The financial markets continue to slide. When the economic crisis first became evident in the Spring, Congress decided to act with a stimulus package in which they gave many families a $400 refund on their taxes. Now, for some families, that $400 meant that they could pay off bills and buy more food to feed their families. But Congress expected that many other families would spend this money on items that were not necessities. Indeed, at the time, my mailbox was inundated with ads from big box retailers suggesting ways that people could spend their stimulus checks.
In this case, people's behavior reflects the same tradeoff between short-term and long-term goals that I discussed in earlier entries about drug use. People are designed to live in the present. Short-term wants, needs, and desires have a strong draw on our behavior. Often, we know the right thing to do conceptually, but have a hard time doing it.
Nira Liberman, Yaakov Trope and their colleagues have done work on what they call temporal construal. The basic idea of this theory is that people represent the present very concretely, and the future more abstractly. So, imagine the case where you are getting by economically. You pay your housing each month, and can feed your family. But there are economic hard times on the horizon. Now, the government comes along and gives you $400. It is easy to envision something like a new blu-ray player hooked to your new television. But, when you think about what your finances will be in six months, it feels only very general. It is hard to put yourself in the mindset that in 6 months, you might need that $400 to help feed your family. The next thing you know, you have a new blu-ray player.
A similar psychological mechanism influenced people's decisions to take on mortgages that they cannot afford. When you start the home-buying process, you often make a budget of what you think you can afford in house payments. But then, you start to look at houses. Suddenly, there it is, the dream home. The right number of bedrooms. A huge master bathroom with Jacuzzi tub and separate shower. Granite countertops in the kitchen. The neighborhood is good, and the schools are excellent. But the house is about $75,000 more than you wanted to spend. And the taxes in that school district are also higher. Then, the mortgage lender introduces you to new financing opportunities. How about an adjustable rate mortgage? For the first few years, you'll pay a low interest rate. Then, it will adjust to reflect current market conditions.
So, now you have the option to buy a specific house that fits your dreams of home ownership right now. Lurking in the distant future (years from now!) is the vague and abstract possibility that interest rates might go up and your payments will get more expensive. And so you find yourself signing the papers and buying the house. And all is well until it is time to adjust those mortgage rates, and suddenly a few years is not as long as it seemed like it would be.
It is really crucial to recognize that the people in this example have made a bad decision, but they have done it because of a fundamental aspect of the way human psychology is organized. We are designed to be drawn to tempting short-term options. We may "know" about the long-term dangers, but they do not exert much force on our current decisions.
After the collapse of the mortgage market, bankers argued that home buyers are as much to blame as bankers, because they made purchases that they must have known they could not afford. At some level, that is true. At the same time, bankers and realtors were taking advantage of the design of the cognitive system by making short term options too tempting to pass by. In the same way, the big box retailers were sending short-term temptations to people receiving economic stimulus checks in the Spring.
Unfortunately, in difficult economic times, we must find ways to take the long view of decisions. The future is uncertain right now. As tempting as it might be to make decisions based only on your current state, it is important to try to make concrete what the future would look like if things go badly. Think about how you would feel if you did not have enough money to make your house payment, your car payment, or to buy food for your family. Then, ask yourself whether the short-term purchase you are about to make is one that is worth doing in light of specific problems you may face in the future.
