we see
25:06
Speaker 1: that which agrees with us. The psychologist called this confirmation bias. Yes,
25:12
Speaker 1: so well, go out looking for evidence that supports our
25:16
Speaker 1: point of view. I mean, but but theory should show
25:19
Speaker 1: should be a hundred percent of trading at or pretty
25:23
Speaker 1: close to intrinsic value. So the fact that you're finding
25:27
Speaker 1: one that's below one day and above that really shows that, hey,
25:33
Speaker 1: that theory is a little bit off. It's what we
25:35
Speaker 1: call an anomaly. Mental accounting. What is mental accounting? So
25:41
Speaker 1: mental accounting is the think of it as the financial
25:45
Speaker 1: accounting of people and economists tell us that money is fungible.
25:54
Speaker 1: If you want to impress people at a cocktail party,
25:57
Speaker 1: use fungible. It just means there's no aables. But of
26:02
Speaker 1: course people put labels on stuff. You go to the casino,
26:05
Speaker 1: you can see this. A guy wins some money early
26:08
Speaker 1: in the even playing with house money exactly. That's the
26:11
Speaker 1: expression playing with the house money. What does that mean?
26:14
Speaker 1: The casino is called the house so it's like you're
26:17
Speaker 1: playing with their money. Well, suppose you won five dollars
26:21
Speaker 1: you put in your right pocket. You brought five hundred
26:24
Speaker 1: dollars to gamble, that's in your left pocket. Both of
26:27
Speaker 1: them will buy something pretty nice if you get home.
26:30
Speaker 1: But the one the house money, easy come, easy go,
26:35
Speaker 1: and it's entertainment. You're you're just putting that in a
26:38
Speaker 1: different So you know, that sounds like small potatoes. But
26:44
Speaker 1: during the nine nineties technology, oh sure, during that boom,
26:50
Speaker 1: everybody thought they were playing with the house money. And
26:54
Speaker 1: four one K investors were just increasing and increasing their
26:58
Speaker 1: equity exposure. And at the time, I said, one of
27:02
Speaker 1: two things is true. Either they've understood that equities outperformed bonds,
27:10
Speaker 1: or they think stock prices only go up. The only
27:14
Speaker 1: thing that will give us an answer is a crash. Fortunately,
27:18
Speaker 1: we got a crash, and we got an answer. You know,
27:21
Speaker 1: I've had this conversation with people that this was early
27:25
Speaker 1: in my career, and I remember getting the calls from
27:28
Speaker 1: people who were significantly older than me saying, hey, I
27:31
Speaker 1: got a ton of profits. I'm rolling a little money
27:34
Speaker 1: out into real estate. I'm picking up that vacation house,
27:38
Speaker 1: or I'm trading up to a bigger property. But they
27:41
Speaker 1: were really the exception. You you it was rational, It
27:44
Speaker 1: made sense. I think most people wish they could go
27:47
Speaker 1: back and buy real estate. As that said, you really
27:51
Speaker 1: didn't see a whole lot of it. And anytime people sold,
27:54
Speaker 1: at least in the until two thousand, they seem to
27:58
Speaker 1: have regretted this LD decision. Yeah, because uh, you know,
28:03
Speaker 1: everything was upside down during that period. The most the
28:07
Speaker 1: most value you know, puffetted poorly that period. All value
28:14
Speaker 1: investors were getting crushed and you had to just be patient.
28:18
Speaker 1: But meanwhile your neighbors were getting rich. It was hard
28:22
Speaker 1: to do so, so why do why is it this
28:25
Speaker 1: mental accounting? Why do we love bargains so much? You
28:28
Speaker 1: tell one of the anomaly stories about when J. C.
28:32
Speaker 1: Pennies de started to get rid of the fake prices
28:36
Speaker 1: with the artificial mark downs and just have one price
28:40
Speaker 1: and it was a disaster. People like deals, even if
28:44
Speaker 1: they know it's nonsense. And you know, even rich guys
28:47
Speaker 1: like deals. You know, there are plenty of rich guys
28:51
Speaker 1: traveling in December to get their one k on, you know,
28:57
Speaker 1: to get more miles and um so totally hit the
29:02
Speaker 1: next break point and get all these three miles right.
29:06
Speaker 1: And you know you you go to Costco, the big
29:09
Speaker 1: discount retailer, you see a parking lot full of fancy
29:14
Speaker 1: Mercedes SUVs. With my wife pointed out, we went to
29:17
Speaker 1: Target a few weekends ago and there is this Rolls
29:21
Speaker 1: Royce Wraith in the parking lot, which is a three
29:24
Speaker 1: hundred and fifty thousand dollar car at Target. I guess
29:28
Speaker 1: he needed a lot of talk. Yeah, yeah. I used
29:30
Speaker 1: to tease my father who was driving around in a
29:35
Speaker 1: fancy BMW looking for the cheapest price for gas, and
29:40
Speaker 1: I said, you know, Dad, how much gas are you
29:44
Speaker 1: using to find the cheapest price? But he had to
29:47
Speaker 1: find the cheapest price. You had mentioned casinos earlier. Um
29:51
Speaker 1: Twain once called gambling a tax on the stupid. Do
29:54
Speaker 1: you agree or disagree with that? You know? I, um,
29:58
Speaker 1: I think it's mostly right. Um why do we Why
30:02
Speaker 1: do people love gambling? They like the thrill, you know.
