Professor Richard Thaler: Masters in Business (Audio)

behavioral economics. When you look at his body of work, when you look at the impact he's had, Professor Taylor on the perennial shortlist for a Nobel Prize in Economics, what um I think you'll find so fascinating about him is not just that he's incredibly intelligence and unbelievably knowledgeable about how human behavior in the world of economics differs

so much from traditional economic theory. But you'll find he's somewhat uh, somewhat mischievous and and very amusing and not your typical dry academic and certainly not your typical dry economist. His background is is really the very very early days of behavioral economics. His early mentors were people like Danny Knoman and and a most diverse ky Uh. He's worked with Bob Schiller for many, many years, for twenty five years.

They've been co chairs of an nb E er UM panel on behavioral economics, and just anybody who's been pursuing this field is certainly familiar with his work, starting with UM. A lot of anomalies that he's identified in the world of economics, including his book The Winner's Curse from so

long ago. He did a book with Cass Sunstein Colts Nudge that's been very influential, and currently he's out promoting his latest book called Misbehaving, which really is a mix of his own autobiography, which of course paralleled the rise of behavioral economics over the past let's call it forty or fifty years, and a quick funny story. After we finished the interview, he had a head somewhere else downtown, and so I walked with him down to his hotel.

We walked down Lexington Avenue, and let me tell you, walking through the streets of Manhattan with Richard Taylor is really quite fascinating because there's a running commentary on everything that's going on, and and it's quite amusing and quite interesting. And he said something that was really has stayed with me.

It was very interesting. During the interview. You'll hear him discuss how traditional economic theory work works really well for the small, insignificant decisions we make over and over again. That we get good at what spaghetti source to buy in the supermarket, you know where to fill up our cars with gas, things like that that, let's be honest, in the scheme of things, are not very consequential. But he also talks about how the big decisions you make

in life you don't get to make that often. You don't get to be that good at making the decisions that really matter, You don't have a lot of experience with them. His examples were, you choose what field you go into where you work saving for retirement, who and how often you get married, who you're gonna marry too,

And I was who are gonna get married to? And how often you end up getting married or remarried, and and the big decisions, the ones that really impact your life, you do once or twice or maybe a handful of times. So you don't get a lot of experience, you don't get a lot of skill at it. It's something that you hopefully make a right decision, and if you don't, the consequences are really significant. And so as we're walking

down Lexington Avenue in New York City. I start talking about that, and I jokingly say to him, Hey, you know that thing about you know how many wives you have and the impact it has on on your life is is kind of interesting. My secret was to marry my second wife first. Just skip the whole first marriage, the whole disastrous first marriage, go right to the second marriage. And he laughed, and then he said something that has stayed with me since we did the interview. It's really very,

very interesting. He said, you can never be happier then your spouses. And look, we've all heard the expression happy wife, happy life, but stop and think of it in that sort of behavioral terms, that the ceiling on your own personal happiness is a function of whatever your spouses happiness is. And when you put it into that context, it certainly makes it clear that, hey, if you make your significant other happy, it's going to come back and ultimately raise

the ceiling for how happy you yourself can be. But lots of other comments and phrases like that, where he's just looking at it slightly a scan, slightly differently then you might consider, and it leads to a lot of insights. So I found him to be absolutely fascinating. I wish I could have kept him there for another hour. Um, without any further ado, here is my conversation with Professor Richard Taylor. This is Master's in Business with Barry Ridholts

on Bloomberg Radio. Once again, I have a fantastic and special guest. His name is Dr Richard Thaller. He has been called the father of behavioral finance. And I'm just gonna give a short version of your curriculum. Vite bachelor's degree from Case Western and then a master's and PhD from the University of Rochester. Dr Thaller is the author of over fifty published papers and notable numerous books, most notably The Winner's Curse, Nudge and Misbehaving for Fessa Faler.

Welcome to Bloomberg, Thanks Berry, happy to be here. I'm leaving out half of your CV, will save that for for for later. Tell us a little bit about your background. How did you find your way to academia. I went into academia because I didn't think I was suitable for anything else. That's literally true. My father was an actuary, and it was a great disappointment to him that I didn't follow into his footsteps. But I saw him. I

grew up in Jersey, worked at Prudential. I saw him taking the training every day and not for you, not for me, and I'm the world's were subordinate. So academia seemed like a good choice. And you know, I was kind of good in math and kind of good in economics, so I went into economics. So you start out as a was it a graduate school student at Stanford or right after being a graduate student? Uh? Yeah, after being graduate student and uh and teaching for a couple of

years is the Stanford episode. Um, you had some really influential mentors. Yeah. I I claimed to have discovered Daniel Kneman and Amos Tversky in the same sense in which Columbus discovered America. I mean it was here. Came to as a surprise to the people who were living here at the time. Yeah, so uh, Conlimen Diversky came to as a surprise to economists. So I claimed to be the first economists who have discovered them. And I had been interested in weird stuff. People do weird from the

perspective of economists. So economists have this creature they study that comes with the Latin term homo econonomicus. I just like calling them econs economic man, economic man, or we should say economic person. Come on, Barry, we have to be you know century. You work in academia, so you have to be more politically career. Yeah right, so economic person,

but I call him econs. And econs are as smart as the smartest economist, or possibly even as smart as the smartest economist thinks he is, which is much smarter, which is right, which is really really smart. Um. They have perfect willpower, never have to die because they weigh exactly the right amount. No hangovers, uh saving for retirement, piece of cake. They calculate how much they need, how much they're gonna earn on their investments, implement so needlessness.

