Dan Ariely: Why Humans Are Hard-Wired To Create Asset Bubbles

"Renowned behavioral economist Dan Ariely explains why humans are biologically wired to make irrational decisions when money is involved. It's a case of our evolutionary wiring interfering with the decisions we face in a modern world very different from the one our ancestors adapted to.

For instance, he explains how one of the easiest phenomena to create in a lab are valuation "bubbles". Our vestigial herding instinct encourages us to imitate the actions of those around us (e.g. bidding for a particular asset), which then strengthens that signal for others (leading to even higher bidding), resulting in behavior not justified by the underlying fundamentals of reality (asset prices destined to crash).

In this podcast, Chris and Dan explore the human cognitive triggers that have led us to our third major bubble in 15 years (tech stocks, housing, credit) and why our natural programming often works against our best interests. In certain cases, like the banking sector, bad decision-making has become so ingrained in our institutions that Ariely thinks the "clean slate" approach is our best option should we have the courage to deploy it:

In very general brushstrokes I think that most bankers are in fact inherently decent people. We just put them in situation in which their conflict of interest is tremendously high and their social norms are incredibly dysfunctional.

When you hear bankers talking about their customers as Muppets, for example, they are forgetting who they are serving. They are hired by the rest of us to do a particular job; and they forget this. And then they have terrible conflicts of interest.

Imagine that I give you a world in which, if you can adopt a particular perspective on life, you could get $5 Million as a bonus. Wouldn’t you start believing that world? And then everybody around you is doing the same thing, and you have some justification for it by talking about financial market theory and so on. All of a sudden you could see how you could take good people and you could put them in this distorted way -- in the same way that we talked about how global warming is probably the perfect storm for inaction -- I think Wall Street is the perfect storm for allowing people to rationalize their own selfish motivations as if they are serving other people..."

at  http://www.zerohedge.com/news/2014-02-15/dan-ariely-why-humans-are-hard-wired-create-asset-bubbles