30:06
Speaker 1: And there are some things like horse racing would be
30:09
Speaker 1: unbelievably boring if you didn't have some action, right. And
30:13
Speaker 1: of course the betting is irrational because the rate of
30:16
Speaker 1: return is minus seventeen per twenty minutes, because that's the take, right, So, um,
30:25
Speaker 1: it's funny you say that. So I'm on a cruise
30:28
Speaker 1: with my my wife and we're walking through the casino
30:31
Speaker 1: to get to the other side of the ship, and
30:34
Speaker 1: we just walked by one of the tables and I noticed,
30:38
Speaker 1: because I have a bit of a I have a
30:40
Speaker 1: head for math. I say to her, Notice that this
30:43
Speaker 1: pays two to one, but you have three chances to lose,
30:46
Speaker 1: and that pays three to one, and you have four
30:48
Speaker 1: chances to lose. And it was a roulette table, and
30:50
Speaker 1: I can look at all the odds. The odds are
30:53
Speaker 1: relatively bad relative to the risk. And she teaches fashion,
30:57
Speaker 1: illustration and design, so she's a visual person. And she says,
31:01
Speaker 1: I don't know about that, but they certainly seemed to
31:02
Speaker 1: be sweeping up a whole lot more chips than they're
31:05
Speaker 1: handing out each each roll. And I'm like, oh, well,
31:07
Speaker 1: that's the other way to to look at it. And
31:10
Speaker 1: yet people sit at the tables and play for hours
31:13
Speaker 1: and hours. So I'll give you my favorite recent mental
31:16
Speaker 1: accounting story, which is, in the early days of the
31:21
Speaker 1: financial crisis, the price of gasoline fell. What did people do? Remember,
31:28
Speaker 1: everybody was belt tightening on all fronts except one. People
31:33
Speaker 1: were splurging on premium gas. On premium gas, premium gas
31:39
Speaker 1: because they have a gas budget and they have been
31:42
Speaker 1: paying a hundred bucks a week to fill up the
31:45
Speaker 1: tank and now it was only fifty and they're thinking, oh,
31:49
Speaker 1: well gas, it's cheap, all right, I'll splurge on by
31:52
Speaker 1: premium Eber, what's on? What? What of the fact that
31:54
Speaker 1: unless you have an engine designed for premium gas, that
31:57
Speaker 1: extra octane just goes out the tailpod? You know, Uh,
32:01
Speaker 1: there's a lot of money left in the gas budget.
32:03
Speaker 1: So so just by premium gas just for you know,
32:06
Speaker 1: it's completely stupid, but you know, what can you do?
32:10
Speaker 1: So let's talk a little bit about self control. That's
32:12
Speaker 1: another chapter in the book. That's another one of your
32:15
Speaker 1: favorite topics. People really seem to lack all manner of
32:20
Speaker 1: self control. How does that manifest itself economically? Well, you know,
32:26
Speaker 1: we talked about saving, not especially United States, not especially
32:31
Speaker 1: high savings rates. You know, we went through a decade
32:34
Speaker 1: where we had negative saving rates. And you know, this
32:38
Speaker 1: is the place, the domain where behavior economists have had
32:42
Speaker 1: their biggest impact, and we've managed to change the way.
32:46
Speaker 1: Most four one K plans work with two small changes,
32:51
Speaker 1: but one automatic enrollment. So you start a new job
32:55
Speaker 1: at a company that has a four oh one K
32:57
Speaker 1: and you're automatically enrolled unless you doubt is. You have
33:01
Speaker 1: to fill out a form not to join. And that
33:06
Speaker 1: raised enrollment in the first year from about to huge
33:13
Speaker 1: juge difference and a completely trivial change. And what was
33:16
Speaker 1: he in the last thirty seconds? What was the other?
33:19
Speaker 1: The other one is what I call save more tomorrow,
33:22
Speaker 1: which is get people to agree to increase their saving
33:26
Speaker 1: rates every time they get a raise, and that has
33:29
Speaker 1: an impact and therefore they're contributing more. We've been speaking
33:32
Speaker 1: with Professor Richard Taylor of the University of Chicago, author
33:36
Speaker 1: of the book Misbehaving Um The History and making of
33:42
Speaker 1: behavioral economics. If you enjoy these conversations, be sure and
33:45
Speaker 1: check out our continuing chat, which you can find on
33:49
Speaker 1: Bloomberg dot com and on Apple iTunes. Check out my
33:53
Speaker 1: daily column on Bloomberg View dot com and follow me
33:56
Speaker 1: on Twitter at Ridholts. I'm Barry Ridholts. You've been listening
34:00
Speaker 1: to Masters in Business on Bloomberg Radio. Hi, this is
34:05
Speaker 1: Barry Ridhult. You're listening to Masters in Business on Bloomberg Radio.
34:09
Speaker 1: This is our podcast portion where only you folks lucky
34:13
Speaker 1: enough to go to SoundCloud or Bloomberg dot com or iTunes.
34:18
Speaker 1: I don't have to tell you if you're listening to this,
34:20
Speaker 1: you already have found the podcast portion and we just
34:24
Speaker 1: kinda take our earpieces out and relax and have some fun. Um.
34:29
Speaker 1: I didn't get to mention. I'm some of your curriculum, Vita,
34:33
Speaker 1: And I know you said it's way too long, but
34:36
Speaker 1: you do something with Professor Bob Schiller that's kind of interesting.
34:40
Speaker 1: You guys are the you're the co director of the
34:43
Speaker 1: Behavioral Economics Project at National Bureau of Economic Research. Um,
34:49
Speaker 1: Professor Schiller is your co director? Is that right? We've
34:52
Speaker 1: been doing this for I think over twenty five years. Really,
34:57
Speaker 1: So here's what I find fascinating, and there are amazing parallels.
35:01
Speaker 1: So Bob Schiller is also a behavioralist. He he thinks
35:06
Speaker 1: people make mistakes, markets get crazy, we have bubbles, we
35:11
Speaker 1: have crashes. One of his very best friends is Warton
35:14
Speaker 1: Professor Jeremy Siegel couldn't be more opposite philosophically then than
35:20
Speaker 1: Professor Schiller. He stocks for the long run. Oh we
35:23
Speaker 1: can never you know, let's not worry about this. If
35:26
Speaker 1: you're thinking long term, you have to be long equities.
35:29
Speaker 1: Bob is you know things look a little pricey. Here's
35:32
Speaker 1: my Schiller cape. And then I look at you and
35:36
Speaker 1: you're at University of Chicago. You're the father of behavioral economics.