Oh one other thing, they're jerks. So these uh rational economic man. Will you know I left my cell phone outside the door to charge. If an econ walked by, he would take it. He would take it. So so let me throw a quote of yours to put this succinctly. Conventional economics assumes that people are highly rational, in fact, superrational and unemotional. They could calculate like a computer and have no self control problems. So so how does this

manifest itself. This this obvious falsehood about the way humans behave. How does this manifest itself in terms of the way economics progresses. Well, take the problem of saving for retirement. It's one one of the biggest financial decisions that we have to make in our lifetime. One is how much education to get and what type, second is who to marry and how often, And the third is saving for retirement, throwing buying a house, and you pretty much have the

big ones. So you know, that's a piece of cake for econs. And it used to be a piece of cake for my father's generation because there were pensions and you would work at prudential for your life and then they would give you an annuity, and retiring was easy. You never had to think about anything. So then you know, we invent the four one K and now people have to figure out whether to join, how much to put in, how to invest it, and then how to draw it down,

which is very hard. And so the idea of this perfect per perfectly rational person making all the right choices, unemotionally, with good self control and perfectly calculated to their needs, that clearly doesn't exist. It clearly doesn't exist. And notice if the world was full of full of people like that. Then the four O one K is unambiguously a big improvement because it's portable and you can customize it, and we all know what's best for ourselves if we're econs.

The the the dal Bar numbers each year show that the average return over the course of thirty years has been about three for four O one K investors. Yeah, and they have a great tendency to buy high and sell low. They massively got out of equities, uh, starting in about two thousand six, and flows didn't turn positive until during which time the market had doubled. Why is it so challenging to get economists to actually understand people

don't behave this way in the real world. Well, let's just say that one of the things that you have trouble with is the economic concept of sunk costs. I was going through your list of mentors. Pretty much your early mentors are all almost all nobile laureates. I've been lucky. You know how to pick them. Yeah, you definitely know how to pick them. So before the break, we were discussing sunk costs, and I had asked you, why is it that economists just won't recognize some of the reality

of the way humans behave in the real world. And and your answer was My answer was, uh, you know, a bit cheeky as I tend to be, which is that economists teach people that they should ignore what they call sunk costs, meaning if that dessert doesn't taste very good, you should need it just because you paid twenty bucks for it. And economists have trouble following their own advice, and they had a lot invested in the rational economic model and weren't gonna give it up without a fight.

Isn't that the nature of so many ideologies that there's all this time and effort, there's this endownment effect that it's yours, you've done, You've done the work, you've done the heavy lifting. Very difficult to just oh this is wrong, let me move on and find a new philosophy. Yeah, that's true. And you know I often say that I don't think in forty years I've changed in anybody's mind. I disagree with that statement. I know you've said that, but you've actually changed a lot of people's If not

change their minds, certainly change their perspectives and enlighten them somewhat. Well, but not not economists. So, I mean, the field is growing, and uh, there are lots of great people in it, but they're young, and so my strategy from the beginning was corrupt the youth. Don't try to you know, there's this old line science much on funeral by funeral and funeral at a time, and uh, you know, there's no

point in trying to convince those guys. But young impressionable graduate students, you know, you can have your way with them. That's hilarious. So don't even bother convincing the old fogies. Just go right for the kids. Yeah, it's a it's a good long term strategy. Yeah, you know, I was playing a long game. You have good impulse control. I have to work on that. That's really interesting. So let's

move a little more specifically to the efficient market hypothesis. Um, you once said, I love I love a lot of your quotes. We don't want to throw away the efficient market hypothesis. We just don't want to believe it's true. Explain what you mean by that. Yeah, So all of behavioral economics and behavioral finance starts with rational models, and they give us a benchmark, and it really wouldn't really

be possible to do behavioral economics without that rational benchmark. So, you know, the official market hypothesis really has two components. One is that you can't beat the market, and the other is that prices are right, that asset prices are equal to their intrinsic value. Now, those are very useful starting points, no hypotheses, right, and the beauty is that they're testable and so over long periods of time. And yeah, well sometimes, like let's take the prices right. Here's an

amusing story. There's a closed and mutual fund, which, if listeners don't know, these are mutual funds that you have to buy and sell on exchanges, which means that their prices can deviate from the value of the assets they own, as opposed to traditional mutual funds where you can only sell at the end buy or sell at the end of the day, and it reflects a calculation of everything

that's held with that that bucket exactly. Now, the fact that the prices sometimes differ from the value of the assets is already embarrassing, but not as bad as the story. I'm gonna tell you. There's a small closed end fund that happens to have the ticker symbol. See you be a Cuba Yeah. Now, needless to say, they don't own any assets in Cuba because A it's against the law

and B there aren't any right. Nevertheless, and for years it was selling at about a fifteen percent discount to its event President Obama made his announcement of his intention to ease relations with Cuba, the Cuba Fund went to a seventy premium. The next day after the presidential announcement, it was up almost fifty. A week later it was up.

