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Issue: Financial decisions

The Issue for week 1
I’ve suggested that the mind is a bit of an improviser. It’s faced with a problem, and it figures out a solution. It’s asked a question about why it did something, and you think, ah, gosh, yes. I can make up an answer to that in no time. But it’s not actually looking inside itself. There is no hidden mental depth where all the answers live. It’s an improviser. Now, that should worry you if you think about the way the financial system works.
It will be nice to think that when we look at a company’s properties and other assets in the economy that we can look at them in a hard nosed way, and we can decide how much we value them, how much we think they are going to be successful, or not unsuccessful in the future. How we can do this in a stable way. But maybe we are improvising. And maybe we’re improvising in a way that means that we can be destabilised very dramatically. Just as we were talking earlier, my preferences about whether I’d like to go on one holiday or another or whether I’m feeling amused or angry, of being kicked around very much in the moment.
So in particular, for example, suppose it’s the case that I’m wondering how much I value a particular company? And, of course, I don’t really know. But on the other hand, I do know that other people seem to value it. It’s got a fairly high share price, or it’s being talked about very well. So I can think to myself, well, I value that as much as the next person. I think that the arguments for it being a good company seem reasonable. So I’ll go with the crowd. Now, of course, it maybe this is a good thing to do if the crowd know what they’re doing. But the crowd obviously may be in the same position as me.
They may also be looking around thinking, well, we don’t really know. But we can come up with a reasonable answer about whether should buy or sell this company based on what other people are saying. And, of course, you can see this could be a bit of a hall of mirrors. For example, if you have a particular class of assets, saying mortgage backed securities in the recent financial crisis, which are actually, on the face of it, a pretty terrible asset, you’d think people would think, hmm, a large amount of money is being lent to people who can’t positive repay it at the bottom of this pyramid. This has got to be a recipe for disaster. I won’t buy these.
On the other hand you think, well, I bought them before. Everything seems to be going OK. And other people are buying them, and they seem happy enough. Then you’re in a different world, a world in which we are not able to consult our some sort of meter of intrinsic value inside ourselves. Instead, we’re cooking up a story about why we’re doing, what we’re doing is reasonable. And that story will tend to be based on things like, well, I’ve done it so far, and it seems to be OK. And other people are doing it, and that seems to be OK. And the papers aren’t saying anything bad about this type of product, so I guess there’s nothing wrong.
Those are the kind of things that push us around. So in a world like that there’s a danger that our collective views can get wildly out of line with reality or at least for a while. Of course it can’t last forever. And when things start to fall back into line then we have some sort of boom followed by some sort of crash.

I’ve suggested that the mind is a bit of an improviser: it’s faced with a problem, and it figures out a solution. It’s not actually looking inside itself. There is no hidden mental depth where all the answers live – it’s an improviser.

What are the implications of this in the context of the financial system?

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The Mind is Flat: The Shocking Shallowness of Human Psychology

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