35:40
Speaker 1: And your golf buddy is Eugene Fama, who couldn't be
35:44
Speaker 1: more opposite in terms of philosophy than you are. How
35:48
Speaker 1: did that relationship develop? You know, when I first arrived
35:53
Speaker 1: at the University of Chicago, UH, a reporter asked UH
36:00
Speaker 1: couple of distinguished financial economists why they had allowed this
36:05
Speaker 1: to happen. One I'll make you read the book to
36:11
Speaker 1: find out who said he didn't block it? Because each
36:16
Speaker 1: generation has to make their own mistakes. That's hilarious, A
36:20
Speaker 1: very warm welcome to a new colleague. Jean said, Oh,
36:26
Speaker 1: we hired him because we wanted to be him. Um,
36:31
Speaker 1: we wanted him nearby so we could keep an eye
36:33
Speaker 1: on him. That's very funny. Also, yeah, so but a
36:37
Speaker 1: little nicer and a little tongue in cheeks, a little
36:41
Speaker 1: half joking exactly exactly. And uh, you know, Jean, what
36:50
Speaker 1: Jean says is and I agree with this that he
36:53
Speaker 1: and I agree about almost all the facts. We dis
37:00
Speaker 1: agree about the interpretations. Yeah, but you agree that there
37:03
Speaker 1: are bubbles. He sort of has ducked that question. What's
37:08
Speaker 1: a bubble? What's a bubble? Right? Look, but what's his
37:13
Speaker 1: real objection is that we can't predict when a bubble
37:17
Speaker 1: is going to end, which is true. Okay, and you know,
37:21
Speaker 1: Bob has had a pretty good run of love with it. No, no,
37:24
Speaker 1: you know, look, Bob is my buddy for twenty five years.
37:28
Speaker 1: But he was warning when did he give the speech
37:32
Speaker 1: to Alan Greenspan four years early? But he wasn't saying
37:38
Speaker 1: it's a bubble get out. He was saying, hey, things
37:40
Speaker 1: have gone well, you know, but kind of what we've
37:42
Speaker 1: been here in the past few years. Yeah, but like
37:46
Speaker 1: you know, he was, his hair was on fire. And
37:50
Speaker 1: you know two thousand you know, so um and my
37:54
Speaker 1: selective perception and confirmation biases that I only saw the
37:58
Speaker 1: two thousand one and the norther earlier, but I do
38:01
Speaker 1: remember the he's the one who planted a rational zuberance
38:05
Speaker 1: and exactly and then and then Greenspan gave him that phrase,
38:09
Speaker 1: which Bob never used. Um and and he turned it
38:14
Speaker 1: into a best selling book, which happened to come out
38:17
Speaker 1: in two thousand, which was lucky, good timing, good timing. Well,
38:21
Speaker 1: he was pretty dead on with the housing again, you know. Again,
38:26
Speaker 1: he started warning that house prices are looking pretty scary,
38:32
Speaker 1: especially in places like Vegas and Scottsdale. But they kept
38:37
Speaker 1: going up for a couple more years. So so jeans
38:41
Speaker 1: right that calling tops and bottoms. There's nobody who's good
38:46
Speaker 1: at that. And now I think it was pretty obvious
38:52
Speaker 1: in both of those cases that there was a bubble
38:54
Speaker 1: going on. But you know, I thought Amazon was ridiculously
39:01
Speaker 1: priced in and you know, some people would argue it was. Yeah,
39:07
Speaker 1: and but I had a guy in my class. I
39:11
Speaker 1: was teaching a PhD class in behavioral finance, And I said, Amazon,
39:16
Speaker 1: who buys this? And there's a guy who raises his
39:19
Speaker 1: hand and he bought it at the I p O.
39:24
Speaker 1: And he says, well, this is so it wasn't that old.
39:30
Speaker 1: And he's still holding onto it. I don't know, I
39:34
Speaker 1: don't know, but um so each weekend class, you know,
39:39
Speaker 1: I'm teasing him about this, and each weekend class he's
39:43
Speaker 1: getting richer. And you know, at the end of the quarter,
39:48
Speaker 1: I gave m an a I said, what the hell
39:50
Speaker 1: he knows more than me. You know, people forget that
39:54
Speaker 1: in nineteen the NASDAC was up eight five and in
40:01
Speaker 1: ninety nine it more than double do was up more.
40:05
Speaker 1: And that's just you could throw a dart at any
40:08
Speaker 1: tech stock and you're making crazy money. Of course, you
40:11
Speaker 1: subsequently ended up with a not too far off from
40:14
Speaker 1: the twenty nine crash um subsequent debacle starting in March
40:20
Speaker 1: two thousand, but Amazon is one of the survivors. It's
40:23
Speaker 1: still still making a money. The The example I always
40:27
Speaker 1: give people when they say, imagine if you bought the
40:30
Speaker 1: I p O of Amazon or or Apple, and my
40:33
Speaker 1: answer is always how many of the original IPO holders
40:36
Speaker 1: of Apple? Do you think are still long Apple that
40:39
Speaker 1: that people buy it and then they can't. They're afraid of,
40:43
Speaker 1: oh my god, I'm gonna lose it. We'll talk a
40:45
Speaker 1: little bit about um prospect theory and about why people
40:49
Speaker 1: seem to heat losses so much more than they like
40:52
Speaker 1: gains in a little while. But how many people who
40:55
Speaker 1: bought Apple even fifteen years ago are still long with today. Well,
41:00
Speaker 1: it's very hard to People have a tendency to get
41:04
Speaker 1: rid of their winners too quickly and to hold onto
41:07
Speaker 1: their losers too long. And that's the exact op I
41:10
Speaker 1: started as a trader in this business. It's the exact opposite.
41:13
Speaker 1: You have to let the runners, winners run. You gotta
41:15
Speaker 1: let them run. And but and you gotta be willing
41:20
Speaker 1: to admit you made a mistake, and you started to
41:23
Speaker 1: get into loss of version. Lots of evidence shows that
41:28
Speaker 1: loss is hurt about twice as much as games feel good.
