It appears that the free market is a confidence game, and that when confidence falters, chaos can run wild. So here is the view of one confident chaopsychologist...
Carlin Flora, Senior Editor at Psychology Today, sent out the following message last week to spark some content from bloggers on the psychology of the economic bailout. She wrote:
Sen. Charles Schumer (D., N.Y.), chairman of the Joint Economic Committee, opened the questioning at today's hearing asking Mr. Bernanke why a smaller authorization - perhaps $150 billion - wouldn't be enough to start. Installments would ensure that taxpayers' interests are protected and allow officials to evaluate the success of whatever program is used to buy mortgage assets. "This is just an idea, one of many that we in Congress are considering as we try to responsibly respond to this dire situation," Mr. Schumer explained.
"Probably $1 trillion would be better than $700 billion," he said. "Do you think that $150 billion is insufficient to assure the markets that Congress is serious and the government is serious about addressing this problem?"
Mr. Bernanke noted that he isn't part of the legislative or executive branches, and therefore has "no standing to negotiate this proposal." (Mr. Paulson wasn't at the committee hearing but is scheduled to testify Wednesday afternoon before the House.) But Mr. Schumer wanted the perspective from Mr. Bernanke, the economist.
"Senator, you asked me my opinion as an economist," Mr. Bernanke replied. "Unfortunately, this is a matter for psychology."
The key issue, Mr. Bernanke explained, is that "markets need to have confidence" the problem will be addressed. The government is essentially sending a signal to financial markets. An insufficient amount could be seen as "dribs and drabs" to solve the issue, he said. "It is a very big problem and we don't want to undershoot it." [endquote]
I am not an expert on economics, far from it. But I do know a bit about how complex adaptive systems work [see my blogs on "Batman Parts I to III"], and the economic markets are indeed complex adaptive systems [see Barkley Rosser's home page for research applying chaos and related theories to economics http://cob.jmu.edu/rosserjb/]. And confidence is one of the most useful and best understood concepts in psychology.
I'll start with the issue of confidence, because that's where I am most confident (get it? ha ha ha, I'm also apparently very funny). Okay, back to work: Albert Bandura has led research into confidence (technical term is "self-efficacy;" for about 30 years now. The central work in this area was based on building confidence in snake phobics, exposing these individuals to Boa Constrictors and assessing which factors most successfully predict their ability to eventually face or handle these snakes. Bandura's primary result was that confidence beliefs predicted success more strongly than any other factor studied, even past success. So belief is crucial, at the level of the individual, and apparently at the larger scale of this complex network - the collective confidence of people in the markets. In other words, the confidence of individuals is critical, as collectively this confidence emerges at the much larger scale of collective behavior within the economy. Confidence is contagious among individuals, as is chaos and panic. The recent fatal run on withdrawals from Washington Mutual is a clear example. The confidence of the part, the individual, is critical for understanding the confidence of the whole, the collective behavior of the markets and the banks. The reverse is true as well. My inclination to pull out of my 401K, to buy gold and bury it in the back yard will combine with that inclination of others as the market drops in day-to-day 10% chunks, and the value of gold puffs up. And these figures serve to feed the catastrophic collapse and ensuing chaos.
So confidence is key. But what will build confidence? Unfortunately, the best confidence builder is prior success. Our minds are practical in that sense. You can't just pump something up when true talent is lacking, there will be an eventual crash. This is the confidence game that was going on with Wall Street, where things were going up in the short-term, building false confidence. But the gains were built upon nothing, no substance. The market was running around in a manic episode, like someone who jumps out a window and thinks he can fly because he feels the wind in his face. Too much confidence can be dangerous.
So unfortunately, the economy and the government have not been too successful lately. You have probably noticed this! Essentially, organisms learn confidence by observing themselves doing well. Through observational learning you see yourself doing well, which builds confidence: Simple as that. If we see things going well in the economy, we will act collectively in a confident manner, and the feedback from the markets, at the larger scale, will inform us that things are getting better.
But the reverse is true as well. And gains made across the backdrop of market volatility will tend to have little power to build true confidence. And reassurance that our leaders will act swiftly to fix things will do little either, even from our great and highly esteemed president (see - I told you I was funny).
You can't just build self-esteem or confidence through will power or cajoling or a massive bailout alone. Things need to genuinely go well, little by little, and we need to notice it. That's it.
Now even though our government and markets have not done "good" lately, it may help a bit that we have survived several recessions and one great depression in the past. These prior survivals may calm the nerves a bit. Former US President, Bill Clinton, on Sunday's meet the press responded with this type of confidence, suggesting that if we can make it out of this crisis we will be on a good path, having relearned some essential lessons concerning the need for regulation: "[when we are through this] you're not gonna have these crazy binges of sub-sub-prime mortgages or derivatives because people now recognize all over again what they had to learn in the depression and two or three times since, that markets that are left unaccountable, at the margins, will self destruct, they will cannibalize themselves, so I think we've learned that." Ironically, Clinton helped to ring the dinner bell when he finished Reagan's work in repealing the last of the post-depression financial regulations.
Nevertheless, by likening the global economic system to an individual human system, Clinton may be describing the type of resiliency that comes following recovery from self-destruction. Surviving a trauma can build very deep confidence indeed, as well as the coping skills that will support that confidence. Clinton was suggesting the optimistic view that we have been through similar problems before and that we will likely evolve some new coping skills: new regulatory policies and business practices.
On the negative, a number of other factors could interfere with this type of growth and confidence as well. For example if you observe yourself doing "good," but you are doing so under special circumstances, if the good is not attributable to "you" you can be left less confident, even if the outcome is success. A good example comes from research into childhood attachment. Within "attachment theory" the goal of parenting is essentially to be attuned to a child's needs for comfort and security on the one hand, and the ability to build competence and self-confidence on the other. If you over-support a child, you erode confidence.
I asked a very well-informed cabbie the other day for his opinion, and he likened it to healing from a back injury - ‘If you leave a brace on too long, your back ends up getting weak, and things get worse.'
Support back to health should be just enough to allow the system to re-organize, evolve, and heal, and nothing more. No you don't want to "undershoot it" as Mr. Bernanke has cautioned, but you don't want to overshoot it either. There are perils on both sides, under support could allow the system to fall apart into chaos, and over-support will maintain the rigidity and fragility of the system.