How inefficient is that? Not efficient? And you know efficient market defenders was like, oh, look, this is one little, tiny example, but there are hundreds of the right and we study these little examples. I call them the fruit flies of finance because no one can possibly defend this. It's still several months later, selling above really above net asset value here. But Jobo, we're opening relations with Cuba.

Why could you? Why are you so negative on a closed and fun called Cuba just because it does nothing whatsoever to do with Cuba? Yeah? Well, and noticed that they're they're holdings are public information. Yeah, and you can buy those stocks on your own for a hundred dollars. Why would you pay a hundred and forty that's unbelievable. Well, markets are not perfectly efficients, they're kind of sort of eventually will get around to it efficient. Well maybe maybe.

So here's what I would say. The part that you can't beat the market is approximately true. Some people can on rare occasion. Good luck picking them in advance. That's right. And look, I mean what we know is most active managers underperformed, and that's kind of the best evidence in favor of the efficient market hypothesis. And that's before fees, cost, taxes time. Yeah, it depends on how you do it, but there's certainly they're certainly not beating the market after fees.

But although it's the best evidence for the efficient market hypothesis, it's also the most evidence against because where is most of the money inactive funds? Yeah? Van Guard has grown a lot that exception. Yeah, and there's still a third of their three trillion dollars is still actively managed. So so I think it's approximately right, And listeners would be

well advised to just say I can't do it. Is it just inherent in human behavior that we're going to get booms and bus markets are gonna rally and crash, and that's just the way it's gonna be. I think we're subject to that risk, but I think there are things we could do to mitigate it. And let's talk a little bit about choice, architecture and nudge, which refers

obviously to the book you wrote with Cassnstein. Yes, so the idea of nudge is that because we're dealing with humans rather than e cons, they sometimes need help, and can we think of ways to help them that don't force anybody to do anything. So that was the conceit of the book. In other words, you're not mandating anything, do it, no bands, how much can you do with those restrictions, So you're just you're just kind of just kind of nudging is the right words, just kind of

nudging them into the right choice. There's an interesting little little bit of behavioral engineering, which is and I see it here in New York. I come up out of a subway to get to my office because it's the fastest way to get around town. And it's a double escalator. I mean, this thing just goes on forever, and about half the people stand on the escalator and half people walk. But sometimes you get people who don't understand the social norms and they stand on the left side instead of

standing on the right side. I'm in an airport or somewhere in maybe it was Brussels, and I see this escalator and on the right hand side are two ft on each step two to two. On the left hand side is alternates left and right. And it made it clear, oh, this is the walking half and that whole issue. You never ran into the person who don't understand the social etiquette. And if you're standing slow traffic moved to the right. It was amazing and it was so simple and very effective.

You know, people have lots of misconceptions about nudge. One is that it has to be sneaky. These notice these things are the opposite of right. Look. My favorite nudge, one that I claim has saved my life many times, is in London at street corners, there's a sign at your feet look right because the cars are coming from the wrong direction if you're from Europe or America, and so you know, many years of looking for cars coming from your left, all of a sudden boom, so you

know there's nothing sneaky about that. Nobody tells you you have to look at it, but several double decker busses haven't hit me because of that look right. So, you know, a couple of years ago, I wrote this thing for tourists coming to New York City, and one of the things was there are many one way streets, but the bicyclists don't have h any obligation apparently to follow that. So when you step off the curb, look left and

right to make sure you don't. And let me tell you how many times I've just missed the bicyclists because I happen to look right. It's the same, it's the same exact thing. So this really is kind of consistent with the philosophy at the University of Chicago, which is really known as a libertarian, a sort of right leaning philosophical um efficient market hypothesis place. Are you considered a bit of a heretic there because you really don't fit

the mold of of Chicago economists. I think heretic would be one of the more polite terms that I've been called. Uh, you know, we called our philosophy libertarian paternalism. Libertarian paternalism. The libertarians were mad that we stole their word, and everybody hates paternalists. They just think of paternalists as Ralph Nader. So, but what we've by libertarian, we use it as an adjective, and by paternalism we mean helping people achieve their goals,

like not getting run over by a bus. So if we can do that without forcing anybody to do anything, why wouldn't we known as the father of behavioral economics. I'm about halfway through the book and I found it to be both informative and amusing, which is an unusual combination. So let's talk a little bit about theory induced blindness. I know you're gonna be seeing your mentor um Daniel Kneman,

and you mentioned um. That's a quote of his. He called theory induced blindness the refusal to see facts when it disagrees with a theory or ideology. Some people call that cognitive dissidence. Is there any difference between No, I think I think this is a different concept. So the idea is that if you have a certain lens that you look at things through, then you're gonna see everything

to be consistent with your point of view. And so, you know, it's like people have various views about the economy from the left and from the right, and every you know, every time there's a bit of news, they'll find a way of interpreting that piece of news as

just confirming what they've always thought. Where I see that every day is the bullbear debate that takes place in the media and in print, And no matter what the data point is, the bulls who are long equities are gonna explain why this is good for the markets, and the bears just try out a counter argument, this is