41:33
Speaker 1: So I have to ask why I have my own
41:35
Speaker 1: pet theory, which is very esoteric. I'm really curious as
41:40
Speaker 1: to why you think, what why that is that losses hurt?
41:44
Speaker 1: Think we're just hard wired that way. Amos Tversky, one
41:48
Speaker 1: of my psychology mentors, had a joke that there once
41:52
Speaker 1: were species that didn't exhibit loss of version, and they're
41:57
Speaker 1: now extinct. So if you're right near subsistence, it makes
42:04
Speaker 1: really good sense to be loss of verse right now
42:08
Speaker 1: for those of us who if we lose two thousand dollars,
42:14
Speaker 1: we're not gonna failed to make our mortgage payment or
42:18
Speaker 1: stop eating. Uh no longer. You know, the the evolutionary
42:25
Speaker 1: cycle is very slow, and so it made sense to
42:30
Speaker 1: be loss of verse when losing something meant you starved
42:34
Speaker 1: to death. But but now you know, people do stupid
42:38
Speaker 1: things like by extended warranties twenty seven billion dollars a
42:43
Speaker 1: year industry, and most of it is for stuff that
42:48
Speaker 1: is just it's disposable. Yeah, that that I forgot. What
42:53
Speaker 1: even the last washing machine we just brought a washing machine.
42:56
Speaker 1: We moved in September November October. We bought washer and
43:00
Speaker 1: a dryer and they were nice, but they weren't, you know,
43:04
Speaker 1: crazy expensive, and they start pitching you in the Washington.
43:07
Speaker 1: I'm gonna throw that that breaks, You're gonna fix it,
43:09
Speaker 1: and if you don't fix it, I'm thrown away and
43:11
Speaker 1: I'm buying a new one. I'm not gonna Why do
43:14
Speaker 1: I need to spend more money on the possibility of
43:17
Speaker 1: this breaking. You know what people have to think about
43:20
Speaker 1: is they're making money selling you that policy, and the
43:27
Speaker 1: salesman at the especially making money is making money. That
43:32
Speaker 1: means you're losing money. They're making more money. In college,
43:36
Speaker 1: I worked part time in an electronics store, and they
43:40
Speaker 1: would make more money on the extended warranties than they
43:44
Speaker 1: would make on the products. So here's an example of
43:46
Speaker 1: mental accounting. What people should do is say, every time
43:53
Speaker 1: somebody offers me an extended warranty, I'm going to take
43:56
Speaker 1: that money and put it into a special save and
44:01
Speaker 1: then anytime anything goes Yeah, I had a I had
44:05
Speaker 1: a friend at at Cornell who had here was his
44:09
Speaker 1: mental accounting trick. At the beginning of the year, he
44:13
Speaker 1: would set aside money for the United Way, say five
44:18
Speaker 1: grand he's gonna give. Then anything bad happens to him,
44:22
Speaker 1: he deducts it from what he's going to give to
44:25
Speaker 1: the United Way. Nothing. So he was totally insured. So
44:29
Speaker 1: he had an insurance policy. And at the end, if
44:32
Speaker 1: he had a good year, you're not away. Got five grants.
44:34
Speaker 1: Yeah that's funny. You know, a speeding ticket, no problem,
44:38
Speaker 1: comes out of United Way, you know, And one year
44:42
Speaker 1: the roof blew off his vacation home in North Carolina,
44:48
Speaker 1: and I told him, look, the reason why you weren't
44:52
Speaker 1: covered is you're too cheap to give United Way enough
44:55
Speaker 1: money to cover the roof. Right, That's that's unbelievable. So
44:59
Speaker 1: in other words, he didn't have homeowners insurance, had insurance,
45:02
Speaker 1: but you know he didn't have insurance for the deductible.
45:07
Speaker 1: That that's that's pretty fascinating mental accounting insurance. So let
45:12
Speaker 1: me keep working my way. So my my pet theory
45:14
Speaker 1: on on why people hate losses more than they like gains.
45:19
Speaker 1: Gains represent a temporary increase in your standard of living.
45:23
Speaker 1: It's temporary, and we all know behaviors have taught us, Hey,
45:28
Speaker 1: you go out and buy a bigger car, or a
45:30
Speaker 1: bigger house, or a nicer television or whatever, and six
45:33
Speaker 1: months later that just becomes your benchmark, your frame or reference,
45:37
Speaker 1: and whatever benefits accrue to that um For the most part,
45:42
Speaker 1: don't really, Most people don't feel. I'm an exception with cars,
45:47
Speaker 1: and I could tell you my wife's car. Every time
45:50
Speaker 1: I drive this, We've had this for two years. It's
45:52
Speaker 1: an utter thrill. The car I forced her to get. Um,
45:57
Speaker 1: it's just this little rocket ship and it's a dull light.
46:00
Speaker 1: Other than getting pulled of speeding tickets, it's a delight.
46:04
Speaker 1: And I'm aware as I'm doing this, I'm like, you know,
46:06
Speaker 1: it's two years and the thrill is not yet gone,
46:10
Speaker 1: but I know that it's about six months for most
46:13
Speaker 1: people for most things. And so you're onto a basic
46:18
Speaker 1: fact of life, which is that we adapt to our
46:21
Speaker 1: surroundings and to the upside. And then yeah, I mean, look,
46:27
Speaker 1: when you're a grad student, you don't feel poor because
46:32
Speaker 1: you're living with a bunch of other grad students and
46:36
Speaker 1: you know you've all got secondhand furniture and Macaronian cheese. Yeah,
46:41
Speaker 1: and you know it's temporary. And now you know, if
46:45
Speaker 1: we had to go back to live in like yeah,
46:48
Speaker 1: but you know we were happy, then you're sure. So
46:52
Speaker 1: you know that. And so that's the first basic fact
46:57
Speaker 1: of human nature. And then the second is that improvements
47:01
Speaker 1: make us happy, but decriments make us miserable. Right, so
47:08
Speaker 1: so so the loss of version thesis. So not only
47:11
Speaker 1: the gains temporary, but and this sort of traces back
47:14
Speaker 1: to what you said about people on the edge when
47:17
Speaker 1: you lose money. In that mental accounting that we do,
47:21
Speaker 1: that loss of the average salary in the United States
47:23
Speaker 1: is about fifty dollars. You lose a thousand dollars, that
47:27
Speaker 1: means that a week of your life is gone and
47:30
Speaker 1: you have nothing to show for it. You work that week,
47:33
Speaker 1: you've got a thousand, you lose it. That's a significant loss.
