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Greenspan Wakes Up to Behavior

From The Wall Street Journal:

“I’ve always considered myself more of a mathematician than a psychologist,” says Mr. Greenspan. But after the Fed’s model failed to predict the financial crisis, he realized that there is more to forecasting than numbers. “It all fell apart, in the sense that not a single major forecaster of note or institution caught it,” he says. “The Federal Reserve has got the most elaborate econometric model, which incorporates all the newfangled models of how the world works—and it missed it completely.” He says JP Morgan had put out a forecast three days before the crisis saying the economy was on the rise. And as late as 2007, the International Monetary Fund also said that global risk was declining. “A few days [after the crisis hit], I run into an article, and it is titled, ‘Do we economists know anything?’ ” he says.

Mr. Greenspan set out to find his blind spot step by step. First he drew the conclusion that the nonfinancial sector of the economy had been healthy. The problem lay in finance, because of its vulnerability to spells of euphoria and irrational fear. Studying the results of herd behavior provided him with some surprises. “I was actually flabbergasted,” he says. “It upended my view of how the world works.”

He concluded that fear has at least three times the effect of euphoria in producing market gyrations. “I wouldn’t have dared write anything like that before,” he says.

Studying the minutiae of the events leading to the financial crisis brought to mind some lessons from his famous friendship, from the 1950s on, with the late Objectivist philosopher Ayn Rand. He says that Rand didn’t influence him politically—he was always a libertarian—but she did point out tensions in his philosophy about life. “She caught me in contradictions, which shook me, and I said, ‘My God, she is right,’ ” he says.

Mr. Greenspan then believed in analysis based mainly on hard science and empirical facts. Rand told him that unless he considered human nature and its irrational side, he would “miss a very large part of how human beings behaved.” At the time they weren’t discussing economics, but today he realizes the full impact of emotions and instincts on markets. He also has come to admire psychologist and Princeton University professor emeritus Daniel Kahneman’s work applying psychological insights to economic theory, for which he won a Nobel Prize in 2002.

Good for Greenspan. So late to the party.

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Posted in Psychology
3 comments on “Greenspan Wakes Up to Behavior
  1. Rob Blay says:

    So late to the party as too be of no use to anyone whatsoever. In fact he has just come to the same realisation that most of us traders come to when we’ve blown our first account on the way to success.

    If Greenspan had managed risk instead of trying to predict the future he might have been respected.

    No fool like an old fool!

  2. DGDye says:

    Hate to get all artsy fartsy on you here, but Shakespeare pointed out over 400 years ago that your identity is defined by your audience and value is defined by people’s perception of the object.

    In other words, a queen is a queen only as long as everyone believes she’s the queen (ask Marie Antoinette what happens when people quit believing you’re the queen!)…

    and objects — including stocks and securities — have only that value which the masses believe them to have. And if a lot of the masses believe in the value, you have a bubble. When the majority quit believing, you have a crash.

    I think Shakespeare should have gotten the Nobel prize.

  3. Johnson says:

    You keep on repeating that three professors were awarded ‘the Nobel prize in economics’. NOOO, as it has been widely misreported as ‘the Nobel prize in economics’ . What they actually received was the ‘Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel’, which is not quite the same thing !!!!! Just get informed, not like those just repeating what they see on TV ( did you get that information on CNBC ?).

    As for mister Greenspan, the fed is a cartel and just like in the film “The Hudsucker proxy”, they (the banks ) needed a man of straw (as it as always been), with an academic background to impress average americans. That people believe he may have known somthing is typically american (ah ah) !

    If there are trends, it is for the simple fact , as stated by mister Ludwig Von Mises in “Human action” that people act to get out of a state of dissactisfaction. Know where the average guy stands, and you know where to trade (indeed just follow the trend) .

    And as for asset managers (the companies) , they sell a product that people ask for, just like a car or an iphone. Only fools do not want to recognize that.In a past podcast, you stated that people like Ford or whoever else made history – hitler , staline, Khan,.. and deserved the money they got and nobody should be entitled to seize their wealth. But you do not get the point. Far back in history, the power was “muscle-cracy”, then tyranny ( greek meaning) , monachy, then democracy, now ineptocracy ( yes we are already in) and the next step is idiocracy then back to
    “muscle-cracy”. The real power is not in the money but in the vote ! If the averag guy votes for politicians to seize your wealth, bad luck ! that’s you ‘re system!

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