Would replacing some bankers with meteorologists have prevented the crisis?
It wasn’t greed after all. Neuroscience shows that experts make illogical decisions when confronted with unprecedented circumstances, because experience can force you to unconsciously override logic in favour of your established beliefs. Experts in entirely unrelated fields need to be brought in on crucial decisions
If you are an expert, trust your intuitions. They help you make faster, more appropriate decisions. Especially in a crisis. So, logically, you would imagine that the best way to deal with a crisis is to leave it to the experts. No matter how bad the financial crisis was, nobody but the financial experts could put things right, right? Wrong.
This study: “The Illogicality of Stock-Brokers: Psychological Experiments on the Effects of Prior Knowledge and Belief Biases on Logical Reasoning in Stock Trading” pitted highly experienced professional stock traders against weather forecasters in experiments aimed at finding whether experts would succumb to “belief biases” when making 24 decisions where they had to choose between logic and “prior beliefs”.
The researchers did not determine whether bankers were any good at weather forecasting, but they did find examples of meteorologists significantly out-performing the pricing capabilities of 19 stock traders (the majority having a minimum of 10 years experience on the trading floor) in carefully devised experiments where deploying the received wisdom of an experienced stockbroker would produce incorrect judgements if given precedence over purely logical reasoning.
Here is a quotation from the report. It is taken from the discussion section.
“Stock-brokers were guided more by prior knowledge and existing beliefs than by logic and rational decision-making. In fact, they often tended to draw logically invalid inferences in favour of their existing beliefs. Thus, they had difficulties to disengage themselves from vastly anchored thinking patterns… Their performance was even inferior to that of a control group of meteorologists who had no experience at all with the stock market”.
Whereas the professor’s team was mostly interested in the cognitive science of the impact of prior beliefs, the financial world may need to look into the issues his research raises. Expertise is essential and unavoidable. But his research shows that you also need to bring a different resource ‘in the loop’. Staff whose qualifications are threefold.
First, no expertise in the field in question. Second, they need to be fully trained and tested in critical reasoning and logic. Third, they need to be put through tests based upon the same principles as those used in professor Knauff’s experiments, in order to see whether they produce decisions which are immune to the shortcomings identified in this study. And by the way, this of course applies to any mission critical field, not just finance.
The study is by Markus Knauff, visiting professor, Cognition, Perception and Cognitive Neuroscience at the University of California Santa Barbara and Chair of Experimental Psychology and Cognitive Science Giessen University, Germany as well as Claudia Budeck, Ann G. Wolf, and Kai Hamburger.
So perhaps one day, when someone rings their broker in a crisis and asks “how bad is it?” instead of being told “it’s now time to sell everything” they may find themselves being told “it’s time we got a meteorological perspective on the situation”. Unless you’ve read this article, that answer will make no sense. But if nobody does, perhaps it may be too late for all of us.
The really good news is that this means we’ve finally found a popular role for bankers. They can be brought in to help out the weather forecasters if unexpected things start to happen. Their lack of expertise in this field will be more than welcome.
Publication details: Experimental Psychology and Cognitive Science, Justus Liebig University Giessen, Giessen, Germany. Antonio Verdejo García, Editor, University of Granada, Spain.
This is almost surprising when viewed in hindsight, but a more careful look at the study reveals that it is closer to reality than most would think. Stock brokers do not really rely on scientific or objective decision-making, and an outsider’s perspective can never hurt, especially if it’s grounded on a scientific basis. But as economics and stock trading not being exact sciences, I wonder how an absolutely objective and scientific basis in decision making would make an impact in the “real world,” or a non-controlled environment?
Decision making is complicated process, and in many cases, depends on experience or type of profession. Like this report states:
http://epubl.luth.se/1402-1781/2005/15/LTU-CDUPP-0515-SE.pdf
‘Research has shown that decision making process in emergency situation is different than that in business or normal situation. In such situation decision makers evaluates different alternatives but in emergency situation he selects the best course of action based on his experience nad situation at hand.’
Thinking ‘out of the box’ is really important, and meteoroligists did just that.
I think it’s best Greg that both methods are used, since both have their advantages and disadvantages. I think, personally, that the best course of action in any emergency crisis would be to look after not only one’s interests, but as well as others.