47:37
Speaker 1: It's a permanent loss versus the benefit the temporary. Hey,
47:42
Speaker 1: here's a thousand dollars. You could buy some nice stuff,
47:44
Speaker 1: you could do things, but it's only temporary. I mean,
47:47
Speaker 1: that's the only way I've been able to rationalize why
47:50
Speaker 1: we despise the losses so much more than we enjoy
47:54
Speaker 1: the game. I'm not much for evolutionary stories, but this one,
47:59
Speaker 1: I think is just we're just hardwired that and uh,
48:04
Speaker 1: maybe in another fifty thousand years will get over it,
48:07
Speaker 1: but not anytime soon. There's a book I'm almost one reading,
48:12
Speaker 1: actually put it down to start yours, called Last Ape Standing,
48:16
Speaker 1: and it looks at the past ten million years and
48:19
Speaker 1: that they were approximately thirty species of either human like
48:23
Speaker 1: or near human, and how the way they've evolved led
48:28
Speaker 1: to some to thrive and some to not make it
48:31
Speaker 1: and we happen to be the last ape standing. And
48:33
Speaker 1: it's a lot of the decision making that that we
48:37
Speaker 1: see today. A lot of these what you mentioned is hardwired. Well,
48:41
Speaker 1: sometimes the hardwiring send you down the wrong path and hey,
48:44
Speaker 1: you ain't around anymore. Well, and you know, we got
48:48
Speaker 1: hardwired to win that battle with the other sapiens, and
48:54
Speaker 1: uh it came. You know, there were pros and cons.
48:58
Speaker 1: We're all bad back X. That'll teach you to walk
49:02
Speaker 1: up right for a thousand years, to say the least.
49:05
Speaker 1: Let's talk a little bit about the winner's curse. We
49:08
Speaker 1: kind of skipped over that earlier. What exactly is the
49:11
Speaker 1: winner's curse? The idea of the winner's curse? This was
49:15
Speaker 1: discovered actually by a couple of engineers at arkellar is
49:21
Speaker 1: Arco old Oil come at Lanta Richmond, exactly, Lanta rich Field,
49:29
Speaker 1: rich Field. So what the here's what they discovered. They
49:34
Speaker 1: discovered that when they were bidding for oil leases. Uh,
49:40
Speaker 1: every time they want a lease, there was less oil
49:44
Speaker 1: in the ground than they expected. Not every time, but
49:47
Speaker 1: on average. Now, they're pretty good geologists, and they couldn't
49:53
Speaker 1: figure out why they were so unlucky. And then they
49:56
Speaker 1: had the insight, well, there's a reason we won the
50:00
Speaker 1: auction paid too much. We paid too much. So and
50:04
Speaker 1: the lesson is, the more bidders there are, the more
50:09
Speaker 1: likely it is that if you win the auction, you lost.
50:14
Speaker 1: That's really interesting. So if there's something that you want
50:18
Speaker 1: that you're bidding at auction four, you should bid a
50:22
Speaker 1: moderate price and either you get lucky and you pay
50:25
Speaker 1: that under price, or if you get enthusiastic and bid
50:28
Speaker 1: too much, that's a that's a losing situation. And live
50:32
Speaker 1: auctions have a way. People get carried away. They certainly did.
50:36
Speaker 1: The only way to rationally participate in an auction is
50:40
Speaker 1: to submit your bid and be done with it, and yeah,
50:44
Speaker 1: and walk away. So figure out the intrinsic value, apply
50:47
Speaker 1: a reasonable discount, submit that in writing, and find out
50:50
Speaker 1: the next day did I win or not, because if
50:53
Speaker 1: you go in person, you're doomed. A friend of mine
50:56
Speaker 1: dragged me to an antique watch auction that took place
51:01
Speaker 1: in in Uptown in man hour from where we are. Yeah,
51:05
Speaker 1: it's still uptown from here. And I looked at all
51:07
Speaker 1: these and they come out with the white gloves and
51:09
Speaker 1: they bring this watch is four thousand dollars, and this
51:12
Speaker 1: watch is ars in this watch is it's was just insane.
51:17
Speaker 1: That's a whole different universe of collectibles. And I watched
51:23
Speaker 1: online the auction go off, and there were some things
51:26
Speaker 1: I thought were really interesting, and I had the slightest
51:30
Speaker 1: idea of I would love to pay, you know, steal
51:34
Speaker 1: that for below. But auctions are pretty good at getting
51:38
Speaker 1: people at the very least a bid fair value and
51:41
Speaker 1: most of the time to bid above, and then there's
51:44
Speaker 1: the hammer cost on top of it. Well that's right.
51:46
Speaker 1: But a colleague of mine, that Chicago booth called Devon Pope,
51:51
Speaker 1: has studied, uh, the auctioneers. It turns out that there
51:57
Speaker 1: are some. There are good and bad auctioneers. Not surprising,
52:02
Speaker 1: but again, in a world of econs, it wouldn't be
52:04
Speaker 1: true because we would all bid up to our reservation
52:08
Speaker 1: price and stop. So what is it that the good
52:12
Speaker 1: auctioneers are getting people to do that? The bad or not? Yeah,
52:16
Speaker 1: I don't remember the just all all. The headline of
52:23
Speaker 1: the is they're different. Just like they're good baseball pitchers
52:28
Speaker 1: and bad ones, there are good auctioneers and bad ones.
