Bailouts, Bad Guys and Behavioural Economics

We reported last week that the initial response to the Bailout that we could pick up, from the online zeitgeist, was the joy of the worthies who stood to benefit from it - but in very short order we could see a strong counter coming up (see our analysis over here.)

This is not an economics blog per se, but we do deal with behavioural psychology & economics, and game theory - mainly as it pertains to online business strategies and e-commerce - and we do believe that the Paulsen team are missing a big trick, as they have been ignoring the behavioural economics of the situation. Worse than that, they have done it in such a way that makes them come across as extremely arrogant and insensitive to the very people whose help they need.

Now in normal circumstances politicians, financiers and other worthies blithely ignore the Will of The People - its one of the reasons why people normally can't be *rsed to vote - but in an election year, with their seats not firmly attached to their bottoms, the politicians are more likely to actually listen to the Vox Populi. Timing, as they say, is everything.

Thus it is worth examining the behavioural economic mistakes here:

- Firstly, study after study has shown that people would prefer to take a loss themselves, rather than give a benefit to people they believe are cheats. Its a part of the way humans are socialised. And make no mistake, outside of Wall St, the bankers are seen as cheats, if not worse.

- Secondly, the original plan was presented initially in a way that was breathtakingly insensitive - almost designed to annoy the hand that was supposedly to feed. Essentially it came across as "hand over $5000 per taxpayer now, so we can pay off the very rich guys who f*cked up, and then leave them to sort this out (potentially to your detriment) - and you only have X hours to do so or else we're all doomed". Behavioural economics suggests we do not take kindly to perceived coercion. This, we suspect, only served to raise hackles farther and make people dig their heels in even more. Would you hand over your money in this way to anyone else?

- Thirdly, it was woefully short on detail, and thus perceived credibility - the message was essentially "trust us" - from the selfsame people who had just lost everyone's trust. There was little in terms of detail to make people feel comfortable that their interests were being looked after. This would not have been too bad (after all, they had very little time) if what detail that did emerge was on the side of the people - but their devilish plans, such as buying assets from banks at inflated prices, did not exactly inspire confidence. Again, it was almost designed to ensure people felt they were being sold a pup.

For these reasons, I believe that the actual initial bailout plan actually made the conditions worse, not better, for acceptance. (Update - these same points are made in this video from Yahoo Finance with Aaron Task & Henry Blodget - by the way, the sponsored Ad worked very well I thought)



If I were to hazard a guess, based on (my own interpretation and view) of what the behavioural economics tells us, then it would be that the successful bailout plan would now have to encompass something like this:

- More of the "cheats" will have to go to the wall. We suspect there is little appetite to give any money to banks while the perceived cheats are still running the joints, and certainly not at inflated values. In a nationalisation or bankruptcy the "bad guys" get visibly wiped out, and the assets get bought at lowest possible cost, so its hard to imagine why the public would support any other approach in preference.

- No taxation without representation - we suspect that the money will only be able to be handed over now if there is public oversight.

- Hand over the money in tranches - again, no one trusts the bankers, so they are likely to prefer a plan that hands things out in parcels, and sees how well it is used and what effect it has.

- There will probably have to be some guarantee of good treatment to those who fall into arrears - it is probably unclear to most people that, if the problem is with bad mortgages, then why doesnt Govt just directly guarantee the mortgages rather than pass the money through all the banks, with all the friction and "cheat rewarding" unfairness that it entails. And never mind the possibility that your taxes are saving the hides of the guys who will repossess your house - this just won't fly.

- Some form of promised retribution on the perpetrators - this will likely the the form of Enron style court cases, but we are also seeing an interesting meme emerging - one of forcing bankers who took large bonuses over the last few years to hand most of the money back (and given the composite size of all those bonuses over the last few years, its no surprise.)

- It will probably have to be "sold" to the people by someone other than the existing administration or Messrs Paulsen and Bernanke, I believe they are seen as being too involved in creating the problems to be credible, and that the misjudged presentation of the initial bailout has made that worse.

Also, removing the "you're doomed if we don't get $700bn in 24 hours" is probably a pre-requisite - the only people doomed in the very short term (next few weeks) are bad bankers, and people probably get that..... and, we suspect, want a bit more reasoned thinking before handing over the loot.

Punting a bit further, if I were to hazard a guess then the most trusted form of organisation to oversee the resolution of this mess would be one that was totally publicly accountable and overseen by elected representatives, and would have a strong "public good" element to it. This almost argues for a Publicly Owned Bank - like an old fashioned Building Society - to manage out the mortgages. In addition I suspect it would not be acceptable for it to pick up inflated assets this side of a Chapter 11 or bankruptcy.

Furthermore, I suspect the "Elliot Spitzer" lesson post dotcom bust has not been forgotten, and many a politically ambitious lawyer is sharpening the blades..... hang on for a whole new class of class action suits if it can be proved the bankers lied to their computers about risk

Update - I see there is a NYT article reflecting similar things, but imho not understanding the underlying behavioural psychology - and also drawing a parallel with the New Deal structures of the 1930's which in my view maps closely to the endgame structure I mooted above (props to Dave Winer for link, he has been one of A list tech guys onto this issue early)

Update 2 - it seems that those who voted against this are being castigated for actually listening to what their consituents wished for. I know it seems incredible that one should do this rather than follow the whip, but when you are facing your own re-election.... Democracy eh

Update 3 - was reading Ina Fried's article on Tech stocks taking a bath and came across this brilliant line from a broker interviewed:

Popular sentiment on Wall Street, he said, is that the government's inaction amounts to "rearranging the deck chairs on the Titanic."

In other words the bankers are still hoping to be first in the queue for lifeboats, and beggar the women and children - which is exactly the reason why Main St doesn't want to let them off the boat until it goes down.

Update 4 - interesting article on the scale of existing corporate bailouts in the US - the only difference here is the size and the public awareness just before an election.