Andreessen on The Psychology of Human Misjudgment
Great insights from two legendary entrepreneurs – that’s what Marc Andreessen is offering up in a series of posts on Charlie Munger’s The Psychology of Human Misjudgment. Munger is Warren Buffet’s long-time partner and vice-Chairman at Berkshire Hathaway. Andreessen writes:
Mr. Munger’s magnum opus speech, included in the book, is The Psychology of Human Misjudgment
— an exposition of 25 key forms of human behavior that lead to
misjudgment and error, derived from Mr. Munger’s 60 years of business
experience. Think of it as a practitioner’s summary of human psychology
and behavioral economics as observed in the real world.
Here’s a taste of Munger:
…almost everyone
thinks he fully recognizes how important incentives and disincentives
are in changing cognition and behavior. But this is not often so. For
instance, I think I’ve been in the top five percent of my age cohort
almost all my adult life in understanding the power of incentives, and
yet I’ve always underestimated that power. Never a year passes but I
get some surprise that pushes a little further my appreciation of
incentive superpower.…We [should] heed the general lesson implicit in the injunction of Ben Franklin in Poor Richard’s Almanack:
"If you would persuade, appeal to interest and not to reason." This
maxim is a wise guide to a great and simple precaution in life: Never,
ever, think about something else when you should be thinking about the
power of incentives…
Andreessen is going through the speech and offering comment from his own experiences. Here’s Andreessen with an important example:
…the result of shifting from stock options to restricted stock should be obvious: current employees will be incented to preserve value instead of creating
value. And new hires will by definition be people who are conservative
and change-averse, as the people who want to swing for the fences and
get rewarded for creating something new will go somewhere else, where
they will receive stock options — in typically greater volume than
anyone will ever grant restricted stock — and have greater upside.
Read the whole thing, it’s the first post in a series I’m very much looking forward to reading.
Interpreting Tylerian Science Fiction
Earlier this week Tyler wrote:
I was thinking of writing a science fiction story. In this world human
capital is incredibly valuable. Even if you lose all your wealth you
can earn back lots very quickly, at least if you are talented and
well-educated….The level of risk-taking is very high and capitalist enterprise starts to collapse…Production resumes only when a) managers precommit to costly drug addictions, so that they again fear pecuniary losses and b) shareholders find altruistic managers and also initiate
charitable contributions to India. They threaten to cut off those
contributions if managers perform poorly.
Some of you were perhaps wondering what on earth this means. (Recall my post on Tyler v. Alex.) Perhaps I can help. Here is a recent item from the NYTimes.
BlackRock, the publicly traded asset manager, and a hedge fund firm, Highfields Capital Management, are backing a new company seeking to raise $2 billion to buy delinquent residential mortgages.
Private National Mortgage Acceptance will be run by Stanford L. Kurland, former president of Countrywide Financial Corporation, the largest American home-loan provider, the companies said Monday in a statement.
The Cone of Silence
Jason Kottke quotes from Arsenals
of Folly, the new Richard Rhodes book about the nuclear arms race. The scene is the
1986 meeting between Gorbachev and Reagan in Reykjavik, Iceland.
Back at the American Embassy, Shultz assembled Donald Regan, John Poindexter,
Paul Nitze, Richard Perle, Max Kampelman, Kenneth Adelman, and Poindexter’s
military assistant, Robert Linhard, inside what Adelman calls "the smallest
bubble ever built" — the Plexiglas security chamber, specially coated to repel
electromagnetic radiation and mounted on blocks to limit acoustic transmissions,
that is a feature of every U.S. Embassy in the world. Since the State Department
had seen no need for extensive security arrangements for negotiating U.S.
relations with little Iceland, the Reykjavik Embassy bubble was designed to hold
only eight people. When Reagan arrived, the air-lock-like door swooshed and
everyone stood up, bumping into each other and knocking over chairs in the
confusion. Reagan put people at ease with a joke. "We could fill this thing up
with water," he said, gesturing, "and use it as a fish tank." Adelman gave up
his chair to the president and sat on the floor leaning against the tailored
presidential legs, a compass rose of shoes touching his at the center of the
circle.
