Was this the consequence of the actions of a powerful few, driven by extraordinary levels of greed and recklessness, or can the roots of the crisis be found in much more commonplace aspects of human psychology? I am going to argue that there is a great deal in common between the psychology of every day decisions about money and the psychological processes involved in the creation of this global financial crisis.

Consider two examples:

Jenny has recently lost her job, she knows that money is tight and she needs to reduce her costs dramatically, but every time she tries to think about sorting things out she feels bad and ends up by going shopping to cheer herself up.

Jared took on a 100% loan to buy a house with repayment levels he could only just afford. As he thought about this decision from time to time, he felt anxious about the possibility that he would not be able to meet the payments. He was able to avoid this anxiety by focusing on the way in which house prices seemed to keep on rising and by telling himself it was really a ‘one way bet’.

In each case there is a common factor: employing a strategy to avoid bad feelings and maintain good feelings, rather than facing the real problem or risk. We all behave like this from time to time. We all have strategies to regulate our emotions and often do so with the goal of avoiding bad feelings. However, when we feel particularly anxious or are powerfully motivated by an important goal, this tendency can cause us to ignore the important information that negative feelings can carry. Often this can involve fostering illusions about ourselves and the world around us which help us feel better.

Stock market results in a newspaper.
[image © copyright Jupiterimages]

We might imagine that professional financial decision-makers would be better at avoiding such traps. After all they work in a climate which places a great premium on rational decisions. However, in a large-scale study of 118 traders in four City of London investment banks, myself and colleagues found traders to be just as prone to these kinds of illusions as the rest of us. In particular we studied traders’ propensity to suffer from the illusion of control: the tendency to believe we are more in control of events than we really are (especially under stress). We found a significant relationship between a tendency to suffer from illusions of control and poor trader performance (including poor management of risk).

How might this relate to the causes of financial crises? One example back in the early 1990s is worth recalling. Peter Baring has been reported as telling shareholders at an AGM one year before the collapse of Barings’ Bank that, on the basis of the previous year’s performance, he had concluded it is easy to make money in the derivatives market. A year later the bank was valued at £1.

Any banker understands that there is a strong relationship between risk and return. Faced with unusually good financial performance in part of a bank’s operations, an important question to ask is “What hidden risks are we carrying that account for this high return?” However, faced with good returns, it is tempting to foster the illusion that good performance is a result of our unique skills and capabilities, while failures are due to events beyond our control. This tendency is known by psychologists as the self-serving bias.

This unwillingness to seriously question what hidden risks lay behind unusually high returns seems to have been an important factor in the recent demise of Lehman brothers and other major banks. A reckless love of money seems to have fuelled collective illusions about the risks being faced.

We need to understand more about how these kinds of emotion regulation processes work in financial decision-making. Current research is helping us understand these processes and how such blindness to risk can be reduced. The European Commission has funded me and an international group of researchers to conduct a major study looking at ways of improving financial decision-making. This study is looking at traders, investors and private citizens, and is paying close attention to the role played by emotions in their decision making.

Take it further

• Trading on emotion
• Has Robert Peston caused a recession?
• Bankers won, politicians lost

Further reading

Traders: risks, decisions, and management in financial markets, by Mark Fenton-O'Creevy, Nigel Nicholson, Emma Soane and Paul Willman, was published by Oxford University Press.

About the author

Mark Fenton-O'Creevy is Professor of Organisational Behaviour at the OU Business School. His research includes investigations into the performance of traders in financial markets, and the problems that occur when management practices are transferred from one country to another.

He is also a National Teaching Fellow, and Principal of the Centre for Practice-Based Professional Learning.

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Peston was the first to break the story of Northern Rock’s shortage of cash. The bank had enough assets to cover its obligations, but the credit crunch was making it hard for them to manage day to day operations. Peston’s story was quickly picked up by other news media. In the days following, queues of customers wanting to withdraw their savings from Northern Rock became so large at times that police had to manage crowd control. The bank’s operational difficulties, on which Peston had reported, quickly turned into a crisis of epic proportions. 

In normal times banks can safely accept savings deposits on terms which allow rapid withdrawal, then lend that money longer term. Deposits and withdrawals tend to average out and temporary imbalances can be covered by borrowing from other banks. But if unusually large numbers of depositors want their money at once, the cash is just not there. The system works because we trust it. Our money is safe so long as enough of us believe it to be. The breaking story about Northern Rock’s difficulties did not just reflect events it played a substantial role in bringing them about.  This pattern has become familiar as the current financial crisis has unfolded; news has not just followed financial events it has often amplified them.         

