An Economy of Faith and Trust | Hacker News Reader

An Economy of Faith and Trust

nytimes.com

17 pointsrobg6 comments

This view explains a lot, but not the current financial crisis - how so many people could be so stupid, incompetent and self-destructive all at once.

I can explain it. Republicans like giving businesses new ways to make money. Subprime loans allowed businesses to lend to a whole group of people they couldn't lend to before. Democrats like giving poorer people the opportunity to build wealth. VPs at banks want to move up and proposing a whole new business area gets noticed and promoted. So, you use overly optimistic calculations that show only good coming from them and lots of people jump on the bandwagon and years later you're in trouble because reality never works as cleanly as paper. No one had done it before and they didn't know what would happen. I'm sure if you took foreclosure rates from standard loans and applied them to these subprime ones, the situation looks fine. Anyway, I remember something about the road to hell being paved with good intentions.

The author (in my opinion) is very right. Until people and companies feel secure in their livelihood, they won't engage in the economic activity that makes an economy truly strong.

Agreed. As soon as people making 40k per year were able to buy 500k houses with little to no money down, my sirens went off.

Reason is not like a rider atop a horse. Instead, each person’s mind contains a panoply of instincts, strategies, intuitions, emotions, memories and habits, which vie for supremacy.

I can't express how badly I want this meme to take hold! I've wondered for years why anyone can believe that humans are rational agents in the face of the existence of the huge marketing apparatus present in advanced economies. I mean, if we really are rational decision-making agents, why does a manufacturer pay someone to come up with a jingle? To engineer a fad via guerrilla marketing? To create brand impressions by slapping a logo on a race car or sports stadium? All of these techniques, and all of the other successful marketing techniques out there, survive precisely because humans can be persuaded to spend money irrationally.

"So what?," you say? Well, that great artifice, "Classical Free Market Theory," rests on the foundation of rational agents making locally optimal solutions with imperfect information. It seems to me to predict, for example, that there's no profit to be made anywhere in a steady state condition. The rational masses, so the theory goes, will always seek the cheapest goods that meet the need, regardless of brand recognition, sexy women placed next to sports cars, or celebrity endorsement. In this case, every competitive scenario results in goods being produced at cost.

Thankfully (I think), this is not the case, and there is a way to wealth that is left open. Namely, a successful entrepreneur needs to be present when people are making non-rational decisions with their money. This is not to say that these are bad decisions, or that the entrepreneur needs to be unscrupulous. It's just an acknowledgment of the fact that rational decision-making in a quasi-equilibirum economic scenario results in zero profit margin.

Even if each individual agent isn't rational it is possible that, on average, we are.

Think of a room full of gas that you slowly heat. All sorts of quantum effects and chaos affect individual particles. But, on average, we can predict the net outcome with fairly good results using very naive models (laws of thermodynamics, ideal gas law, etc).

And you're absolutely right about profit. Standard economic theory predicts that, in a free market that is at a stable equilibrium, each firm won't earn any profits exceeding the marginal cost of production (economists say that a firm is earning "Normal profits"). But, obviously, no markets (that I can think of) are perfectly free or in perfect equilibrium (and economists know this, and have far more complex models for real world situations).

Although, if memory serves, this hypothesis has been empirically verified by many almost-free markets (i.e., commoditized goods sold to intelligent/large consumers). You have a bunch of sellers doing business, barely making ends meet, until something happens that disrupts equilibrium (new technology, another company's bankruptcy, sudden changes in demand, etc), where they can hope to earn supernormal profits in the short term, before the market returns to equilibrium.

When each individual agent is not rational the group is not rational. Take car buying, a major car company that cut it's advertising budget in half they could try to sell a higher quality product for less money. At which point all other company's would have to limit their budget to compete etc. However, this does not happen because consumers are not rational as a group.

You can even measure the level of rational behavior by comparing stable markets. EX: Gasoline vs Bottled water, there is vary little to distinguish the products, but brand name water carries a huge price premium.

I can't wait for the NYT to go out of business. No more of these paywall/registerwall articles.

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