Why Anti-Cassandras Get the Media Attention
Paul Krugman today bemoans the fact that on the housing crisis and especially on Iraq the people who get the most media attention are those who got it wrong.
It’s even worse, of course, on the matter of Iraq: just about every one of the panels convened to discuss the lessons of five disastrous years consisted solely of men and women who cheered the idiocy on.
(Brad DeLong, Dean Baker and others have made similar complaints.) I think the fact is correct so what is going on?
The answer is media incentives. It wasn’t just the experts who were wrong, the majority of the American people got Iraq and housing wrong. The war was popular in the beginning and people continued to buy houses even as prices rose ever higher. So what does the American public want to hear now?
The public wants to hear why they weren’t idiots. And who better to explain to the public why they weren’t idiots than experts who also got it wrong?
Government Incentives to Overcook Babies
Australia has a baby bonus. The birth rate shot up on the day the bonus first went into effect, July 1, 2004. As Andrew Leigh and Joshua Gans explained, over 1000 births were delayed from June to July and about 300 births were delayed by more than two weeks.
The bonus is scheduled to rise from $4,187 to $5,000 this July 1 and Leigh and Gans have pleaded with the government to phase it in order to prevent too much birth delay which they think could be unhealthy for the child. Alas, the government has declined.
All of which leads Andrew to denounce, in delightful Aussie-speak, the bonus as an "unhealthy incentive for women to over-cook their babies."
I couldn’t agree more. As a libertarian and a humanist I join with Andrew to denounce all government incentives to overcook babies.
Hat tip to Dave Undis.
Hayek Doesn’t Stop at the Water’s Edge
In the miasma (here and here) of people explaining why they got the war wrong here is Jim Henley explaining why he got it right.
I wasn’t born yesterday. I had heard of the Middle East before
September 12, 2001. I knew that many of the loudest advocates for war with Iraq
were so-called national-greatness conservatives who spent the 1990s arguing that
war was good for the soul. I remembered Elliott Abrams and John Poindexter and
Michael Ledeen as the knaves and fools of Iran-Contra, and drew the appropriate
conclusions about the Bush Administration wanting to employ them: it was an
administration of knaves and fools…Libertarianism. As a libertarian, I was primed to react
skeptically to official pronouncements. “Hayek doesn’t stop at the water’s
edge!” I coined that one. Not bad, huh? I could tell the difference between
the government and the country. People who couldn’t make this
distinction could not rationally cope with the idea that American foreign policy
was the largest driver of anti-American terrorism because it sounded to them too
much like “The American people deserve to be victims of terrorism.” I
could see the self-interest of the officials pushing for war – how war would
benefit their political party, their department within the government, enhance
their own status at the expense of rivals. Libertarianism made it clear how
absurd the idealistic case was. Supposedly, wise, firm and just American
guidance would usher Iraq into a new era of liberalism and comity. But none of
that was going to work unless real American officials embedded in American
political institutions were unusually selfless and astute, with a lofty and
omniscient devotion to Iraqi welfare. And, you know, they weren’t going to be
that….What all of us had in common is probably a simple recognition: War is a big
deal. It isn’t normal. It’s not something to take up casually. Any war you can
describe as “a war of choice” is a crime. War feeds on and feeds the negative
passions. It is to be shunned where possible and regretted when not. Various
hawks occasionally protested that “of course” they didn’t enjoy war,
but they were almost always lying. Anyone who saw invading foreign lands and
ruling other countries by force as extraordinary was forearmed against the lies
and delusions of the time.
More here.
The reasons why I opposed the war are given here.
Hat tip to Brad DeLong for the link.
Progress on Dual Tracking?