52:32
Speaker 1: And the only reason that would only be surprising if
52:35
Speaker 1: you're an economist, because there shouldn't be There should be
52:38
Speaker 1: only good because so much money getting you know, it's
52:42
Speaker 1: a huge incentive to get a good auctioneer if you're
52:45
Speaker 1: the one. You know, if you've ever gone to like
52:47
Speaker 1: a charity auction, if there's a good auctioneer, they raise
52:53
Speaker 1: a lot of money. Really, then, you know, they just
52:57
Speaker 1: they just have their ways of people get emotionally excited,
53:02
Speaker 1: they get into its enthusiastic right, and then they'll there's
53:07
Speaker 1: a good trick which is they'll have two people bidding
53:11
Speaker 1: on like a week in some villa in Italy, and
53:17
Speaker 1: uh one bids twenty grand and the other wins it
53:20
Speaker 1: at one and the guy finally says on call, and
53:26
Speaker 1: then he says, okay, I happened to have a second week,
53:30
Speaker 1: and then he sells the second week to the and
53:35
Speaker 1: so yeah, there's a lot of skill in that. So
53:38
Speaker 1: let's talk a bit about these biases that are so
53:42
Speaker 1: challenging to overcome. Why is it the are we just
53:46
Speaker 1: creatures of habit is the way we're wired. Why do
53:49
Speaker 1: people find these inherent issues so challenging to to circumvent?
53:56
Speaker 1: You know again, I mean it's you know, it's like
54:00
Speaker 1: asking why we have bad backs, um, you know, or
54:04
Speaker 1: why why we can't run as fast as UH or
54:08
Speaker 1: same bolt. UH. We're built that way, and you know,
54:13
Speaker 1: in many domains we recognize it. So you know, if
54:18
Speaker 1: my wife sends me to the store to UH to
54:23
Speaker 1: pick up some groceries, if there are more than two items,
54:27
Speaker 1: I need a list, you know, I you know, I
54:30
Speaker 1: understand my memory. My wife hasn't figured that out yet.
54:34
Speaker 1: You know, she's like, where's the juice? You know? You know,
54:37
Speaker 1: so we all understand at some level. You know, we
54:41
Speaker 1: sett alarm clocks if we have to get up early
54:43
Speaker 1: in the morning, and so we're not perfect, and it's
54:48
Speaker 1: just silly to think that we are perfect. And you know,
54:52
Speaker 1: as you mentioned earlier in the show, there there's nothing
54:56
Speaker 1: wrong with theories that assume everyone's perfec. The only thing
55:01
Speaker 1: that's wrong is in believing that those theories are true. So,
55:05
Speaker 1: you know, green Span was convinced there couldn't be a
55:11
Speaker 1: technology bubble because asset prices are equal to their intrinsic value,
55:17
Speaker 1: the rational of course. And you know, meanwhile, companies are
55:20
Speaker 1: selling for a hundred times sales and they're computing that
55:24
Speaker 1: because there are no profits and you know, we're all
55:28
Speaker 1: looking at this and saying this is completely crazy. But
55:32
Speaker 1: then the market goes up another and you start to wonder,
55:36
Speaker 1: maybe this time is different. One of my missing Yeah,
55:40
Speaker 1: I'm not seeing that. Although he did do a mia
55:43
Speaker 1: kalpa post Financial Price did do a mia kalpa, that's right.
55:49
Speaker 1: He believed that reputation would have prevented banks from doing
55:54
Speaker 1: the really dumb things they did. You know what bank
55:56
Speaker 1: is going to risk a hundred and fifty eight year
55:59
Speaker 1: reputation and as Lehman Brothers and bear Stearns and everybody
56:03
Speaker 1: else did, and now they're no longer. Yeah, and I
56:06
Speaker 1: think in a lot of that, a lot of the companies.
56:10
Speaker 1: There's something I talked about in the book is, uh,
56:14
Speaker 1: you know, economists have the theory they called agency theory
56:17
Speaker 1: about principles and agents. And the idea is usually the
56:22
Speaker 1: principle is the owner, so the shareholders the shareholders or
56:27
Speaker 1: you know Bloomberg. It would be Mr Bloomberg, right, so
56:31
Speaker 1: he would be the principle. And uh, then you know
56:34
Speaker 1: he's got guys like you working for him, and you're shirking.
56:38
Speaker 1: That's the kind of and the the usual idea is
56:42
Speaker 1: that things go wrong because the agent, the employee isn't
56:48
Speaker 1: doing their job. I think in a lot of cases
56:51
Speaker 1: it's what I call it dumb principle problem. Right. So
56:56
Speaker 1: you know, let's take the banks that we're paying mortgage
57:01
Speaker 1: brokers two grand up pop to sell mortgages without any documentation. Now,
57:09
Speaker 1: I'm not blaming the mortgage broker. That's what he's getting
57:13
Speaker 1: paid to do. I'll take it a step further. Those
57:16
Speaker 1: mortgages had a warranty on them that was often ninety
57:21
Speaker 1: days three months. So you're selling a thirty year mortgage.
57:25
Speaker 1: You've basically told this mortgage broker, go find me someone
57:29
Speaker 1: who's gonna at least make the first three, first three
57:33
Speaker 1: out of three sixty payments. Crazy, right, So you know,
57:39
Speaker 1: dumb principle. Dumb principle. And you know, I think in
57:43
Speaker 1: a lot of cases, Uh, you know, if we think
57:47
Speaker 1: of the big catastrophes like Barings and Barkley's and um,
57:55
Speaker 1: what we had were CEOs who didn't understand what the
58:00
Speaker 1: people that we're working for them were doing. That's a
58:03
Speaker 1: dumb principle problem. Yeah, it's a dumb principle. That's fascinating.
58:07
Speaker 1: So we've talked about finance. We've talked about how irrational
58:10
Speaker 1: people can be in the markets. Let's talk about fairness
58:14
Speaker 1: where people and fairness games where people are willing to
58:18
Speaker 1: give up benefit to themselves even if they think something
58:22
Speaker 1: is because they think something is not fair. A classic
58:26
Speaker 1: experiment is something called the ultimatum game. So, um, let's say, uh,
58:36
Speaker 1: the experiment or gives me a hundred dollars and he
58:41
Speaker 1: tells me to make you an offer of some share
58:44
Speaker 1: of the hundred, and the rules are either you take
58:48
Speaker 1: it and you get what I offer you, or you
58:51
Speaker 1: say no, in which case we both get nothing. So
58:53
Speaker 1: it's it's an all or nothing since ultimatum. That's why
58:57
Speaker 1: it's called the ultimatum game. Now, let's suppose I'll offer
59:00
Speaker 1: you two dollars out of my hundred. Well, I don't
59:06
Speaker 1: need two dollars, you're keeping. The hell with you? Go jump.