Robert Peston.
[image by SouthbankSteve, some rights reserved]

Of course the title of this article is mostly a rhetorical flourish. It would be unfair and untrue to accuse Robert Peston of single-handedly causing a recession. However, it is very much the case that media stories on the current turmoil are not just reflecting events they are also creating them.

Two ideas from social psychology and sociology can be helpful in understanding what is going on here: social amplification and performativity.

Social amplification of risk is the process though which public perceptions of risks can be produced and magnified as a consequence of the ways in which hazards come to public attention. A key issue in social amplification is the interest key parties have in the story. For example, media outlets have an interest in generating high circulation or viewing figures and ‘scare stories’ sell. This media focus on generating headlines can thus be a key factor in amplifying risk perceptions. Indeed the Daily Mail's outrage at the influence of Robert Peston might be seen as a little hypocritical given that paper's role in amplifying risk perceptions of other kinds, not least in relation to health.

If I drop a rock, it will fall to the ground (or perhaps on my toe) whether I believe in gravity or not. Gravity is independent of my belief in it. But many ‘facts’ I believe in are social facts and are true only so long as enough people believe in them; the value of money for example. What you believe does not just reflect our social world it helps create it. Performative statements or beliefs are those which help bring about the conditions they describe.

What you believe does not just reflect our social world it helps create it

The beliefs we subscribe to about banks are performative. By trusting that banks are safe places to keep our money we help bring about the stability which makes this true. By trusting each other with funds, banks ensure the stable operation of financial systems which in turn helps make that trust justified. Equally though, when we withdraw trust we help bring about conditions in which trust would be ill advised.

What we all think and feel about our financial security will have important consequences over the next few months. If we mostly fear the future, stop spending, withdraw our savings from banks, this will be part of the process which makes our fears true. Likewise as businesses take a view on the future and take decisions about investment and disinvestment, new hiring and layoffs these decisions will have a part to play in bringing about the future market conditions which that view is based on.

The media have an important role to play creating this future; they are not just disinterested bystanders. Whether they like it or not, journalists are not just reporting a financial crisis, they are performing it.

For a detailed account of social amplification at work in relation to a wide range of public risks see here. [Please note this link is to a 2.63 MB pdf document which may take longer to download with some internet connections] 

A recent book examines the role of performativity in economies and financial markets: Do Economists Make Markets? By Donald A. MacKenzie, Fabian Muniesa and Lucia Siu published by Princeton University Press.

About the author

Mark Fenton-O'Creevy is Professor of Organisational Behaviour at the OU Business School. His research includes investigations into the performance of traders in financial markets, and the problems that occur when management practices are transferred from one country to another.

He is also a National Teaching Fellow, and Principal of the Centre for Practice-Based Professional Learning.

Subscribe to Mark Fenton-O'Creevy's posts

 

New York Stock Exchange.
[Photo: Helico used under a creative commons licence]

Emotion in financial markets is not all about fear and panic. We know for example that, on average, prices on the New York Stock Exchange are higher on sunny days than on cloudy days. Sunny weather tends to make us feel more optimistic and it turns out that professional traders are no exception.

Meanwhile recent work by Cambridge University neurologists John Coates and Joe Herbert has shown a significant link between traders behaviour and the levels of hormones, such as testosterone, which have important links to emotion.

This is all in complete contrast to financial economists accounts of market behaviour which see investor decisions as driven by rational analysis, and prices as perfectly reflecting rational analysis of all available information.

So should we simply conclude that traders need to get a better grip on their emotions, calm down and start making rational decisions on the basis of considered analysis? Certainly my own research (with colleagues Nigel Nicholson, Emma Soane and Paul Willman) shows that learning to regulate their emotions is an important part of traders learning as they gain experience. As one trader told us:-

“I would cite myself as a great example of someone who started trading when I was 18 and got terribly emotional about everything, every loss; and I’d lie awake at night and think everything through and try and replay the tape - I wish it happened a different way … Over time you realize that nothing matters and you not only realize that nothing matters in here, it doesn’t matter outside here either. It took me a long time to get that.” 

However our research, which involved detailed interviews with 118 traders and their managers, also seemed to suggest that learning effective emotion regulation is not simply learning to set feelings aside. In the fast paced world of trading, rapid decision-making is at a premium; and the emotional cues and hunches that come from long experience can be an important aid. Rather than emotionless machines, high performing traders were often aware of their emotions. They used them as important sources of information; but were not at their mercy. Our findings are supported by a recent study by Myeong Seo and Lisa Barrett (220K PDF) who found that stock investors who were better able to identify and distinguish among their current feelings outperformed other investors.