One hundred leading European officials in health regulation, the
pharmaceutical industry, and the health media will gather in Stockholm
March 27 to discuss a new proposal that would enable patients to gain
faster access to life-saving drugs not yet approved by regulators.One track of this new proposal, known as "Dual Tracking," provides
that patients and their doctors try to minimize risk by using only
approved drugs as they do now. On the other track, patients and doctors
can choose not-yet-approved drugs that have passed safety trials.
Patients would be able to balance their own preferences for risk with
substantial new opportunities for health improvement. (Quoted here.)
See Bart Madden’s More Choices, Better Health (pdf) for a very good explanation and defense of the dual tracking proposal.
Liability Law and Firm Size
I would like to tile my front porch steps and have been shopping. Lowe’s and Home Depot have plenty of tile but although they advertise installation they won’t install it outdoors. The salespeople, however, will surreptitiously recommend small family contractors. Call Jose, they tell me handing me a number. Why won’t the big firms install outdoor tile?
As best as I can figure the answer is liability. A few slips, falls and an enterprising lawyer or two and Lowe’s could be out millions of dollars. The revenues aren’t worth the risk so small firms step into the breach. The key, of course, is that the small firms won’t be sued because they are judgment proof.
Roberta Romano was here yesterday and offered another example. The big auditing firms won’t do SOX audits for small firms because the revenues are low relative to the risks. The smaller firms must turn to judgment proof auditors of less reliable reputation.
In one sense, this is a good workaround for a liability system that seeks out deep pockets. Consumers are better off than they would be if neither Lowe’s nor the judgment proof firms offered services and they are also better off than if Lowe’s was required to offer services, because the price at which Lowe’s would do so voluntarily would be prohibitive (consumers would be forced to buy insurance they didn’t want at the price).
But more deeply the resulting system is inefficient. Consumers don’t get the insurance that the liability law is supposed to provide and they must turn to lower quality, higher cost service providers even when they would prefer larger firms with solid reputations.
Fear
We have nothing to fear but fear itself, but
fear itself can be pretty scary.…Fear is ruling the
financial markets. Billions of dollars have been lost in mortgage-related
investments. The Federal Reserve worked madly over the weekend to
engineer a takeover of Bear Stearns and avert a systemic meltdown. But
the big fear remains. How low will house prices go?If prices continue to fall, mortgage defaults will move well beyond the
subprime sector. Trillions of dollars in losses for investors are not
impossible. But that doesn’t mean they are inevitable.
That’s me in today’s New York Times. Believe it or not, my piece is one of the more optimistic pieces you are likely to read on the housing crisis.
I think that housing prices went beyond the fundamentals sometime around 2004 (and I said so in 2005, see here and also note my warning that prices could fall dramatically here). But 2004 levels are still well above long run trend. Thus my optimism stems from thinking that unlike Japan, our housing prices need not fall back to long run trend (see my piece for graphs).
But the problem is that we can overshoot the fundamentals going down as well as going up and the United States now faces two potentially
self-fulfilling prophecies.
If the financial markets can predict where and when house prices will
stabilize, then credit conditions can quickly return to normal, the
economy can expand and house prices will indeed stabilize.
But if the financial markets remain uncertain about when the decline in
house prices will end, then fear will tighten credit even further, which
would strangle the housing market and generate even more fear.
Unfortunately, I do not know what will push us into the right prophecy (but read my piece, that will help!) Thus, I am more optimistic than Paul Krugman, who thinks that we may have slipped into the state where no prophecy can bring us back to a good equilibrium, but I’m not that much more optimistic.
The Holiday-Year Challenge
Suppose you want every day to be a holiday. To fulfill your dream you can travel around the world. You can take up to a 3-day holiday, like Japan’s 3-day New Year, but not the 12 days of Christmas. You can also count Sunday or equivalent day of rest as a holiday. Can it be done? What is the longest holiday stretch possible?