Sure thing Rob, worst thing to do is to rely on one opinion, without checking alternatives and different angles to look on the problems at hand.
For people interested in experience’s role in decision making – this article is a good read:
http://www.sciencedaily.com/releases/2009/05/090513130930.htm
Great find there Greg! Hopefully Knauff’s study will help open more minds when it comes to finding alternatives in solution finding, whether in stock trading or other fields.
It’s a good thing that the person who created this study put in an important classifier: a non-expert outsider who is nevertheless trained and tested in critical reasoning and logic. I doubt that many people will feel comfortable having important financial decisions made on their behalf by random strangers with zero qualifications.
I read that, as far as investing goes, one needs to detach oneself from one’s emotions in order to become successful.
http://www.nytimes.com/2007/09/29/business/29nocera.html?_r=1
http://www.gsb.stanford.edu/news/research/finance_shiv_invesmtdecisions.shtml
So perhaps what we need is not just someone who is not a non-expert; we need someone who’s also emotionally-detached. With that said, I agree that this job is something that bankers are well-equipped to do. Or even loan officers.
That’s true Meg, but can’t agree in full. Experienced workers in any trade have their ways, are used to some logical and behavioural patterns, that can – at times – backfire at them.
Actually, Greg, I was just throwing that out there I do agree with you to some extent, that experts in one field are often better equipped to make decisions related to their field of expertise; however, their expertise (and experience) can often act like a double-edged sword. According to some studies, memory enhances a person’s perception of a problem or situation.
http://amitaietzioni.org/documents/A49.pdf
For example, if a professional investor has had a bad experience of investing in shares in a particular IT company (i.e. the stocks lost value in a short amount of time), he’s not going to be in a hurry to buy shares from that company again, despite the fact that it might be wise for him to do so (shares are gaining value and are consistently upwardly mobile). Memory, perception expertise and experience all seem to be important factors in the decision-making process.
Whoa, interesting analysis there, Meg! Not sure though if the bankers involved in such situations who have their stakes at risk would agree. But judging from what I would say a good amount of generalization regarding bankers and investment brokers, you do raise a quite interesting and controversial point there.
Controversial is right Rob. However, I would have to agree with Meg on her point about investors who have had bad experiences in investing in particular companies. No matter how professional or how knowledgeable an investor may be, one bad experience would be enough to make them stay away from any investment. With the economic downturn these days, I think investors may be more emotionally involved when it comes to business.
Surely, past experiences and emotions are both important factors in decision making process. However, should they really be so?
Shouldn’t knowledge or education play the leading role here?
That’s so right Sharpe. With people being more exposed to what’s currently happening around the world because of cable and the internet, I would have thought that most of us, especially those who are involved with business, would be quite apathetic. But I’ve had some talks with a number of entrepreneurs and most take more time with decision-making these days because they have been suffering some losses due to the global crisis. These people’s families have been in business for so many years and have built a name for themselves!
Sure Grace, I imagine entrepreneurs think twice these days before making investment decision, no doubt about that.
Exactly, we need someone emotionally-detached. Are bankers such people? Looking at world’s economical crisis, bank’s problems and missed investments, not so sure. Or Meg’s statements were just an irony, forgive me then.
Most bankers that I know are definitely emotionally detached. Especially if you have outstanding loans. Sorry, but I personally saw people from the bank come to a neighbor’s house and take their car away because they couldn’t make the payments for their car loan. They weren’t even allowed to take their things out of the car.
In this way-yes. But not when it comes to investment decisions. When we needed them to, they trusted their emotions and feelings, instead of knowledge. Hence missed decisions and lots problems we are still facing in the world of finances.
I can’t argue with that Sharpe. Makes you wonder if bankers these days are not as well-trained or well-equipped as their predecessors. Could their level of education be blamed?
Hard to say. I imagine education is alright – maybe just too much responsibility, too much ‘power’ for too young bankers?
Yes, I have to agree with that. Apart from that, maybe banking is a lot more complicated today compared to 20 or 30 years ago.
Yes, have to remember about that as well Grace. Different world now for bankers when compared to few decades ago.