There is an interesting (albeit flawed) analysis in this month’s New Yorker by John Cassidy: Rational Irrationality. The subject is “the real reason that capitalism is so crash-prone.”

The author’s main point seems to be its rational to pursue profits even in an irrational manner when everyone else is profiting from it. Indeed, to miss out on gains — even ruinous ones that force your firm into bankruptcy — is irrational.

How can we spot the flaw in that argument?

Many children have been admonished as a kid, “If all your friends jumped off the Brooklyn Bridge, would you?” Yet that excuse seems to be the basis for some of the worst, money losing decisions made by the financial sector.  All of the cool kids were doing it!

Consider:

“The same logic applies to the decisions made by Wall Street C.E.O.s like Citigroup’s Charles Prince and Merrill Lynch’s Stanley O’Neal. They’ve been roundly denounced for leading their companies into the mortgage business, where they suffered heavy losses. In the midst of a credit bubble, though, somebody running a big financial institution seldom has the option of sitting it out. What boosts a firm’s stock price, and the boss’s standing, is a rapid expansion in revenues and market share. Privately, he may harbor reservations about a particular business line, such as subprime securitization. But, once his peers have entered the field, and are making money, his firm has little choice except to join them. C.E.O.s certainly don’t have much personal incentive to exercise caution. Most of them receive compensation packages loaded with stock options, which reward them for delivering extraordinary growth rather than for maintaining product quality and protecting their firm’s reputation.” (emphasis added)

Pardon me, but the easy choice of aping your competitors ruinous policies is hardly CEO leadership. Sometimes, you have to make the difficult decision, even if it costs you short term. Otherwise, this line reasoning requires one to assume that there is never any “objective reality.” It is herding writ large, only with billions of dollars leveraged up. There is never a good reason to practice risk management, to avoid aggressive speculation when your peer group is so engaged.

For example:

“This was the climate that produced business successes like New Century Financial Corporation, of Orange County, which originated $51.6 billion in subprime mortgages in 2006, making it the second-largest subprime lender in the United States, and which filed for Chapter 11 on April 2, 2007. More than forty per cent of the loans it issued were stated-income loans, also known as liar loans, which didn’t require applicants to provide documentation of their supposed earnings. Michael J. Missal, a bankruptcy-court examiner who carried out a detailed inquiry into New Century’s business, quoted a chief credit officer who said that the company had “no standard for loan quality.” Some employees queried its lax approach to lending, without effect. Senior management’s primary concern was that the loans it originated could be sold to Wall Street. As long as investors were eager to buy subprime securities, with few questions asked, expanding credit recklessly was a highly rewarding strategy.”

I disagree. Chasing short term profits regardless of cost is not “Rational Irrationality” — its short termism of the worst kind. And if it ultimately leads to your firm’s liquidation, how rational is that?  That is the equivalent, IMO, of suggesting you can set the race track record on the straight away, ignoring the hairpin turn at the end. So what if you smash into the wall! You were, for a moment, winning!

Rational Irrationality” asks us to ignore the repercussions of our behaviors. We can rationalize short term gains at the expense of long term losses, because we need to obtain quarterly profits regardless. Apparently, when it bankrupts the company, only then with the benefit of hindsight can we see what went wrong.

I am terribly sorry, but that is precisely the sort of thinking that led to the crisis in the first place. Making loans to people who cannot pay them back is not rational when its profitable — its NEVER rational.

Goldman Sachs avoided most of the credit debacle — were they being irrational when they forewent short term profits for a few years — but avoided the worst of the sub-prime debacle? And what about hedge fund manager John Paulson? His fund bet against all of these other players, netting several billions in profits while others suffered from their “Rational Irrationality.” How irrational was Paulson’s investment posture?