59:11
Speaker 1: So what we find is in that game, if you
59:15
Speaker 1: offer less than about you're likely to get turned down.
59:20
Speaker 1: That's amazing. And why is that Because to this person
59:23
Speaker 1: making that decision, it's free money. It's free money. It's uh.
59:28
Speaker 1: But you know they say, the hell the hell with you?
59:33
Speaker 1: I mean, that's not fair. And um, you know. Uh,
59:39
Speaker 1: my friend Danny Kaneman and I did a study way back.
59:46
Speaker 1: Uh what pisces people off? Right? Uh? Well, the more
59:50
Speaker 1: polite term was what people think is fair? And we
59:53
Speaker 1: had an example. There's a blizzard. A hardware store has
59:57
Speaker 1: been selling snow shovels for fift doers. They raised the
1:00:01
Speaker 1: price to twenty dollars the morning after a blizzard. Is
1:00:04
Speaker 1: that fair? Well, people hated it, you know, they all
1:00:08
Speaker 1: hated it. Price gouging, Yeah, right, exactly. Now think about Uber, right,
1:00:16
Speaker 1: they do search price surge pricing. Now, at some level,
1:00:20
Speaker 1: search pricing makes total sense in the raader demand finite
1:00:24
Speaker 1: supply prices. But we're all used to the fact that
1:00:27
Speaker 1: if you want to buy an airline ticket at Christmas
1:00:30
Speaker 1: and a hotel room at Aspen, you're gonna pay more
1:00:34
Speaker 1: than two weeks earlier. They even call that. Hey it's
1:00:38
Speaker 1: high season, it's prime season. But you do it in
1:00:44
Speaker 1: a blizzard, you're gonna make people mad. Well, you're gouging
1:00:48
Speaker 1: your advance. Think of the very word gouging, the literal
1:00:54
Speaker 1: means PoCA hole and that's the way people feel. So
1:01:00
Speaker 1: my opinion about Uber is that they should cap the
1:01:04
Speaker 1: search and to sor to reduce animus and maintain a reputation. Yeah,
1:01:13
Speaker 1: and and it makes sense because they're fighting a political
1:01:17
Speaker 1: battle in every city as to whether they can operate
1:01:22
Speaker 1: and whether they can go to the airport. They can't
1:01:25
Speaker 1: afford to be making people mad, at least not in
1:01:28
Speaker 1: the beginning. And you know, there's it never makes sense
1:01:34
Speaker 1: to make people mad. I mean, you're in this for
1:01:39
Speaker 1: the long run. There most businesses have learned this. So
1:01:45
Speaker 1: after a hurricane down to Florida, the cheapest place to
1:01:51
Speaker 1: buy plywood, Walmart is Walmart in Florida. Their notorious for
1:01:56
Speaker 1: anticipating weather and shipping extra whatever it is, extra ply
1:02:02
Speaker 1: whatever is needed if and it generates a lot of
1:02:05
Speaker 1: good will, a lot of goodwill. Now there will also
1:02:08
Speaker 1: be a guy in Atlanta who will load up his
1:02:13
Speaker 1: truck with plywood, sell it off the back of the
1:02:17
Speaker 1: truck for market price. Both Walmart and that guy are
1:02:22
Speaker 1: being rational. Walmart's playing the long game, and that guy
1:02:26
Speaker 1: is just doing a one off. Hey, it's not my reputation,
1:02:29
Speaker 1: not my business in Florida. I'm selling this plywood and
1:02:32
Speaker 1: going back to Atlanta. So you know, we've all had
1:02:36
Speaker 1: the experience in New York. It's raining, can disappear, cabs disappear,
1:02:42
Speaker 1: some guy in a black car pulls up right, and
1:02:47
Speaker 1: you know, you pay unless you want to get wet,
1:02:50
Speaker 1: unless you want to get wet. But uh, if if
1:02:54
Speaker 1: a cab driver pulled up and let's say it's a
1:02:58
Speaker 1: six dollar fair normally and he says it's raining, it'll
1:03:02
Speaker 1: be twenty bucks, you're gonna write down is that would
1:03:05
Speaker 1: be very very unhappy. But you put up with it
1:03:08
Speaker 1: from over because it's a different choice. It's a third option.
1:03:12
Speaker 1: It's a third option. But I think they could, uh,
1:03:15
Speaker 1: they could do better. So let me ask you some
1:03:17
Speaker 1: of my favorite questions that that I ask all of
1:03:20
Speaker 1: my guests. These are these are some regular ones. Let's
1:03:23
Speaker 1: start with an easy one. What are some of your
1:03:26
Speaker 1: favorite books? And and they can but don't have to
1:03:30
Speaker 1: be economic books. What books do you really have you
1:03:33
Speaker 1: really enjoyed? Maybe my favorite book of all time is
1:03:37
Speaker 1: Catch twenty two. I love Joseph Heller. That book was
1:03:40
Speaker 1: just I read that in college and just that's some
1:03:44
Speaker 1: catch that Catch twenty two. Yeah, it's a fantastic catch.
1:03:47
Speaker 1: Here's a weird thing. It's not I'm kindle. That's funny
1:03:51
Speaker 1: because it's I've been I've been meaning to reread it.
1:03:55
Speaker 1: It's really it's sold something like twenty eight million copies.
1:03:59
Speaker 1: I wonder if the date has not is the reason
1:04:02
Speaker 1: why it was published pre Kindle, so there's no obligation
1:04:06
Speaker 1: for it to show up that way. Um if you like,
1:04:09
Speaker 1: if you like Hellar, were you a Vonnegut fan at all? Yeah?