Trade-offs
If Governor Spitzer wanted to have sex with a younger woman then instead of hiring a prostitute he could have gotten a divorce and remarried, just like so many other rich and powerful men. Or he could have had an affair. Of these options hiring a prostitute is the least threatening to marriage but it’s the only option which is illegal. In contrast, getting a divorce and remarrying a younger woman is so common it doesn’t even stop a man from running for President.
Trade-offs are everywhere, whether we choose to acknowledge them or not.
In closely related news, Eric Zitzewitz says that although Spitzer may have hired a prostitute he was not himself for sale. Justin Wolfers reflects and like me thinks our moral compass is off kilter.
Markets in Everything: Adam Smith’s House
The house where Adam Smith lived for many years with his mother and which more recently was used as a home for troubled youth has been put up for sale by the Edinburgh Council for £700,000. Sir Alan Peacock says "It’s a disgrace that the council has
agreed to dispose of a building as significant as this. It should be
saved for the nation."
I think it would be a disgrace if the house went to anyone but the highest bidder.
Bad Incentives?
The Center for Union Facts will ask parents, students and other
teachers Tuesday to nominate the "worst unionized teacher in America."
The center says it will choose 10 and offer each $10,000 to quit;
"winners" must allow the center to write about them on its website.
More here.
Thanks to Lee Spector for the link.
Mad Men
Thomas Schelling showed that it could sometimes pay to be irrational, or at least to appear to be irrational. If they think you’re crazy then in a game of chicken it’s your opponent who will backdown.
It’s known that Nixon understood the theory but in an frightening article in Wired we learn the insane extent to which the theory was practiced.
Frustrated at the state of affairs in Vietnam, Nixon resolved to:
…threaten the Soviet Union with a massive nuclear strike and make its
leaders think he was crazy enough to go through with it. His hope was
that the Soviets would be so frightened of events spinning out of
control that they would strong-arm Hanoi, telling the North Vietnamese
to start making concessions at the negotiating table or risk losing
Soviet military support.
Much more was involved than words, at one point nuclear bombers were sent directly towards Soviet airspace where they triggered the Soviet defense systems.
On the morning of October 27, 1969, a squadron of 18
B-52s – massive bombers with eight turbo engines and 185-foot wingspans
– began racing from the western US toward the eastern border of the
Soviet Union. The pilots flew for 18 hours without rest, hurtling
toward their targets at more than 500 miles per hour. Each plane was
loaded with nuclear weapons hundreds of times more powerful than the
ones that had obliterated Hiroshima and Nagasaki.
The Soviets went nuts but following Nixon’s orders Kissinger told the Soviet ambassador that the President was out of control.
Apparently neither Nixon or Kissinger had absorbed another Schelling insight – if you want to credibly pretend you are out of control then you have to push things so far that sometimes you will be out of control. The number of ways such a plan could have resulted in a nuclear war is truly frightening. After all, Nixon was gambling millions of lives on the Soviets being the rational players in this game.
Next time you are told how a madman threatens the world remember the greatest threats have come from our own mad men.
Kill the Farm Bill
Farm subsidies in the United States go to just a handful of crops, corn, wheat, cotton, soybeans, and rice. Most fruits and vegetables are not subsidized, at least not directly but don’t forget opportunity cost!
David Zetland has the dirt:
In this op/ed,
a Minnesota farmer complains that he cannot increase production of
garden crops by growing them on former-program crop land because these
acres will lose their corn subsidy forever if non-program crops are
grown on the land for a year.Why? Because national
fruit and vegetable growers based in California, Florida and Texas fear
competition from regional producers like myself. Through their control
of Congressional delegations from those states, they have been able to
virtually monopolize the country’s fresh produce markets.…In
other words, it seems that non-program crop states have been willing to
support continued subsidies for program crop states because they are
facing less competition in return. Less competition, higher prices and
more money. Voila!