Julius Caesar crosses the Rubicon and risks it all
Check out this must read from James Kwak at Baseline Scenario on risky behavior in the banking industry. He cites another post at VoxEU by Anne Siebert entitled “Why did the bankers behave so badly?”. They behaved badly because they were overconfident. This overconfidence was brought on by three things: confirmation bias, a steroid feedback loop and bonus compensation strategies. In other words, we have a repeat of The Smartest Guys in the Room that brought down Enron.
The steroid feedback loop hypothesis is fascinating. I’ve referred to it as testosterone poisoning. We saw it up close and personal on some of our former favorite websites like DailyKos during the election. Aw, Jeez, here come the guys again doth protesting too much. “How dare you insult our gender, you insensitive, brazen hussy! You discriminate against me and my brethren. Help! Help! I’m being oppressed!” Give it a rest, guys. This phenomenon has legs. Some geeky types have been doing research on the subject:
There is a substantial economics literature on the effect of gender on attitudes toward risk and most of it appears to support the idea that men are less risk averse than women in their financial decision making.1 There is also a sizable literature documenting that men tend to be more overconfident than women. Barber and Odean (2001) find that men are substantially more overconfident than women in financial markets. In general, overconfidence is not found to be related to ability (see Lundeberg et al (1994)) and that success is more likely to increase overconfidence in men than in women (see, for example, Beyer (1990)). Thus, if confidence helps produce successful outcomes, there is more likely to be strong feedback loop in confidence in men than in women.
In a fascinating and innovative study, Coates and Herbert (2008) advance the notion that steroid feedback loops may help explain why male bankers behave irrationally when caught up in bubbles. These authors took samples of testosterone levels of 17 male traders on a typical London trading floor (which had 260 traders, only four of whom were female). They found that testosterone was significantly higher on days when traders made more than their daily one-month average profit and that higher levels of testosterone also led to greater profitability – presumably because of greater confidence and risk taking. The authors hypothesise that if raised testosterone were to persist for several weeks the elevated appetite for risk taking might have important behavioural consequences and that there might be cognitive implications as well; testosterone, they say, has receptors throughout the areas of the brain that neuro-economic research has identified as contributing to irrational financial decisions.
A couple of interesting things jump out at me in the above paragraphs. First, overconfidence is not related to ability. That is, assertions that one is God’s gift to the financial world are not born out by any qualitative measurment of performance. So, all you rich brokers and financiers who are whining that you lost your bonus or job and can’t afford the summer rental in the Hamptons this year to support the new servant class that you refuse to pay a living wage probably didn’t earn it in the first place.
The other thing that strikes me as interesting is that we don’t really know what would happen if we had more women in the financial industry. It is mere specualation that they wouldn’t fall prey to the same behaviors. It isn’t clear to me that there isn’t as much nurture as nature going on in excessive risk taking. But I think we can say that there is a very high barrier for admission to the party for women. Four females out of 260 traders on a typical London trading floor is pretty pathetic. If it is true that the steroid feedback loop is responsible in part for risky behavior, then breaking up the critical mass of men with additional women would be a worthwhile experiment. But how do you get women in there? Are women discouraged from pursuing these kinds of jobs in the first place? Let’s assume that there is a “nurture” component to the absence of women in the financial industry and unpack some real world scenarios.
First up, a woman applying for a particular job on the trading floor is responsible and takes her fiduciary responsibility seriously. In the atmosphere of testosterone poisoning, she would be seen as weak and not pulling her weight sufficiently. Her lack of risk taking behavior would not be compensated nor praised. Even women’s egos need stroking. Why would a woman who is responsible want to subject herself to this? Good question. We should ask Sheila Bair, Elizabeth Warren and Hillary Clinton. All three of these women have bucked the system and have advocated a bottom up approach to solving the financial crisis. All three have met tremendous resistance from the status quo and the new status quo of the incoming administration.
Now let us consider a woman who has the temprament to compete on the same level playing field as a man. This woman would not just need to be smart and ambitious, she would also need to possess the kind of moxie to seek forgiveness rather than permission. She has to possess the kind of overconfidence that make people believe her. In the real world, these kind of women don’t have a prayer. They are labeled pushy, troublemakers, “not team players”. We reward women for being team players, obedient and pleasant, not for being aggressive risk takers.
So, adding women to the mix is unlikely to be of any great assistance because the environment of the financial industry at the present time is incompatible with preferred gender behaviors. There are a couple solutions to this problem. We could either allow women to exercise these facets of their personalities so that they can compete with men in a dog eat dog world. I think we should do this anyway because it’s time that smart ambitious women were encouraged to take risks. But this wouldn’t solve the immediate problem of excessive risk taking in the financial sector.
The other solution is to punish excessive risk taking behavior and testosterone poisoning to begin with. That is, hold people accountable for excessive risk taking. As Paul Krugman says, make banking boring again. It has been done before. As Elizabeth Warren points out, the boom-bust cycle that plagued the American economy every 10-15 years since the creation of the republic didn’t happen in the 50 years that followed the Great Depression. That’s because we had such a great shock to the system that we knew that curbing these behaviors was the only way to make sure the testosterone poisoned didn’t bankrupt us again.
The problem is that few people alive now remember what the Great Depression was like and the present shock to our system may not be as acutely debilitating, requiring clear, immediate steps to save the system. Instead, it’s going to be like chronic back pain. We’ll still have to work through it but the pain will never completely go away. We’ll be expected to muddle through it, debating whether an operation or bedrest will make it end. Meanwhile, the testosterone poisoned will go their merry way, wrecking havoc.
Podcast of the day: Mike Duncan has a terrific podcast on the History of Rome. History does indeed repeat itself. Oligarchs apparently have behaved the same way for a long time. And unfortunately for all of us, there are only a few harsh remedies for getting rid of them. Check out Insert Well Known Idiom Here.
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Filed under: Economy | Tagged: Anne Siebert, James Kwak, testosterone poisoning | 45 Comments »
The Confluence 