Nice little piece on the bubbliness of the art market recently. (Hat tip--er . . . one of the many blogs I read. It's been that kind of a morning). For some reason, it puts me strongly in mind of the book I've been reading: The Billionaire's Vinegar by Benjamin Wallace. Perhaps because both involve rich people spending outrageous sums of money on something that we proles will never get close to.
The book--which I highly recommend, as it's gripping--involves possibly the most elaborate hoax pulled before Bernie Madoff became a household name, the counterfeiting of bottles of old wine allegedly from Thomas Jefferson's Paris cellars. The way Wallace tells it, you can't help but notice the fraud--and wonder how everyone else didn't. One guy makes all of these amazing finds of hidden oenological gems, but no one wonders how come Christies or Sotheby's never managed to beat him to the punch? Why didn't people realize it was too good to be true?
Because success is self-reinforcing. If you believed the first eight amazing finds, the fact that Rodenstock had found the ninth actually made it more believable that the find was real. After all, it was Rodenstock.
It's easy, in hindsight, to see that we should have stuck with the tried-and-true wisdom; but there's a reason that evolution has trained people to overweight recent experience. If you didn't, you'd be in big trouble when the situation changed. And the situation did change. There were genuine hoardes of old wines found before the Rodenstock frauds by a few amazing wine conoisseurs who specialized in unearthing them; Broadbent of Christies was the genuine article.
Similarly, housing markets really did change, thanks to things like zoning and environmental regulations that dramatically slowed the pace and scope of new development on the coasts. Credit brokers really did get better at assessing credit risk. it's just that housing didn't get as difficult to build, or credit risk as easy to assess, as recent experience showed.
Because we overweight recent experience, we overshoot on the bubbles. But if we didn't overweight recent experience at all, it would take us 100 years to notice that FICO scores were pretty good--or that many treasured innovations in liberal governance hadn't actually caused society to implode.
Is there some way to make us weight only, always, the right things, to never go too far in rewriting what we know about the world? Somehow, I doubt it.
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Is there some way to make us weight only, always, the right things, to never go too far in rewriting what we know about the world?
Just ask yourself "What would Mr. Spock do?"
I have a basic rule - 'Cooperate, trust and verify'. People in markets often seem to go light on the cooperation and verification, and long on the trust. That could be what Madoff exploited.
Verification is not mainly about finding the frauds and deceits; its principal role is to reduce misunderstandings. It therefore serves to give a perspective on the recent fact or factoid versus the wisdom of the ages. It also tends to reduce one's confidemce in one's latest generalisation, to similar effect.
Experience has convinced me that this is a damned good rule. I only wish I kept to it.
The Mark Hofmann affair that the Mormon Church went through back in the 80s is similar to this. Hofmann was a dealer in rare documents who had an amazing and uncanny ability to dig up various and sundry documents relating to the early history of the Mormon church. Hofmann dug up documents that had hitherto been nothing more than legends and which other dealers and collectors had searched for for decades. Of course it turned out that Hofmann was forging, quite brilliantly, all of the documents he found and when he finally realized that he was about to get caught he murdered two people with letter bombs in an attempt to divert attention from himself.
Steve Naifeh's book about Hofmann, "The Mormon Murders" describes the mindset of the collectors and of the Mormon elders who purchased the documents that Hofmann found. Once Hofmann had successfully sold one set of forged documents he established a track record, and with that track record found it easier and easier to make successive sales of his forgeries. Later, after Hofmann was arrested and the truth came out everyone realized that Hofmann was too good to be true and that the chances that a 20 something dealer in rare documents would have been able to find documents that more experienced collectors and dealers had hitherto been unable to find was completely improbable.
Megan,
Okay, you are going to laugh, because my engineering nerd-credentials are showing a little here. But perhaps a way that is very cool, in a cross-discipline sort of way.
What you describe has a analog in basic control theory. Controls which are sensitive to deviation tend to over-shoot. Controls which resist over-shoot are slow to respond. But, the good news is it is possible to tune most controllers to have "critical dampening", so that there is a optimal approach to the "set point", with minimal oscillation around it. These oscillations are the boom/bust cycle we are familiar with.
One very common control is a PID control, standing for for proportional/derivative/integral. If you are interested in more, you can look it up :) I won't bore you with the math.
But, there are tools to measure the "response" of the system, and tune the variables to a optimal. I have no idea if these methods have been applied to social sciences. I have no idea if the response of the system is constant. It very well could be, if it has a neurological/biological basis.
Food for thought!
- Jay
"Because we overweight recent experience, we overshoot on the bubbles."
No, the constant "overshooting" on Wall Street's part is due to simple greed - & the knowledge that they won't ever be accountable for their folly, as history both past & present shows.
"housing markets really did change, thanks to things like zoning and environmental regulations that dramatically slowed the pace and scope of new development on the coasts. Credit brokers really did get better at assessing credit risk. it's just that housing didn't get as difficult to build, or credit risk as easy to assess"
Surely you jest. Risk ratings, like GNP or unemployment stats, have been wandering in the land of fantasy for many years now - numbers tweaked to suit the ends of people with enough money & clout to put their thumbs on the markets' scales.
A LOT of money had nowhere to go, until some geniuses came up with the brilliant idea of simply cancelling out credit risk, in order to make it possible for anyone with a pulse to qualify for a mortgage - at which point the floodgates opened & the housing boom was on. Throw in a labyrinth of financial entities designed to be literally too complex for any human mind to unravel, & you've got a guaranteed recipe for economic disaster.
Housing markets changed, again, due to greed & total disregard of already weak regulations, & credit brokers & insurers were more than happy to reel in anyone foolish enough to buy the "conventional wisdom" that the aptly-named bull market was immortal. The results are not trivial. There are bloody school-boards & town councils now going broke because they got suckered into putting public funds into the market - much like more than a few companies' pension funds ... & more than a few folks' life savings. Lives ruined by lies - while the liars collect fat bonuses (& presumably plot their next scam).
Such rank idiocy ought to be against the law, but never will be in a society that values profit over everything else.
"Is there some way to make us weight only, always, the right things, to never go too far in rewriting what we know about the world?"
Such a magical entity does indeed exist. It's called common sense, & sadly, it's rapidly becoming an oxymoron.