proof that we're all going to die. It's amazing with the same data points, how people just focus on what justifies Now how much of that is selective perception and how much of that is just you know, we see that which agrees with us. The psychologist called this confirmation bias. Yes, so well, go out looking for evidence that supports our point of view. I mean, but but theory should show should be a hundred percent of trading at or pretty

close to intrinsic value. So the fact that you're finding one that's below one day and above that really shows that, hey, that theory is a little bit off. It's what we call an anomaly. Mental accounting. What is mental accounting? So mental accounting is the think of it as the financial accounting of people and economists tell us that money is fungible. If you want to impress people at a cocktail party, use fungible. It just means there's no aables. But of

course people put labels on stuff. You go to the casino, you can see this. A guy wins some money early in the even playing with house money exactly. That's the expression playing with the house money. What does that mean? The casino is called the house so it's like you're playing with their money. Well, suppose you won five dollars you put in your right pocket. You brought five hundred dollars to gamble, that's in your left pocket. Both of them will buy something pretty nice if you get home.

But the one the house money, easy come, easy go, and it's entertainment. You're you're just putting that in a different So you know, that sounds like small potatoes. But during the nine nineties technology, oh sure, during that boom, everybody thought they were playing with the house money. And four one K investors were just increasing and increasing their equity exposure. And at the time, I said, one of two things is true. Either they've understood that equities outperformed bonds,

or they think stock prices only go up. The only thing that will give us an answer is a crash. Fortunately, we got a crash, and we got an answer. You know, I've had this conversation with people that this was early in my career, and I remember getting the calls from people who were significantly older than me saying, hey, I got a ton of profits. I'm rolling a little money out into real estate. I'm picking up that vacation house, or I'm trading up to a bigger property. But they

were really the exception. You you it was rational, It made sense. I think most people wish they could go back and buy real estate. As that said, you really didn't see a whole lot of it. And anytime people sold, at least in the until two thousand, they seem to have regretted this LD decision. Yeah, because uh, you know, everything was upside down during that period. The most the

most value you know, puffetted poorly that period. All value investors were getting crushed and you had to just be patient. But meanwhile your neighbors were getting rich. It was hard to do so, so why do why is it this mental accounting? Why do we love bargains so much? You tell one of the anomaly stories about when J. C. Pennies de started to get rid of the fake prices with the artificial mark downs and just have one price and it was a disaster. People like deals, even if

they know it's nonsense. And you know, even rich guys like deals. You know, there are plenty of rich guys traveling in December to get their one k on, you know, to get more miles and um so totally hit the next break point and get all these three miles right. And you know you you go to Costco, the big discount retailer, you see a parking lot full of fancy

Mercedes SUVs. With my wife pointed out, we went to Target a few weekends ago and there is this Rolls Royce Wraith in the parking lot, which is a three hundred and fifty thousand dollar car at Target. I guess he needed a lot of talk. Yeah, yeah. I used to tease my father who was driving around in a fancy BMW looking for the cheapest price for gas, and I said, you know, Dad, how much gas are you using to find the cheapest price? But he had to

find the cheapest price. You had mentioned casinos earlier. Um Twain once called gambling a tax on the stupid. Do you agree or disagree with that? You know? I, um, I think it's mostly right. Um why do we Why do people love gambling? They like the thrill, you know. And there are some things like horse racing would be

unbelievably boring if you didn't have some action, right. And of course the betting is irrational because the rate of return is minus seventeen per twenty minutes, because that's the take, right, So, um, it's funny you say that. So I'm on a cruise with my my wife and we're walking through the casino to get to the other side of the ship, and we just walked by one of the tables and I noticed, because I have a bit of a I have a

head for math. I say to her, Notice that this pays two to one, but you have three chances to lose, and that pays three to one, and you have four chances to lose. And it was a roulette table, and I can look at all the odds. The odds are relatively bad relative to the risk. And she teaches fashion, illustration and design, so she's a visual person. And she says, I don't know about that, but they certainly seemed to be sweeping up a whole lot more chips than they're

handing out each each roll. And I'm like, oh, well, that's the other way to to look at it. And yet people sit at the tables and play for hours and hours. So I'll give you my favorite recent mental accounting story, which is, in the early days of the financial crisis, the price of gasoline fell. What did people do? Remember, everybody was belt tightening on all fronts except one. People

were splurging on premium gas. On premium gas, premium gas because they have a gas budget and they have been paying a hundred bucks a week to fill up the tank and now it was only fifty and they're thinking, oh, well gas, it's cheap, all right, I'll splurge on by premium Eber, what's on? What? What of the fact that unless you have an engine designed for premium gas, that extra octane just goes out the tailpod? You know, Uh, there's a lot of money left in the gas budget.

