Human Nature: Or, Why Human Beings Are Bad Investors

By James Kwak

Free Exchange has Anthony Gottlieb’s recollections of interviewing Bernie Madoff about financial regulation:

at the time he came across merely as calm, strikingly rational, devoid of ego, and the last person you would expect to make your wealth vanish. I certainly would have trusted him with my money. I cannot say the same of other financial superstars I interviewed. . . . Perhaps it is the most confidence-inspiring ones that you have to look out for.

I couldn’t agree more. We human beings have this completely misplaced confidence in our ability to judge people by “looking them in the eye.” I recall reading about one study (sorry, I don’t remember anything else about it) which showed that hiring managers were more likely to make good hires by selecting solely on the basis of resumes than by interviewing people - because using resumes is completely objective, while interviews allow you to interject your own erroneous beliefs. (I do believe that if you use interviews well - that is, to obtain factual information, like how well someone can actually write a computer program - you can do better than just using resumes; but maybe I’m just fooling myself.)

There are a couple of ways to look at this phenomenon. One is to think about motivations. There are people who are trying to rip you off and people who aren’t. The latter have no motivation to try to seem trustworthy, so they don’t bother. The former do have that motivation, so they try. Some are bad at it; some, however, are very good at it.

More broadly, what does it mean to appear trustworthy? “Trustworthiness” is just a set of signifiers that are generated by one person and that enter the brain of another person, like a firm handshake or a steady gaze. It’s like those luxury car manufacturers who expend effort and cost engineering the sound of the car door closing, because that sound is a signifier for quality. There is some evolutionary process whereby these signifiers got attached to the concept of trustworthiness in our brain over the history of the species, and maybe the connection was valid at some point. But now that people can reverse-engineer the connection and replicate the signifiers whether or not they are actually trustworthy, our instincts aren’t much use anymore.

The only way not to be fooled by your instincts is to rely solely on objective facts. Now, in the Bernie Madoff case, one can object that the only visible “facts” were themselves cooked, and that is true. But that just means we need better policing of things that are presented as facts. And I think the overall point still holds.

Comments

[sr9web:]

" he came across merely as calm, strikingly rational, devoid of ego"

A personality patina which was used TO INSPIRE CONFIDNECE

What a dummy!

2008 Dec 31 09:48 PM

[notsosmart:]

this will never change.most people cant look at themselves in an honest way.if you cant be honest with yourself what can you expect?if you are a liar,dishonest,etc. no law is going to change that.

Jan 01 11:55 AM

[aristide z:]

The lack of transparency should have been a red flag.We should all remember,it is not what men say but what they do that matters most!

Jan 01 02:40 PM

[Roger Knights:]

“There was an honesty oozing out of Moocher such as only dishonest men have. They need it. If one of them looks just ordinarily honest, somebody says, ‘We had better test him, to make sure.’ And almost at once he is found out. So a crook has to seem so honest that it is sheer impiety to suggest making any test.”
—Lord Dunsany, “A Matter of Business,” in Jorkens Has a Large Whiskey, p. 261

"People who bend the truth have figured out how not to look nervous and guilty, and actually will appear calmer than someone who is actually telling the truth, according to a study [by] behavioral expert Samantha Mann of Portsmouth University. 'Those who are lying have to think harder, and when we think harder we tend to be still.'”
—“How to spot a liar: They DO look you in the eye,” Examiner, 5/29/06, p. 52

“Never trust to general impressions, my boy, but concentrate yourself upon details.”
—Sherlock Holmes, “A Case of Identity”

Jan 01 07:30 PM

[auto44:]

I Have been fooled by many people many times. This is why it is necessary to limit risks by some diversification. If you expect, inspect.

Jan 02 12:45 AM

[Kunst:]

People who asked Madoff objective questions didn't get taken. Either they realized the weren't getting the kind of data that supported investing with him, or he kicked them out because he didn't want to answer those kinds of questions. Normal due diligence questions, like how he operated his business. His victims substituted gut feeling or reliance on reputation and demeanor for basic analysis. While he is a bad guy, they did it to themselves.

Jan 02 02:59 AM