1:04:12
Speaker 1: I loves so fantastic catch um so the two big ones.
1:04:19
Speaker 1: Slaughter House five always comes up every time, um, catch
1:04:23
Speaker 1: twenty two comes up, but a few of his other
1:04:25
Speaker 1: ones were just Cat's Cradle is just so good. You know.
1:04:28
Speaker 1: There's a book that that many people know that I
1:04:32
Speaker 1: read because I was there about called Gallopagus Callous. I
1:04:39
Speaker 1: think that's the title. Maybe it's not the title, but
1:04:42
Speaker 1: it's a book that takes place and to the Gallopagus
1:04:49
Speaker 1: book that's in the back of my head. Douglas Adams,
1:04:52
Speaker 1: who wrote The Hitchhiker's Guide to the Galaxy, he did
1:04:55
Speaker 1: a book called Last Chance to See and he talked
1:04:58
Speaker 1: about by the way you want to go see this
1:05:01
Speaker 1: is not going to be here for another hundred years.
1:05:03
Speaker 1: If you want to go see this, go take a look.
1:05:06
Speaker 1: If you want to go see that, Go go take
1:05:08
Speaker 1: a look. So here's another book. And this is a
1:05:10
Speaker 1: book I went back and reread while I was writing
1:05:14
Speaker 1: my book, and it's Richard Feynman's surely you must be joking. Yeah,
1:05:22
Speaker 1: it's on audio now. Also you could get the versions
1:05:24
Speaker 1: of him narrating some of his speeches and some stuff. Yeah,
1:05:29
Speaker 1: his stuff is wonderful. So in some ways, writing this
1:05:35
Speaker 1: book wasn't my final act of misbehaving. You know, the
1:05:41
Speaker 1: title technically refers to the fact that people misbehave according
1:05:47
Speaker 1: to economists, but a second meaning is that by pointing
1:05:53
Speaker 1: that out during my career, I was misbehaving. Well, you
1:05:57
Speaker 1: didn't conform to what reforms they were expecting you do.
1:06:01
Speaker 1: And then the third act was writing the book the
1:06:05
Speaker 1: way I did because my publisher assured me that there's
1:06:09
Speaker 1: no market for a book like this, Right, they're very
1:06:12
Speaker 1: bad at predicting these sorts. But that's true in television
1:06:16
Speaker 1: and film. And you know that's the famous William Goldman line.
1:06:20
Speaker 1: Nobody knows anything talking about Hollywood that they would make
1:06:23
Speaker 1: these if it was up to them, they would just
1:06:25
Speaker 1: make sequels of what was originally successful. But you gotta
1:06:29
Speaker 1: at least try something to see what's going to be successful.
1:06:32
Speaker 1: So Synman's book, you know you've read it. It's a
1:06:36
Speaker 1: bunch of stories, uh, and some of them are very funny.
1:06:42
Speaker 1: He's a funny guy. And but but there's no physics.
1:06:47
Speaker 1: So the book I wanted to write is as it
1:06:50
Speaker 1: would be if Fynman had tried to explain physics in
1:06:55
Speaker 1: that book. Got it. I don't know whether you think
1:06:58
Speaker 1: I achieved that, but that was what I was trying
1:07:00
Speaker 1: to do. So let me ask you. My next question
1:07:03
Speaker 1: is what sort of advice would you give to a
1:07:05
Speaker 1: young economic student or a millennial either just entering grad
1:07:09
Speaker 1: school or just starting their career today? Find your own problem,
1:07:17
Speaker 1: to work on your own problem. Yeah, don't don't be
1:07:21
Speaker 1: your advisor's research assistant. And it may cost you a
1:07:26
Speaker 1: year um because it's the easy thing to do is
1:07:33
Speaker 1: do a variation on your advisor's life work. And uh,
1:07:40
Speaker 1: that doesn't put you in good standing for the rest
1:07:42
Speaker 1: of you know, I think you know the My book
1:07:48
Speaker 1: starts out with this story about Daniel Kheman having a
1:07:56
Speaker 1: an interview with Roger Lowenstein, the guy who wrote When
1:08:01
Speaker 1: Another Right, and I just had lunch with him not
1:08:06
Speaker 1: too long. He's so insightful. Roger, Yeah, he's a great guy.
1:08:09
Speaker 1: So the story is that Roger was writing a piece
1:08:14
Speaker 1: about me for the New York Times magazine. You were
1:08:16
Speaker 1: in the room while while, Um, Danny was actually having
1:08:20
Speaker 1: the conversation. So Danny said, you want to stay for this,
1:08:23
Speaker 1: and I said sure, And then he starts explaining, UH,
1:08:28
Speaker 1: to Roger, Sailor's best quality, what really makes him special
1:08:34
Speaker 1: is that he's lazy. And I'm I'm waving my hands
1:08:40
Speaker 1: in the air and shaking my head and saying, you know,
1:08:45
Speaker 1: come on, I admit to being lazy, but is it
1:08:48
Speaker 1: my best quality? And uh, Danny still sticks to that story.
1:08:55
Speaker 1: I love that. That's a great story. Professor Taylor, thank
1:08:58
Speaker 1: you so much for being so generous with your time. Um,
1:09:01
Speaker 1: we're gonna wrap right here. I know you have a
1:09:03
Speaker 1: place to go to from here, and I will see
1:09:06
Speaker 1: you on the radio tomorrow. For those of you are listening,
1:09:09
Speaker 1: we've been having a conversation with Professor Richard Taylor of
1:09:12
Speaker 1: the University of Chicago. Be sure and check out some
1:09:15
Speaker 1: of our other UH podcast You can look an inch
1:09:18
Speaker 1: up or an inch down and end up checking them out.
1:09:22
Speaker 1: Checkout Professor Taylor's Twitter handle at our Underscore Taylor at Twitter.
1:09:28
Speaker 1: I'm Barry Retults. You've been listening to Masters in Business
1:09:31
Speaker 1: on Bloomberg Radio