So so just by premium gas just for you know, it's completely stupid, but you know, what can you do? So let's talk a little bit about self control. That's another chapter in the book. That's another one of your favorite topics. People really seem to lack all manner of self control. How does that manifest itself economically? Well, you know, we talked about saving, not especially United States, not especially high savings rates. You know, we went through a decade

where we had negative saving rates. And you know, this is the place, the domain where behavior economists have had their biggest impact, and we've managed to change the way. Most four one K plans work with two small changes, but one automatic enrollment. So you start a new job at a company that has a four oh one K and you're automatically enrolled unless you doubt is. You have to fill out a form not to join. And that raised enrollment in the first year from about to huge

juge difference and a completely trivial change. And what was he in the last thirty seconds? What was the other? The other one is what I call save more tomorrow, which is get people to agree to increase their saving rates every time they get a raise, and that has an impact and therefore they're contributing more. We've been speaking with Professor Richard Taylor of the University of Chicago, author of the book Misbehaving Um The History and making of

behavioral economics. If you enjoy these conversations, be sure and check out our continuing chat, which you can find on Bloomberg dot com and on Apple iTunes. Check out my daily column on Bloomberg View dot com and follow me on Twitter at Ridholts. I'm Barry Ridholts. You've been listening to Masters in Business on Bloomberg Radio. Hi, this is Barry Ridhult. You're listening to Masters in Business on Bloomberg Radio.

This is our podcast portion where only you folks lucky enough to go to SoundCloud or Bloomberg dot com or iTunes. I don't have to tell you if you're listening to this, you already have found the podcast portion and we just kinda take our earpieces out and relax and have some fun. Um. I didn't get to mention. I'm some of your curriculum, Vita, And I know you said it's way too long, but you do something with Professor Bob Schiller that's kind of interesting.

You guys are the you're the co director of the Behavioral Economics Project at National Bureau of Economic Research. Um, Professor Schiller is your co director? Is that right? We've been doing this for I think over twenty five years. Really, So here's what I find fascinating, and there are amazing parallels. So Bob Schiller is also a behavioralist. He he thinks people make mistakes, markets get crazy, we have bubbles, we

have crashes. One of his very best friends is Warton Professor Jeremy Siegel couldn't be more opposite philosophically then than Professor Schiller. He stocks for the long run. Oh we can never you know, let's not worry about this. If you're thinking long term, you have to be long equities. Bob is you know things look a little pricey. Here's my Schiller cape. And then I look at you and you're at University of Chicago. You're the father of behavioral economics.

And your golf buddy is Eugene Fama, who couldn't be more opposite in terms of philosophy than you are. How did that relationship develop? You know, when I first arrived at the University of Chicago, UH, a reporter asked UH couple of distinguished financial economists why they had allowed this to happen. One I'll make you read the book to find out who said he didn't block it? Because each generation has to make their own mistakes. That's hilarious, A

very warm welcome to a new colleague. Jean said, Oh, we hired him because we wanted to be him. Um, we wanted him nearby so we could keep an eye on him. That's very funny. Also, yeah, so but a little nicer and a little tongue in cheeks, a little half joking exactly exactly. And uh, you know, Jean, what Jean says is and I agree with this that he and I agree about almost all the facts. We dis agree about the interpretations. Yeah, but you agree that there

are bubbles. He sort of has ducked that question. What's a bubble? What's a bubble? Right? Look, but what's his real objection is that we can't predict when a bubble is going to end, which is true. Okay, and you know, Bob has had a pretty good run of love with it. No, no, you know, look, Bob is my buddy for twenty five years. But he was warning when did he give the speech to Alan Greenspan four years early? But he wasn't saying

it's a bubble get out. He was saying, hey, things have gone well, you know, but kind of what we've been here in the past few years. Yeah, but like you know, he was, his hair was on fire. And you know two thousand you know, so um and my selective perception and confirmation biases that I only saw the two thousand one and the norther earlier, but I do remember the he's the one who planted a rational zuberance and exactly and then and then Greenspan gave him that phrase,

which Bob never used. Um and and he turned it into a best selling book, which happened to come out in two thousand, which was lucky, good timing, good timing. Well, he was pretty dead on with the housing again, you know. Again, he started warning that house prices are looking pretty scary, especially in places like Vegas and Scottsdale. But they kept going up for a couple more years. So so jeans right that calling tops and bottoms. There's nobody who's good

at that. And now I think it was pretty obvious in both of those cases that there was a bubble going on. But you know, I thought Amazon was ridiculously priced in and you know, some people would argue it was. Yeah, and but I had a guy in my class. I was teaching a PhD class in behavioral finance, And I said, Amazon, who buys this? And there's a guy who raises his hand and he bought it at the I p O. And he says, well, this is so it wasn't that old.

And he's still holding onto it. I don't know, I don't know, but um so each weekend class, you know, I'm teasing him about this, and each weekend class he's getting richer. And you know, at the end of the quarter, I gave m an a I said, what the hell he knows more than me. You know, people forget that in nineteen the NASDAC was up eight five and in ninety nine it more than double do was up more. And that's just you could throw a dart at any

tech stock and you're making crazy money. Of course, you subsequently ended up with a not too far off from the twenty nine crash um subsequent debacle starting in March two thousand, but Amazon is one of the survivors. It's still still making a money. The The example I always give people when they say, imagine if you bought the I p O of Amazon or or Apple, and my answer is always how many of the original IPO holders of Apple? Do you think are still long Apple that

that people buy it and then they can't. They're afraid of, oh my god, I'm gonna lose it. We'll talk a little bit about um prospect theory and about why people seem to heat losses so much more than they like gains in a little while. But how many people who bought Apple even fifteen years ago are still long with today. Well, it's very hard to People have a tendency to get rid of their winners too quickly and to hold onto their losers too long. And that's the exact op I

started as a trader in this business. It's the exact opposite. You have to let the runners, winners run. You gotta let them run. And but and you gotta be willing to admit you made a mistake, and you started to get into loss of version. Lots of evidence shows that loss is hurt about twice as much as games feel good. So I have to ask why I have my own pet theory, which is very esoteric. I'm really curious as to why you think, what why that is that losses hurt?

