Why We Can't Face Facts
When victims of Charles Ponzi's original scam were offered 30 cents on the dollar, many of them refused to turn over their original notes and get what they could. Though Ponzi was in jail, they still believed he would make good on his initial promise of 50% interest.
"That was probably not the first, and certainly not the last, example of what might be called ‘buyer's denial'," as The New York Times reporter Floyd Norris put it in his article on a more recent fraud. Investors in CMKM Diamonds are suing to recover an alleged $3.87 trillion in compensation they claim they are owed by the government. (See "Dealing With Fraud By Denial.")
The CMKM investors sound more than usually paranoid and grandiose. That puts them in a somewhat different category. But, still, why is denial so common and so powerful, especially when it comes to financial matters?
The Times quotes Dean G. Kilpatrick, director of the National Crime Victims Research and Treatment Center: denial "may be better than having to admit to yourself that it is over and you're never going to get your money back."
The study of consciousness offers a different explanation. It's not about the reluctance to accept loss so much as the difficulty of acknowledging the mistake. A major function of the unconscious is to protect us from information damaging to self-esteem, and few things can be more humiliating than being suckered into losing your money, especially in a get-rich-quick scheme that defies common sense. Our consciousness invents alternative explanations, such as governmental conspiracy, as in the case of CMKM. The simplest response of all is denial: I didn't actually make the mistake.
In the wake of our recent credit disaster, economists are searching for better models to explain our economic behavior. It would be a shame if they failed to take into account our unconscious tendencies to "fix" reality. Beyond or below the sight-lines of "behavioral economics" lie deeper and more powerful motivations.