John Dickhaut, a prominent Chapman University economist, will inaugurate the school’s Lectio Magistralis lecture series on Thursday. Nov. 20 with a talk titled, “Bad Guys and Good Guys: Reputation and Counting is What Makes Modern Economics Work.” The free lecture begins in Memorial Hall at 7 p.m. Dickhaut, co-founder of Chapman’s Economic Sciences Institute, recently fielded a series of questions that focus on greed, trust and the state of Wall Street.
Question: Bad guys and good guys. Is it as black and white as that? Are people one way or the other? I’m specifically talking about people working on Wall Street and in our financial sectors.
Answer: Here bad and greedy are synonomous, and good and trustworthy are synonomous. If I invest a specific amount in a project and the money triples the person who takes all of it and leaves nothing for me is greedy and the person who sends back 1/2 is trustworthy.
In my research I can and do isolate relative trustworthiness and relative greed. What I find is that even the greedy in the right circumstances chose to look trustworthy. Society, if its institutions are working, is often designed so that it is the interest of the greedy to act in a trustworthy manner. In a legal environment this means that because there are laws some people who would otherwise break them follow the laws. Many behaviors in economic environments can be greedy and are not illegal but the conventions of conducting business generally have served to discipline the greedy. Currently there appears to be some failure.
Q: You’ve said that “reputation and counting is what makes modern economics work.” How can an average person — or an average investor — evaluate anything that’s being said by Wall Street? Many highly reputable companies and individuals have fallen. People are wondering whom to trust.
A: The average person in my mind needs to put the phrase “Fool me once shame on you, fool me twice shame on me” to test. It seems an average citizen wants to ask questions like, “Do we want to cover mortgages that possibly should not have been made in the first place? Do we want to bail out banks who knowingly accepted bad loans and failed to exercise due care? Do we hope to improve regulation in institutions who systematically avoided old regulations that seem to have been well thought out through historical precedent? Do we want to empower financial advisors who impugned the behavior of those who seemed to have seen the financial disaster coming?
I think that many citizens sense what seem to be inconsistencies and should point to and ask of their congressman, newspapers and others why should one trust. More than asking whom to trust it may be most important to ask what approach are you taking to the problems that should lead one to trust you. It seems to me these questions needed to be asked all the time.
Q: Do you think that the average consumer is so frustrated and angry that they’ll tune out such messages? I mean, the Wall Street Journal is carrying headlines that say that Treasury Secretary Paulson has decided to pursue an entirely different strategy with the $700 billion rescue package. Doesn’t that build distrust for government and financial institutions?
A: My guess is that tuning out will only make an individual persons problems worse. It appears from the last 10 years that the number of major unexpected phenomena affecting all of us will not decrease. What kind of people do we think will survive in the next decades. I think it will be those who can better assess and appreciate the uncertainty that is there.
In my opinion the major benefit from the current debacle may be that we as a people eventually do a better job of living with that uncertainty. Part of the current uncertainty is that the people in charge may simply not be very sure of what is going to happen with respect to any plan. Paulson for one,
the current and next President for others. The record also suggests major financial figureheads such as Alan Greenspan were living in a world of immense uncertainty yet did not really come across that way. We live in a world where most professionals palliate us with respect to risk in the environment be they doctors, lawyers, politicians, etc. Gerd Gigerenzer has argued that we as people as well as our statesman will be much better off if we learn to speak in the language of uncertainty, including statistics.
Q: Can we apply technology to determine who has been cheating the public? If so, how?
A: We may never know who has been really cheating the public but the important
issue is can we protect against future instances of this problem. In my opinion we can apply even old conventions that helped us deter people fromcheating through history.
Q: How can this be done?
A: Well my favorite example of what has been disgraced and what has been so useful over a number of years is accounting systems. Today those people who teach and study accounting have only a vague understanding of why accounting exists and what makes it work. One looks at the simple avoidance of basic recordkeeping and the attempts to undermine the basic operations of internal accounting systems that permeate the current scandal and it is not clear to what degree the zealous pursuit of the subprime mortgage could not have been at least partially avoided if the accounting functions had not been undermined.
There is an interesting issue relative to accounting. When it works best there are relatively few scandals. Thus with the exception of Enron and WorldComm the world was going along rather smoothly relative to big collapses and that is I believe because the accounting systems provided adequate controls.
But accounting is like a police force. For police forces if there are no crimes some people argue for reducing the police force. What is not realized is that the size of the police force may be why there is no crime. In the current financial crisis there was encouragement by major financial figures to reduce credit standards, creditors chose not to collect income information ( or faulty information) and internal control systems for assessing risks were dismantled in major firms where the crisis ensued. These relaxiations probably seemed somewhat innoucuous in light of the previous successes of the economy. It seems to me mark to market accounting is a similar relaxation of accounting control.
Besides appreciating more what we had in the past, there are of course new issues. Today a person can make enough money in one or two years in some companies to have the highest imaginable standard of living indefinitely. Some of these people just might be greedy and could care
less about ruining a firm. How to effectively deal with such huge incomes in such a way that the greedy will not exploit the opportunities is a challenge that requires some new theory andundoubtedly some experimental testing.
What is appealing to me is that technologies are developing to study such issues empirically. There is a huge need and value to research these issue.
Q: Which technologies?
A: Well I am a member of a set researchers whose role is to build laboratory versions of economies and see what makes them work and not work. People trade in real money in these laboratories. My colleagues Vernon Smith, Steve Rassenti, Dave Porter and Bart WIlson study fascinating phenomena including whether it is possible to create stock market bubbles in the laboratory, what is the best type of auction to run depending on the types of assets being sold, under what conditions will members of an economy create an appropriate level of property rights to make the economy viable.
Recently because of the financial debacle I and Steve Gjerstad, a visiting scholar at Chapman, have begun to ask under what conditions can we produce a financial crisis in the laboratory based on the introduction of lending intruments(including derivatives). It is our belief that by beginning to really go after such questions in the laboratory it might help us avoid additional 700 billion dollar experiments down the road.
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