Think we're just hard wired that way. Amos Tversky, one of my psychology mentors, had a joke that there once were species that didn't exhibit loss of version, and they're now extinct. So if you're right near subsistence, it makes really good sense to be loss of verse right now for those of us who if we lose two thousand dollars, we're not gonna failed to make our mortgage payment or

stop eating. Uh no longer. You know, the the evolutionary cycle is very slow, and so it made sense to be loss of verse when losing something meant you starved to death. But but now you know, people do stupid things like by extended warranties twenty seven billion dollars a year industry, and most of it is for stuff that is just it's disposable. Yeah, that that I forgot. What even the last washing machine we just brought a washing machine.

We moved in September November October. We bought washer and a dryer and they were nice, but they weren't, you know, crazy expensive, and they start pitching you in the Washington. I'm gonna throw that that breaks, You're gonna fix it, and if you don't fix it, I'm thrown away and I'm buying a new one. I'm not gonna Why do I need to spend more money on the possibility of this breaking. You know what people have to think about is they're making money selling you that policy, and the

salesman at the especially making money is making money. That means you're losing money. They're making more money. In college, I worked part time in an electronics store, and they would make more money on the extended warranties than they would make on the products. So here's an example of

mental accounting. What people should do is say, every time somebody offers me an extended warranty, I'm going to take that money and put it into a special save and then anytime anything goes Yeah, I had a I had a friend at at Cornell who had here was his mental accounting trick. At the beginning of the year, he would set aside money for the United Way, say five grand he's gonna give. Then anything bad happens to him, he deducts it from what he's going to give to

the United Way. Nothing. So he was totally insured. So he had an insurance policy. And at the end, if he had a good year, you're not away. Got five grants. Yeah that's funny. You know, a speeding ticket, no problem, comes out of United Way, you know, And one year the roof blew off his vacation home in North Carolina, and I told him, look, the reason why you weren't covered is you're too cheap to give United Way enough

money to cover the roof. Right, That's that's unbelievable. So in other words, he didn't have homeowners insurance, had insurance, but you know he didn't have insurance for the deductible. That that's that's pretty fascinating mental accounting insurance. So let me keep working my way. So my my pet theory on on why people hate losses more than they like gains. Gains represent a temporary increase in your standard of living.

It's temporary, and we all know behaviors have taught us, Hey, you go out and buy a bigger car, or a bigger house, or a nicer television or whatever, and six months later that just becomes your benchmark, your frame or reference, and whatever benefits accrue to that um For the most part, don't really, Most people don't feel. I'm an exception with cars, and I could tell you my wife's car. Every time I drive this, We've had this for two years. It's

an utter thrill. The car I forced her to get. Um, it's just this little rocket ship and it's a dull light. Other than getting pulled of speeding tickets, it's a delight. And I'm aware as I'm doing this, I'm like, you know, it's two years and the thrill is not yet gone, but I know that it's about six months for most people for most things. And so you're onto a basic fact of life, which is that we adapt to our

surroundings and to the upside. And then yeah, I mean, look, when you're a grad student, you don't feel poor because you're living with a bunch of other grad students and you know you've all got secondhand furniture and Macaronian cheese. Yeah, and you know it's temporary. And now you know, if we had to go back to live in like yeah, but you know we were happy, then you're sure. So you know that. And so that's the first basic fact of human nature. And then the second is that improvements

make us happy, but decriments make us miserable. Right, so so so the loss of version thesis. So not only the gains temporary, but and this sort of traces back to what you said about people on the edge when you lose money. In that mental accounting that we do, that loss of the average salary in the United States is about fifty dollars. You lose a thousand dollars, that means that a week of your life is gone and you have nothing to show for it. You work that week,

you've got a thousand, you lose it. That's a significant loss. It's a permanent loss versus the benefit the temporary. Hey, here's a thousand dollars. You could buy some nice stuff, you could do things, but it's only temporary. I mean, that's the only way I've been able to rationalize why we despise the losses so much more than we enjoy

the game. I'm not much for evolutionary stories, but this one, I think is just we're just hardwired that and uh, maybe in another fifty thousand years will get over it, but not anytime soon. There's a book I'm almost one reading, actually put it down to start yours, called Last Ape Standing, and it looks at the past ten million years and that they were approximately thirty species of either human like or near human, and how the way they've evolved led to some to thrive and some to not make it

and we happen to be the last ape standing. And it's a lot of the decision making that that we see today. A lot of these what you mentioned is hardwired. Well, sometimes the hardwiring send you down the wrong path and hey, you ain't around anymore. Well, and you know, we got hardwired to win that battle with the other sapiens, and uh it came. You know, there were pros and cons. We're all bad back X. That'll teach you to walk up right for a thousand years, to say the least.

