Fallout: The Financial Crisis

U.S. hasn’t learned stock market lesson

Marketplace Staff Jun 1, 2009
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Fallout: The Financial Crisis

U.S. hasn’t learned stock market lesson

Marketplace Staff Jun 1, 2009
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TEXT OF INTERVIEW

Kai Ryssdal: Last Friday we did a quick economic progress report to see whether we’d hit bottom yet. Not really, was the answer, for the most part. But confidence is returning in drips and drabs. The markets have started ticking back up. Take today, for one perfect example. At the risk of raining on some parades, though, behavioral economist Dan Ariely is back to tell us how that might not a good thing. Hey Dan, good to talk to you again.

DAN ARIELY: Same here.

Ryssdal: You know, things don’t look quite as bad in the stock market, as they did the last time we spoke. But actually improvement, according to you, may not to be such a good thing?

ARIELY: Well, first of all it’s very hard to understand why the market went so low and what happened in the last month and that it seems to be going up in terms of fundamentals. But the problem is much of the time that we are called into action, it’s not based on rationality, it’s based on emotions. And right now our emotions are not so bad and because of that we’re unlikely to take substantial action to improve the markets.

Ryssdal: So do emotions not work as well on the way up as they do on the way down?

ARIELY: They work against changes. Right? So right now you’re saying I know how bad things would be, I don’t want to experience it again, I just experienced it. And I know if we would shake Wall Street up, stock value would go down because everybody would panic again. And because of that, we’re not going to go in, we’re not going to change all the fundamental things we now know are wrong.

Ryssdal: Let me ask you about this badly designed market. Isn’t the stock market reasonably efficient? If you want to buy something, you go in, you discover the price, you pay it, and then you’re done. And the same way on the sell side, isn’t that not true?

ARIELY: No, it’s not true in many ways. You know the economic theory basically tells us the free markets can work fantastically, but under very, very small set of circumstances. I think it’s clear to all of us that right these circumstances don’t hold in the market. So, you know, we talked a lot about cheating in the past. But think about the following. You have individuals who are bankers, who have really pervasive incentives, where they can make a lot of money, where their investors make money, and they don’t lose when they’re investors lose. What does that mean? It means they have a huge incentive to take extra risk. What about the rating agencies? They’ve basically been given triple A’s when they shouldn’t have gotten triple A’s. Me, as a consumer, I can’t go and read everything and understand everything and basically get my own reputation ratings, credit ratings. So I trust these entities. They’ve clearly failed us.

Ryssdal: For those who are in the markets, though, how do you separate you short-term interest in wanting a gain, wanting a return, with the more widely desirable goal of long-term increases in market value?

ARIELY: This is very tough, and I think this is the reason why we’re not really taking any action right now. Now, because it’s emotional we’re not going to do it. Personally, for individuals it’s very hard to go now and protest when the stock market is doing slightly better. And start creating local activity groups that will basically try to persuade the government to do something to regulate the market. And because of that it’s unlikely that the government will get into action and try to create substantial regulations. I’m actually very worried about this. And I think in many ways it would have been better for us as a society in the long term if the stock market didn’t recover, and if we would have a continuous bad situation for another six months. It would have been a painful six months. But three, four, five years from now we would have been in a better situation if that was the case.

Ryssdal: Who knows, though, Dan, it may be lousy for another six months, and then you’d get your wish, right?

ARIELY: I don’t want, this will happen and then people would say…

Ryssdal: It was that Ariely guy on Marketplace, man. It was his fault.

ARIELY: That’s right.

Ryssdal: Dan Ariely is a professor of behavioral economics at Duke University. His book on why we do what we do is called “Predictably Irrational.” Dan, thanks a lot.

ARIELY: My pleasure.

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