On a risk adjusted basis, the behaviors of Citi, Bear, Lehman, New Century and others was hardly rational. Call it whatever you want, but do not forget this simple fact: It was the sort of narrow, risk-ignoring thinking that is ALWAYS rewarded in the short term, and ALWAYS punished in the long term.

~~~

One last thing: The article also manages to get through the entire subject without so much of a mention of Hyman Minsky, the economist behind what has become the definitive theory of why Capitalism is so crash prone: Stability breeds over confidence, which breeds instability. See Stephen Mihm’s aricle, Why capitalism fails for an excellent discussion of the same. Perhaps understanding that aspect might provide the reader with greater insight than rational irrationality does . . .

>

See also
The synchronous lateral excitation of markets (or pseudo-wobbles)
Paul Murphy
FT Alphaville, September 29, 2009

http://ftalphaville.ft.com/blog/2009/09/28/74351/the-synchronous-lateral-excitation-of-markets-or-pseudo-wobbles/

Source:
Rational Irrationality
John Cassidy
New Yorker, OCTOBER 5, 2009

http://www.newyorker.com/reporting/2009/10/05/091005fa_fact_cassidy

Category: Bailouts, Corporate Management, Credit, Psychology, Really, really bad calls

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

161 Responses to “Can Irrationality Be Rational?”

  1. call me ahab says:

    ok- let’s assume that’s true- just for the sake of argument- but still

    why are the bears shaking in their boots?

  2. bubba says:

    i don’t know why you guys are tag teaming on the wanker. dude’s making $$$. isn’t that the whole point of playing in t he market? you guys actually sound silly bashing him now when he’s actually been right staying in this rally. bash him when he’s wrong. don’t get me wrong, i think he’s way off on his macro view.

  3. HarryWanger says:

    Based upon the last moves off of these shallow pullbacks, we should have a pretty clear run to 10,200-10,400 area before repeating the 2-4% pullback.

  4. Thor says:

    Bubba – if you can’t figure out why they bash HW, or be bothered to go back within past threads to read their many explanations why ask?

  5. HarryWanger says:

    ahab: the market has moved higher as the dollar moved lower. Last week when the dollar gained strength mid week, the indices moved lower. Today the dollar had a fairly strong move upward and stocks followed along. That signifies strength and confirms the bullish trend. If you were thinking of or were short, that would have you worried.

  6. Mannwich says:

    @bubba: I agree to an extent, but the certitude (and lack of humility), and lack of cogent arguments to back up his “Big Picture” outlook is a bit aggravating. I couldn’t care less about the markets. I’m not a trader. I just want a return OF my principle at this point.

  7. call me ahab says:

    not tag teaming anyone-

    doing it on my very own-

    what other’s do is their business- and if they are so inclined to criticize Mr. Wanger- who am i to say no

  8. HarryWanger says:

    bubba: thanks. Yes, it’s difficult to understand how or why you bash someone who keeps telling you to buy on shallow dips of 2-4% so you can make some money. We even saw it happen last week, yet for some reason, they just don’t seem to get it.

  9. Mannwich says:

    @bubba: There you go. Need more reason? The know-it-all certitude is annoying as hell (t0 me). If it doesn’t annoy you, then that’s your prerogative. The fact that it annoys me is mine.

  10. bubba says:

    but mannwich, like him or not…the guy’s been right (and more importantly, making $$$$) — gotta respect that. no? i’m not defending him by any stretch, but it just seems silly to me.

  11. call me ahab says:

    harry-

    ok bubba’s right-

    what the fuck was i thinking-

    sorry bubba- i will try to live up to your expectations next time

  12. Harry Wagner says:

    Mannwich, why do I need cogent arguements when I have the indices on my side. Some day the consumer will get back to borrowing like they should and we will have mini booms all over the place.

    Besides making coming up with cogent aruments will destract me from being self rightous and boring.

  13. Thor says:

    bubba – He’s been wrong (very publicly) quite a few times. Read the threads.

  14. HCF says:

    @Harry:

    It’s 1 friggin’ day that the “normal” dollar vs. stocks correlation didn’t work… Aren’t you drawing too large of a conclusion from 1 data point?

    HCF

  15. HCF says:

    Completely off topic….

    @Thor:

    Noticed that you changed your pic… Before, you looked like Satan; now you look like Satan in a muscle tee. I don’t know why, but that kinda makes my day =)

    HCF

  16. call me ahab says:

    and might i add bubba- not that i give a shit that you should know this-

    the only trade ‘ol Harry said in real time- he lost

    and anyone ‘s who’s objective in coming onto this board is to tell us how to make money-

    is a suspect bullshit artist

  17. Mannwich says:

    @Wanger: “Someday the consumer will get back to borrowing like they should?” That’s all I need to know about you right there. No, the consumer shouldn’t be burying themselves into more debt. That’s the exact opposite of what they “should” be doing at this point.

    @bubba: Yeah, he’s been right about the markets, but I don’t care about the markets that much. I’m not a trader. I care about “THE BIG PICTURE”. Remember that?

  18. Thor says:

    HCF – Thanks! :-) It’s the widows peak. I’ll try to be more original with my next pic. I’ve been trying to copy Ahab’s but I can’t seem to get that facial expression down.

  19. Mannwich says:

    Are there two “HarryWangers” now? One post above says “Harry Wagner”. The other is from “HarryWanger”. Something smells rotten to me. Otto or Borchers? Come clean now.

  20. Mannwich says:

    You also spelled “distract” (“destract”) incorrectly. I think we have a bunch of Wanger imposters here at TBP.

  21. HCF says:

    @Thor:

    Personally, I think Bluto was legit… Popeye was clearly on performance enhancing drugs! Kind of like Barry Bonds, Sammy Sosa, or our friend Harry Wanger…

    HCF

  22. HarryWanger says:

    If nothing else, this blog is usually void of immaturity. Well, not anymore. I always love on any forum when someone comes along with the fake/imitation i.d. So much for mature discussions.

  23. leftback says:

    LB was long over the weekend, made money but doesn’t feel the need to parade the trade like the WANGster.

  24. Mannwich says:

    @leftback: BINGO. And that’s why we here at TBP get irritated with Wanker. It’s all too reminiscent of the bull & real-tards incessantly telling us just how smart they were in ’06 and ’07 before the bottom fell out of the thing and the scittered away like a bunch of dirty cockroaches. Well, it appears some of them are back out from under the fridge.

  25. Thor says:

    Manny – “Are there two “HarryWangers” now? ” Bingo, I thought that post had too many HW buzz words in it to be the genuine article.

  26. HarryWanger says:

    ahab: I continually give you real time trades. Told you when I was adding to my long efts. Also, on the day I bought RIMM AH I also told you I was adding more AAPL. So actually, you are quite wrong. And, I admit when I’m wrong and that one RIMM trade was wrong and I got stopped out. Other than that, I’ve been completely forthcoming with my calls.

  27. hopeImwrong says:

    Wanger – ignore the immature. You contribution is appreciated.

  28. call me ahab says:

    manny-

    don’t you know – Wagner is one of the many faces of a certain poster we know- the “11 faces of eve” got nothing on him-

    think April 20

  29. HarryWanger says:

    leftback, Mannwich: I’m not parading the trade. I’m giving my insight to market moves. I actually receive a lot of email from people who thank me for the trading ideas. If other people choose to use my calls to make money that’s a good thing, right?

  30. bubba says:

    aw com’on guys. “hwagner” is obviously a counterfeit — read the post again, he’s actually mocking “hwanger”. methinks it’s cvienne and his many aliases (f420d being one of them).

  31. Mannwich says:

    @bubba: I figured that out after the fact. Read it too quickly but it sure sounded a lot like him. My apologies to the real “Wanger”.

  32. MikeG says:

    Pardon me, but the easy choice of aping your competitors ruinous policies is hardly CEO leadership.

    Examples of this kind of ‘leadership’ are few and far between.
    Corporate America rewards short-termism, aggression, blame-shifting and herd-following. Arrogant stupidity rules the roost.

  33. call me ahab says:

    bubba-

    ding . .ding . .ding . .ding..

    Bubba wins the chicken dinner ;-)

  34. Mannwich says:

    @MikeG: Excellent point. So true. People respond to the right (or wrong) incentives (positive or negative). That’s the bottom line. It’s a mass race for the riches now in our culture. How you get there doesn’t matter anymore. Just that you got there.

  35. bubba says:

    @ahab

    can i trade that in for a ribeye? i hate chicken.

  36. HCF says:

    @Mannwich:
    > It’s a mass race for the riches now in our culture. How you get there doesn’t matter anymore. Just that you got there.

    As Jay-Z so eloquently stated the priorities in life:

    Money, cash hoes…

    HCF

  37. ben22 says:

    Consumer Confidence:

    Consumer confidence follows, it doesn’t lead so I don’t think it has much predictive value.

    The all-time high for consumer confidence occurred in October 1968, with a reading of 142.3. The Dow topped two months later and lost 36% over the next 18 months. Conversely, in February of this year, consumer confidence hit an all-time low — and the DJIA bottomed days later. In April of this year, after the stock market rally had already started, the Conference Board consumer confidence Index leaped 45% to 39.2, the second biggest jump on record. The biggest-ever increase came in April 1974, when three-quarters of the damage from the 1972-1974 bear market was still to come.

    As for the dollar and the indicies, well, it’s not a perfect +1/-1 correlation there so I wouldn’t go getting all green shootsy over today.

    Just in case anyone is looking for some alternative thoughts outside the Wangman’s….

  38. call me ahab says:

    good observations b22

  39. HarryWanger says:

    ben22: I agree with you on Consumer Confidence, it follows the market. People are happy when the market goes up and they see their 401(k)s regaining value. That’s why I think it’s easy for the market to move up on the number. Self fulfilling prophecy. I don’t think we’ll see any numbers this week that are a surprise on the negative side. Hence, the indices should continue their upward momentum.

  40. Thor says:

    “I don’t think we’ll see any numbers this week that are a surprise on the negative side”

    Noted

  41. franklin420d says:

    Ahab, I am a little surprised with you thinking I could be a cv spin off.

    Bubba, you can believe what you want, I know I am a real person, the voices in my head tell me so.

    I have no clue who cvienne (really) is but I personally find it quite humorous that you are thinking him responsible for so many different names, especially this one, the others I have no clue about, but I doubt it is as many as you want to believe. I hope he smiles when he reads all that he is supposed to be doing.