Let's talk a little bit about the winner's curse. We kind of skipped over that earlier. What exactly is the winner's curse? The idea of the winner's curse? This was discovered actually by a couple of engineers at arkellar is Arco old Oil come at Lanta Richmond, exactly, Lanta rich Field, rich Field. So what the here's what they discovered. They discovered that when they were bidding for oil leases. Uh, every time they want a lease, there was less oil

in the ground than they expected. Not every time, but on average. Now, they're pretty good geologists, and they couldn't figure out why they were so unlucky. And then they had the insight, well, there's a reason we won the auction paid too much. We paid too much. So and the lesson is, the more bidders there are, the more likely it is that if you win the auction, you lost.

That's really interesting. So if there's something that you want that you're bidding at auction four, you should bid a moderate price and either you get lucky and you pay that under price, or if you get enthusiastic and bid too much, that's a that's a losing situation. And live auctions have a way. People get carried away. They certainly did. The only way to rationally participate in an auction is to submit your bid and be done with it, and yeah,

and walk away. So figure out the intrinsic value, apply a reasonable discount, submit that in writing, and find out the next day did I win or not, because if you go in person, you're doomed. A friend of mine dragged me to an antique watch auction that took place in in Uptown in man hour from where we are. Yeah,

it's still uptown from here. And I looked at all these and they come out with the white gloves and they bring this watch is four thousand dollars, and this watch is ars in this watch is it's was just insane. That's a whole different universe of collectibles. And I watched online the auction go off, and there were some things I thought were really interesting, and I had the slightest idea of I would love to pay, you know, steal

that for below. But auctions are pretty good at getting people at the very least a bid fair value and most of the time to bid above, and then there's the hammer cost on top of it. Well that's right. But a colleague of mine, that Chicago booth called Devon Pope, has studied, uh, the auctioneers. It turns out that there are some. There are good and bad auctioneers. Not surprising, but again, in a world of econs, it wouldn't be true because we would all bid up to our reservation

price and stop. So what is it that the good auctioneers are getting people to do that? The bad or not? Yeah, I don't remember the just all all. The headline of the is they're different. Just like they're good baseball pitchers and bad ones, there are good auctioneers and bad ones.

And the only reason that would only be surprising if you're an economist, because there shouldn't be There should be only good because so much money getting you know, it's a huge incentive to get a good auctioneer if you're the one. You know, if you've ever gone to like a charity auction, if there's a good auctioneer, they raise

a lot of money. Really, then, you know, they just they just have their ways of people get emotionally excited, they get into its enthusiastic right, and then they'll there's a good trick which is they'll have two people bidding on like a week in some villa in Italy, and uh one bids twenty grand and the other wins it at one and the guy finally says on call, and then he says, okay, I happened to have a second week, and then he sells the second week to the and

so yeah, there's a lot of skill in that. So let's talk a bit about these biases that are so challenging to overcome. Why is it the are we just creatures of habit is the way we're wired. Why do people find these inherent issues so challenging to to circumvent? You know again, I mean it's you know, it's like asking why we have bad backs, um, you know, or why why we can't run as fast as UH or same bolt. UH. We're built that way, and you know,

in many domains we recognize it. So you know, if my wife sends me to the store to UH to pick up some groceries, if there are more than two items, I need a list, you know, I you know, I understand my memory. My wife hasn't figured that out yet. You know, she's like, where's the juice? You know? You know, so we all understand at some level. You know, we sett alarm clocks if we have to get up early in the morning, and so we're not perfect, and it's

just silly to think that we are perfect. And you know, as you mentioned earlier in the show, there there's nothing wrong with theories that assume everyone's perfec. The only thing that's wrong is in believing that those theories are true. So, you know, green Span was convinced there couldn't be a technology bubble because asset prices are equal to their intrinsic value,

the rational of course. And you know, meanwhile, companies are selling for a hundred times sales and they're computing that because there are no profits and you know, we're all looking at this and saying this is completely crazy. But then the market goes up another and you start to wonder, maybe this time is different. One of my missing Yeah, I'm not seeing that. Although he did do a mia kalpa post Financial Price did do a mia kalpa, that's right.

He believed that reputation would have prevented banks from doing the really dumb things they did. You know what bank is going to risk a hundred and fifty eight year reputation and as Lehman Brothers and bear Stearns and everybody else did, and now they're no longer. Yeah, and I think in a lot of that, a lot of the companies. There's something I talked about in the book is, uh, you know, economists have the theory they called agency theory

about principles and agents. And the idea is usually the principle is the owner, so the shareholders the shareholders or you know Bloomberg. It would be Mr Bloomberg, right, so he would be the principle. And uh, then you know he's got guys like you working for him, and you're shirking. That's the kind of and the the usual idea is that things go wrong because the agent, the employee isn't doing their job. I think in a lot of cases

it's what I call it dumb principle problem. Right. So you know, let's take the banks that we're paying mortgage brokers two grand up pop to sell mortgages without any documentation. Now, I'm not blaming the mortgage broker. That's what he's getting paid to do. I'll take it a step further. Those mortgages had a warranty on them that was often ninety days three months. So you're selling a thirty year mortgage.

