Sublime

What are the odds that people will make smart decisions about money if they don’t need to make smart decisions—if they can get rich making dumb decisions? The incentives on Wall Street were all wrong; they’re still all wrong.

foundations were laid in Victorian times. Now it is changing radically. Standard economics is suddenly being challenged by a number of new approaches: behavioral economics, neuroeconomics, new institutional economics. One of the new approaches came to life at the Santa Fe Institute: complexity economics.

“The answer as to why bubbles form,” Blodget told me, “is that it’s in everybody’s interest to keep markets going up.”

In complexity economics, agents differ and in general lack full knowledge of each other and of the situation they are in. Fundamental uncertainty is therefore the norm; ill-defined problems are the norm; and rationality is not necessarily well defined. Agents explore and learn and adapt and open to novel behavior. Outcomes may not be in equilibrium

The markets in the long run are no doubt driven by fundamental economic laws; if the United States runs a persistent trade deficit the dollar will eventually plummet. But in the short run money flows less rationally. Fear and, to a lesser extent, greed are what make money move.

Both are dynamic systems in which the selfish actions of countless individuals—whether they be cells or investors—lead to unpredictable consequences at the system level. In turn, these collective actions and consequences feed back to influence individual actions in endless cycles of adaptation and evolution.

Behavioral finance is the study of the way people consistently act against their own best financial interests, as well as how to exploit these psychological weaknesses when peddling questionable securities and products. These are proven behaviors with industry-accepted names like “money illusion bias,” “loss aversion theory,” “irrationality bias,”

Andrew Redleaf and Richard Vigilante write in Panic: The Betrayal of Capitalism by Wall Street and Washington, “The ideology of modern finance replaced the capitalist’s appreciation for free markets as a context for human creativity with the worship of efficient markets as substitutes for that creativity. The result was a divorce of entrepreneurial