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Archive for November, 2008
By Richard Thaler and Cass Sunstein
(Originally published in the Financial Times, November 11, 2008, under the headline “Human frailty caused this crisis”.)
Mea culpas are rare these days. In a debate with John Kerry in 2004, President George W. Bush famously could not name a single mistake he had made in his first term. So it is both noteworthy and commendable that Alan Greenspan, the former US Federal Reserve chairman, fessed up that he had failed to anticipate the financial crisis.
“Those of us who have looked to the self-interest of lending institutions to protect shareholders’ equity (myself especially) are in a state of shocked disbelief,” he said. Mr Greenspan had faith that banks were prudent enough to make sure they were not lending money cheaply to people who could not pay it back. Yet that is what happened. As Mr Greenspan says of securities based on subprime mortgages: “To the most sophisticated investors in the world, they were wrongly viewed as a ‘steal’.”
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DANIEL KAHNEMAN:You call and ask people ahead of time, “Will you vote?”. That’s all. “Do you intend to vote?”. That increases voting participation substantially, and you can measure it. It’s a completely trivial manipulation, but saying ‘Yes’ to a stranger, “I will vote” …
NATHAN MYHRVOLD: But to Elon’s point, suppose you had the choice of calling up and saying, “Are you going to vote?”, so you prime them to vote, versus exhorting them to vote.
KAHNEMAN: The prime could very well work better than the exhortation because exhortation is going to induce resistance, whereas the prime‚ the mild embarrassment causes you to make what feels like a commitment, and the commitment, if it’s sufficiently precise, is going to have an effect on behavior.
RICHARD THALER: If you ask them when they’re going to vote, and how they’re going to get there, that increases voting.
KAHNEMAN: And where.
From the transcript of a conversation featuring Daniel Kahneman on “Two Big Things Happening in Psychology Today.”
Credit card minimum payment amounts have an anchoring effect on many consumers’ repayment schedules. According to Neil Stewart of the University of Warwick, if you don’t pay the full amount every month or always pay just the minimum, your repayment level is correlated with your card’s minimum payment. Interestingly, among partial payers, the mere presence of repayment actually decreased the amount sent in to credit card companies (among those who pay their entire bill each month, there was no relationship). According to Stewart’s research, which relied on observational data and an experiment that manipulated minimum payment information, about one-third of consumers may fall into this partial-payer category.
These results should be of real concern to credit card companies. Virtually all credit card statements include minimum payments. But this consumer safeguard has an unexpected negative consequence: Minimum payments distort the behaviour of many customers in a way that increases interest charges and increases the duration of their debt. Those paying off the balance in full each month seem to be immune, but anyone repaying only part of the debt is at risk―not just those making only the minimum payment.
According to Stewart’s calculations, a 2 percent reduction of minimum payments on a 20 percent APR card with a $4,000 balance quadruples interest charges. Stewart’s suggestion is the inclusion of a table of repayment scenarios with each bill. A more paternalistic policy implication of this research is to raise minimum payment rates on all credit cards, which the U.S. government pressured banks to do back in 2005. The increase from 2 percent to 3 or 4 percent (depending on the person and the card) caused some short-term pain. According to the latest numbers, though, there’s still plenty of pain to come.
A copy of the paper is available by request at Stewart’s web page.
Addendum: From the Economist:
Economists will be interested in the results. Behavioural economists advocate “nudging” people in the right direction by subtly altering the choices that they are presented with. The insistence on minimum payments is a variation on this theme. Supposedly, those confronted by minimum-payment requirements should pay at least that much. In fact Mr Stewart’s work suggests that people who would have paid a lot, paid less. In economics, as in life, nudging needs to be done carefully.
If you start thinking about (humans) faulty perceptions, the first thing you realize is that markets are not perfectly efficient, people are not always good guardians of their own self-interest and there might be limited circumstances when government could usefully slant the decision-making architecture (see “Nudge” by Thaler and Cass Sunstein for proposals).
From The Behavioral Revolution by David Brooks, who tempers his initial enthusiasm by claiming that “government officials are probably going to be even worse perceivers of reality than private business types.” Nudging, as we have argued, is not the exclusive purview of policymakers. It is for CEOs, social entreprenuers, doctors, parents, and anyone who is responsible for structuring the context of choices for other people.