Behavioral Finance

Bad Behaviorism

The once noble field of behavioral finance has taken a dire turn for the worse.

Academics are exceedingly good at two things: One, telling us what we ought to be doing; two, transforming fascinating subjects into potent insomnia cures.

And so, sitting in on a behavioral finance conference a few weeks ago, I must admit to dozing once or twice. It happened somewhere between the crash course in hedonomics, the study of happiness and economics (happiness at a finance seminar…the very idea!) and a forty minute presentation on the history of annuities.

In a moment of greater lucidity I witnessed an inexplicable, if not truly bizarre, presentation. It had a two pronged approach: First, to prove the US housing market was in a downturn. Simple enough. I could follow that logic. Secondly, to assert that—based on behavioral research—policy makers ought to force owners to hedge the value of their homes.


Never mind that housing prices have been rather docile over time and hardly justify the capital necessary to hedge. Never mind that nothing ever really stopped folks from hedging the value of their homes in the first place. None of that matters. Because the housing market is currently in a downturn and some are overextended and even face foreclosure, this is "undeniable" behavioral evidence we need to mandate an insurance system to make sure no one ever loses money on their home again.

This presenter was not alone. I slowly realized most presenters had a similar message: We need to tell people what to do because they aren't clever enough to choose optimally for themselves.

What's going on here?

Behaviorism (aka, "Behavioralism") used to be a beautiful thing. A few decades ago it was a burgeoning field of study, linking observations on human behavior to how markets and economies function—even if some conclusions were a tad obvious. (Did we really need a team of PhDs to tell us humans sometimes make bad decisions?) Behaviorists' major contribution was to revise economic theory to account for human bias and irrationality based on innate neural wiring. This replaced the traditional model of rational man (aka, "Homo Economicus"). Such findings are nothing to scoff at and today still have powerful implications.

But that golden era of discovery is over. New insights in the field have given way to proposals to engineer public policy or "nudge" (to use their term) the populace into certain behaviors. That's a shame. To pervert the objective study of human behavior into justification for ideology and new regulation is abhorrently contradictory to what real behaviorism ought to teach us.

A popular ethos today is to believe rational individuals must be the basis for a rational market; therefore, if we know people aren't rational then markets can't be either. In fact, just the opposite is true: it's the sum total of all irrational individuals that create a wiser market.

That we are imperfect is evidence that we should shun an elite central decision maker whenever possible. It's because folks are not rational that markets are a better way. Knowing we're all myopic and have a highly limited view of the world, any empowered elite group would surely and ultimately lead to inefficiency, if not ruin. And through history, it has.

Today's behaviorists casually eschew free market capitalism's demonstrated power to allocate capital where needed and create vast, interconnected wealth across populations. How many times must we bear witness to the constricting and suffocating grasp of socialism before we realize attempting to control people "for their own good" is not only a fool's errand, but immensely dangerous?

Though imperfect, truly free markets are a tumult of relentless competition. From markets all viewpoints are given voice—all possible permutations and innovations are tried until optimal solutions are brought to market (and duly rewarded). No one group, even one with the power of behavioral science on its side, could possibly ascend to such a feat.

In looking back on those presentations, I sense a strong (dare I say, innate) propensity for humans to tell other humans what to do. I'd humbly suggest the behaviorists endeavor to investigate that urge, and start with themselves as the test subjects. Until then, I might take another snooze.

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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.