As we learn more about the ways in which human cognition and emotion are inseparably entangled it is becoming clear that emotional competence is not just important to our relationships, it is a vital element of success in the world of high finance.

If you are interested in learning more about decision-making, you can find a free course designed by this author on Openlearn: Making decisions. You can also find a free course which gives a financial economics perspective on markets: The financial markets context.

About the author

Mark Fenton-O'Creevy is Professor of Organisational Behaviour at the OU Business School. His research includes investigations into the performance of traders in financial markets, and the problems that occur when management practices are transferred from one country to another.

He is also a National Teaching Fellow, and Principal of the Centre for Practice-Based Professional Learning.

Subscribe to Mark Fenton-O'Creevy's posts

 

The great aids to idealization in love were present here: occasional observation of her from a distance, and the absence of social intercourse with her – visual familiarity, oral strangeness. The smaller human elements were kept out of sight; the pettinesses that enter so largely into all earthly living and doing were disguised by the accident of lover and loved-one not being on visiting terms; and there was hardly awakened a thought in Boldwood that sorry household realities appertained to her, or that she, like all others, had moments of commonplace, when to be least plainly seen was to be most prettily remembered.

Hardy gives us a picture of romantic idealisation; an important part of the process of falling in love. In the psychoanalytic view of love and infatuation, we are inclined to project on to others what we most desire in ourselves. We each foster within ourselves an idealised self and look to the other to complete what we lack. For this to happen, it helps that the other person fits our ideal in some sense. However, it also helps that we don’t see too much detail; thus the other person can become a blank slate on which we write our desires. Popular sayings and songs remind us of this:

‘Love is blind’,

‘When your heart’s on fire, you must realize, smoke gets in your eyes’ ,
‘You know it’s clear that I’ve been blind, I’ve been a fool’.

Internet communication, for many, provides the ideal conditions in which to fall in love. Just enough cues about the other person to hook into our desires, not enough information to shatter the romantic illusion. Candid self disclosure becomes common as it is the only means of getting to know each other and is protected by a degree of anonymity, but it is also easy to build a picture that the other wishes to see. Indeed, as I discussed in a recent column on the psychology of deception, the distancing provided by the internet can reduce the emotional costs of deceiving others. Many are attracted to the internet as a medium for relationships for just this reason – it provides the opportunity for emotional contact without personal risk or exposure.

Face-to-face relationships move from an initial encounter in a physical location and based on physical attractiveness, to the discovery of common interests and self-disclosure. Internet relationships proceed in the opposite direction – the physical encounter comes last. For some the transition from romantic idealisation to genuine attachment happens during the course of an internet romance. For others the fantasy becomes tempered with reality as they meet for the first time. For a few the relationship endures. For many the intense feelings of the online relationship evaporate when confronted with the detailed reality of their amorata.

Rosantonietta Scramaglia interviewed fifty people who had fallen in love on the internet. She describes what they told her about the positive and negative sides of the experience:

It creates ‘mystery’, ‘the unknown’, ‘the excitement of something you’ve never experienced before’, ‘it lets you dream’. It is ‘more fun because you can discover the other person gradually’. People feel ‘the fascination of novelty’…

[but] a relationship can spring up which is, … ‘not as serious because it is easier to leave each other because you do not have to face the situation in person’, or ‘not as easy because you are going into it blind’, or a situation where ‘uncertainty’ prevails, where it is ‘impossible to be sure that the other person is really sincere’, where you have to have a blind faith in what you are told, and you risk meeting the wrong kind of people or being taken for a ride’. And, confronted with these unknowns, ‘the worse thing is that you get your expectations up’, and tend to ‘idealize the partner more’.

An increasing number of online services exist to provide opportunities for online romance. A Google search identifies nearly 8.6 million references on the net to ‘online dating’. As we have seen the internet is a medium which provides mystery and distance. As Thomas Hardy shows us, these provide a fertile medium in which love can flourish.

Is internet romance here to stay? I think I can confidently predict that it will continue to grow and make a few entrepreneurs, who have captured the right mix of mystery, distance and intimacy, very rich indeed.

Further reading

• The dating game – are you loyal? The competition among advertisers for our consumer fidelity is fierce.

About the author

Mark Fenton-O'Creevy is Professor of Organisational Behaviour at the OU Business School. His research includes investigations into the performance of traders in financial markets, and the problems that occur when management practices are transferred from one country to another.

He is also a National Teaching Fellow, and Principal of the Centre for Practice-Based Professional Learning.

Subscribe to Mark Fenton-O'Creevy's posts

 

Why the massive surge in telephone fraud?

