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<DIV class=timestamp>October 28, 2008</DIV>
<DIV class=kicker><NYT_KICKER>Op-Ed Columnist</NYT_KICKER></DIV>
<H1><NYT_HEADLINE type=" " version="1.0">The Behavioral Revolution
</NYT_HEADLINE></H1><NYT_BYLINE type=" " version="1.0">
<DIV class=byline>By <A title="More Articles by David Brooks"
href="http://topics.nytimes.com/top/opinion/editorialsandoped/oped/columnists/davidbrooks/index.html?inline=nyt-per">DAVID
BROOKS</A></DIV></NYT_BYLINE><NYT_TEXT>
<DIV id=articleBody>
<P>Roughly speaking, there are four steps to every decision. First, you perceive
a situation. Then you think of possible courses of action. Then you calculate
which course is in your best interest. Then you take the action.</P>
<P>Over the past few centuries, public policy analysts have assumed that step
three is the most important. Economic models and entire social science
disciplines are premised on the assumption that people are mostly engaged in
rationally calculating and maximizing their self-interest.</P>
<P>But during this financial crisis, that way of thinking has failed
spectacularly. As Alan Greenspan noted in his Congressional testimony last week,
he was “shocked” that markets did not work as anticipated. “I made a mistake in
presuming that the self-interests of organizations, specifically banks and
others, were such as that they were best capable of protecting their own
shareholders and their equity in the firms.” </P>
<P>So perhaps this will be the moment when we alter our view of decision-making.
Perhaps this will be the moment when we shift our focus from step three,
rational calculation, to step one, perception.</P>
<P>Perceiving a situation seems, at first glimpse, like a remarkably simple
operation. You just look and see what’s around. But the operation that seems
most simple is actually the most complex, it’s just that most of the action
takes place below the level of awareness. Looking at and perceiving the world is
an active process of meaning-making that shapes and biases the rest of the
decision-making chain. </P>
<P>Economists and psychologists have been exploring our perceptual biases for
four decades now, with the work of Amos Tversky and Daniel Kahneman, and also
with work by people like Richard Thaler, Robert Shiller, John Bargh and Dan
Ariely. </P>
<P>My sense is that this financial crisis is going to amount to a coming-out
party for behavioral economists and others who are bringing sophisticated
psychology to the realm of public policy. At least these folks have plausible
explanations for why so many people could have been so gigantically wrong about
the risks they were taking.</P>
<P>Nassim Nicholas Taleb has been deeply influenced by this stream of research.
Taleb not only has an explanation for what’s happening, he saw it coming. His
popular books “Fooled by Randomness” and “The Back Swan” were broadsides at the
risk-management models used in the financial world and beyond.</P>
<P>In “The Black Swan,” Taleb wrote, “The government-sponsored institution
Fannie Mae, when I look at its risks, seems to be sitting on a barrel of
dynamite, vulnerable to the slightest hiccup.” Globalization, he noted, “creates
interlocking fragility.” He warned that while the growth of giant banks gives
the appearance of stability, in reality, it raises the risk of a systemic
collapse — “when one fails, they all fail.” </P>
<P>Taleb believes that our brains evolved to suit a world much simpler than the
one we now face. His writing is idiosyncratic, but he does touch on many of the
perceptual biases that distort our thinking: our tendency to see data that
confirm our prejudices more vividly than data that contradict them; our tendency
to overvalue recent events when anticipating future possibilities; our tendency
to spin concurring facts into a single causal narrative; our tendency to applaud
our own supposed skill in circumstances when we’ve actually benefited from dumb
luck.</P>
<P>And looking at the financial crisis, it is easy to see dozens of errors of
perception. Traders misperceived the possibility of rare events. They got caught
in social contagions and reinforced each other’s risk assessments. They failed
to perceive how tightly linked global networks can transform small events into
big disasters. </P>
<P>Taleb is characteristically vituperative about the quantitative risk models,
which try to model something that defies modelization. He subscribes to what he
calls the tragic vision of humankind, which “believes in the existence of
inherent limitations and flaws in the way we think and act and requires an
acknowledgement of this fact as a basis for any individual and collective
action.” If recent events don’t underline this worldview, nothing will.</P>
<P>If you start thinking about our faulty perceptions, the first thing you
realize is that markets are not perfectly efficient, people are not always good
guardians of their own self-interest and there might be limited circumstances
when government could usefully slant the decision-making architecture (see
“Nudge” by Thaler and Cass Sunstein for proposals). But the second thing you
realize is that government officials are probably going to be even worse
perceivers of reality than private business types. Their information feedback
mechanism is more limited, and, being deeply politicized, they’re even more
likely to filter inconvenient facts.</P>
<P>This meltdown is not just a financial event, but also a cultural one. It’s a
big, whopping reminder that the human mind is continually trying to perceive
things that aren’t true, and not perceiving them takes enormous effort.
</P></DIV></NYT_TEXT></FONT></DIV></BODY></HTML>