    Harry, you post an article asking people to read it then, when they do and post something counter to how you see things and it becomes irrelative. Nice to see you are here trying to pass your agenda and not here for dialogue and communication. I come here to learn and the only thing I have learned from you is that – You are an attention whore and buffoon, but hey when you have those qualities why would you need anything else.

    Harry – just how is it you “actually receive a lot of email from people who thank me for the trading ideas” Are these people from this blog? And if you have your own finacial company why are you giving out free adivice here…….. Hey you aren’t really Eric Tyson are you?

  42. franklin420d says:

    @ben22 – FYI Eliot Wave Theory arrived this weekend spent Satuday night with a couple beers and the book, the beers won out, read it last night without the beers, very interesting and will get a lot of good use out of it. Thanks

  43. HarryWanger says:

    franklin: I didn’t really see how you refuted the article – that’s all. Like I said, the article addressed the consumer shifting segments (you seemed to agree to that).

    People from this blog and MW.

  44. franklin420d says:

    Not sure what NW is.

    This blog????
    Just how do they get your email address?

  45. call me ahab says:

    420d-

    well one of those voice have to be right :D and-

    i don’t know- i’m starting to get a little creeped out-

    voices in your head and Winston Munn listening to what the dog tells him-

    gives me the willies (whatever that is)

  46. bubba says:

    @f420d/cvienne/hanrrywagner

    i used to think that split personality disorder was wholly fictitious and made up by overly imaginative psychologists — you’ve made me reconsider this.

  47. mcHAPPY says:

    LB @2:19

    I took notice of these events today as well. Things are getting strangely curious.

    @ Wanger/Wagner/Bully
    Whichever you are, regardless, a comment was made about consumer borrowing to get a mini-boom going – this is the point – there is no credit. As much money can be printed as possible but if banks don’t lend and consumers don’t borrow – who gives a shit? I recommend you google “prechter jaguar inflation”.

    Also today was the first day we’ve seen some real forward looking predictions from HW. I’m watching 10,200-10,400 and 1100. Not much of a stretch of a prediction but at least you put something down for time to tell.

  48. franklin420d says:

    @ ahab – the trouble is more then one voice is correct…. I wonder if winston munn will patch me through to his nieghbors dog.

    Hey on a serious not – HarryWagner is claiming people from this blog have been emailing him “thank yous”

    You haven’t been sending him thank yous have you?

    @Bubba – I guess cvienne has way too much free time on his hands…..But hey believe what you want :)

  49. HarryWanger says:

    mcHappy: i’ve actually been saying DOW 11,500+ area before a real pull back of 8-12% for some time on these boards.

    And FWIW, HarryWanger is no one other than myself. Period.

  50. impermanence says:

    Barry says:

    “Many children have been admonished as a kid, “If all your friends jumped off the Brooklyn Bridge, would you?”

    Actually, only the kids in New York were told that. Your (NYC) tendency to assume that your experience is universal, is showing.

  51. Harry Wagner says:

    And when the stellar economic news comes in later this week we could be seeing 1150+ in our rearview mirrors. I can not wait to see these numbers and watch all the mini-booms advance our economic growth for years to come.

  52. Thor says:

    Hah – that’s just wrong

  53. Harry Wagner says:

    Thor: It is not wrong, you will see the economic data is getting better every day, you doom and gloomers choose to sit there and ignore the vital changes taking place. Don’ say I did not warn you.

  54. Alex E says:

    I don’t see how any of the CEOs ot those working at the banks can necessarily be called irrational. They get paid asymmetrically for the risk they run and from a selfish view it makes perfect sense. Were they irresponsible and self-centred? Most likely but I do not think you can call them irrational.

  55. bergsten says:

    Who is this Harry Wagner, and how come he’s taken over Barry’s blog?

    And how many of them are there? (one user name has a blank between the first and last names, one doesn’t). Maybe HE’S CNBC Sucks (who by the way wanted me to tell you all to go follow his tweets)!

    Is it this guy at Allen & Co.? — hwagner@allenco.com

    Anything to do with this?
    http://www.urbandictionary.com/define.php?term=Harry%20wanger

    And finally, why is everybody worked up about his posts?

  56. call me ahab says:

    bergsten-

    hmmm . . .

  57. [...] Ritholtz responds to John Cassidy’s Rational Irrationality [...]

  58. MelJ says:

    You seem to assume that what is good for the officers of banks is
    good for the banks themselves and vice versa. Now that’s irrational.

  59. [...] Can Irrationality Be Rational? (ritholtz.com) [...]

  60. Tom Hickey says:

    Millennia ago, Aristotle observed that rational agents act for an end that they regard as a good. He then distinguished between real and apparent goods. The difference between someone who is wise and someone who is not is the ability make this judgment correctly. For example, reason is often colored by passion or venality, information may be lacking, or a person may lack sufficient intelligence in complex situations. Thus, people can be rational and still be wrong.