Fraud requires a supply of victims, weak safeguards and motivated crooks. Changes in technology have increased access to potential victims. It’s relatively cheap and easy to set up machines to communicate with people. It’s also possible to obscure the trail back to the fraudster. The widespread use of electronic money exchange (online banking, credit card use, etc) also makes it easier – by making it easy for us to part with our cash. Safeguards are poor; law enforcement has struggled to keep up with these new forms of fraud.

However, I don’t think the availability of new means of fraud, alone, is sufficient to explain why there is so much fraud going on. An important aspect of the recent surge in telephone and internet crime seems to be the seemingly endless supply of fraudsters.

Successful fraud requires both a set of skills and a willingness to deliberately target and deceive others. The most successful fraudsters have a capacity to look us in the eye, to engage our trust and then betray it without a qualm. This capacity is actually quite rare and often associated with personality disorder (or perhaps politicians?!).

Typically, those committing fraud use psychological strategies to distance themselves from any sense of guilt. Criminologists refer to this as ‘neutralisation’. A common form of neutralisation is to view the victim as in some way to blame – “He had it coming; I couldn’t have taken him in if he wasn’t so greedy”. Another is to depersonalise or belittle the victim – for example the recently prosecuted perpetrators of a series of frauds on Ebay, referred to their 3,000 victims as ‘the idiots’. However, for most people, such attitudes are difficult to maintain in the face of personal contact with an intended victim.

By contrast, telephone or internet fraud guarantees a psychological distance between fraudster and victim. The technology already provides a significant amount of depersonalisation: a ready-made neutralisation strategy. Thus, people who would find the emotional costs of face-to-face fraud too high are much more able and willing to engage in remote fraud.

Why are we so easy to fool?

When we fall victim to fraud, or the more legal but related forms of advertising and marketing manipulation, we often assist in our own deception. Effective fraudsters don’t try to fill out all the gaps in a story. Like professional magicians, they know that manipulating us to reach a conclusion for ourselves is more powerful than making a direct statement. We’ll fill in the gaps in story for ourselves given the right motivation; and they know that greed and fear are both powerful motivators that they can easily manipulate.

If we believe someone can enrich us, or we think they can prevent something we dread, we want to believe them and will often explain away any holes in their story for ourselves.

Once we have become victims of deception, another factor comes into play. Fraud is often under-reported. For most of us, self-esteem is important; and we, often quite unconsciously, look for ways to protect it. For this reason, we tend to pay more attention to information that builds our own self-esteem than information that threatens it. So, many of us are quite reluctant to accept that we are victims and are even more reluctant to tell others.

Intelligence and education are not a protection here. Indeed, there is some evidence that highly educated people are easier to fool, because they don’t expect to be fooled.

There are important parallels between the traits that make many of us easily deceived by fraud and those that make traders in financial markets easily deceived by market movements. In my own research on the behaviour of traders in investment banks, I found these well educated, intelligent and highly trained professionals to be often prone to illusions about the extent to which they were in control and able to make unbiased financial judgements.

Fear, greed and the need to maintain self-esteem may make many of us more easily trapped by a telephone scam, but they also account for some major mishaps in financial markets.

Protecting yourself from fraud

So if the world is full of fraud and human psychology disposes us to be dupes, how can we protect ourselves? There is no foolproof solution, but some simple rules may help: 

• If it seems too good to be true, it probably is.
• If a person, or organisation, starts to play on your fears it may be that person or organisation that you should fear.
• If you are fooled, it does not mean you are an idiot. You are in good company. Do take the time to report the scam.

Further reading

• The psychology of decision making – the same thinking processes that help you cope with everyday life prejudice your judgements in other areas
• The Psychology of Fraud by Grace Duffield and Peter Grabosky, pubilshed by the Australian Institute of Criminology
• Introduction: Traders, markets and social science by M P Fenton-O'Creevy, N Nicholson, E Soane and P William, published by Oxford University Press
• Trio jailed for £300,000 fraud on eBay 'idiots' by Audrey Gillan and Bobbie Johnson in The Guardian (29 October 05)
• 'The Psychology of Deception' by R Hyman in Annual Review of Psychology
• The American Confidence Man by R Hyman and Charles C Thomas

About the author

Mark Fenton-O'Creevy is Professor of Organisational Behaviour at the OU Business School. His research includes investigations into the performance of traders in financial markets, and the problems that occur when management practices are transferred from one country to another.

He is also a National Teaching Fellow, and Principal of the Centre for Practice-Based Professional Learning.

Subscribe to Mark Fenton-O'Creevy's posts