You've basically told this mortgage broker, go find me someone who's gonna at least make the first three, first three out of three sixty payments. Crazy, right, So you know, dumb principle. Dumb principle. And you know, I think in a lot of cases, Uh, you know, if we think of the big catastrophes like Barings and Barkley's and um, what we had were CEOs who didn't understand what the people that we're working for them were doing. That's a

dumb principle problem. Yeah, it's a dumb principle. That's fascinating. So we've talked about finance. We've talked about how irrational people can be in the markets. Let's talk about fairness where people and fairness games where people are willing to give up benefit to themselves even if they think something is because they think something is not fair. A classic

experiment is something called the ultimatum game. So, um, let's say, uh, the experiment or gives me a hundred dollars and he tells me to make you an offer of some share of the hundred, and the rules are either you take it and you get what I offer you, or you say no, in which case we both get nothing. So it's it's an all or nothing since ultimatum. That's why it's called the ultimatum game. Now, let's suppose I'll offer you two dollars out of my hundred. Well, I don't

need two dollars, you're keeping. The hell with you? Go jump. So what we find is in that game, if you offer less than about you're likely to get turned down. That's amazing. And why is that Because to this person making that decision, it's free money. It's free money. It's uh. But you know they say, the hell the hell with you? I mean, that's not fair. And um, you know. Uh, my friend Danny Kaneman and I did a study way back. Uh what pisces people off? Right? Uh? Well, the more

polite term was what people think is fair? And we had an example. There's a blizzard. A hardware store has been selling snow shovels for fift doers. They raised the price to twenty dollars the morning after a blizzard. Is that fair? Well, people hated it, you know, they all hated it. Price gouging, Yeah, right, exactly. Now think about Uber, right, they do search price surge pricing. Now, at some level, search pricing makes total sense in the raader demand finite

supply prices. But we're all used to the fact that if you want to buy an airline ticket at Christmas and a hotel room at Aspen, you're gonna pay more than two weeks earlier. They even call that. Hey it's high season, it's prime season. But you do it in a blizzard, you're gonna make people mad. Well, you're gouging your advance. Think of the very word gouging, the literal means PoCA hole and that's the way people feel. So my opinion about Uber is that they should cap the

search and to sor to reduce animus and maintain a reputation. Yeah, and and it makes sense because they're fighting a political battle in every city as to whether they can operate and whether they can go to the airport. They can't afford to be making people mad, at least not in the beginning. And you know, there's it never makes sense to make people mad. I mean, you're in this for the long run. There most businesses have learned this. So after a hurricane down to Florida, the cheapest place to

buy plywood, Walmart is Walmart in Florida. Their notorious for anticipating weather and shipping extra whatever it is, extra ply whatever is needed if and it generates a lot of good will, a lot of goodwill. Now there will also be a guy in Atlanta who will load up his truck with plywood, sell it off the back of the truck for market price. Both Walmart and that guy are being rational. Walmart's playing the long game, and that guy is just doing a one off. Hey, it's not my reputation,

not my business in Florida. I'm selling this plywood and going back to Atlanta. So you know, we've all had the experience in New York. It's raining, can disappear, cabs disappear, some guy in a black car pulls up right, and you know, you pay unless you want to get wet, unless you want to get wet. But uh, if if a cab driver pulled up and let's say it's a six dollar fair normally and he says it's raining, it'll be twenty bucks, you're gonna write down is that would

be very very unhappy. But you put up with it from over because it's a different choice. It's a third option. It's a third option. But I think they could, uh, they could do better. So let me ask you some of my favorite questions that that I ask all of my guests. These are these are some regular ones. Let's start with an easy one. What are some of your favorite books? And and they can but don't have to be economic books. What books do you really have you

really enjoyed? Maybe my favorite book of all time is Catch twenty two. I love Joseph Heller. That book was just I read that in college and just that's some catch that Catch twenty two. Yeah, it's a fantastic catch. Here's a weird thing. It's not I'm kindle. That's funny because it's I've been I've been meaning to reread it. It's really it's sold something like twenty eight million copies. I wonder if the date has not is the reason why it was published pre Kindle, so there's no obligation

for it to show up that way. Um if you like, if you like Hellar, were you a Vonnegut fan at all? Yeah? I loves so fantastic catch um so the two big ones. Slaughter House five always comes up every time, um, catch twenty two comes up, but a few of his other ones were just Cat's Cradle is just so good. You know. There's a book that that many people know that I read because I was there about called Gallopagus Callous. I

think that's the title. Maybe it's not the title, but it's a book that takes place and to the Gallopagus book that's in the back of my head. Douglas Adams, who wrote The Hitchhiker's Guide to the Galaxy, he did a book called Last Chance to See and he talked about by the way you want to go see this is not going to be here for another hundred years. If you want to go see this, go take a look. If you want to go see that, Go go take

a look. So here's another book. And this is a book I went back and reread while I was writing my book, and it's Richard Feynman's surely you must be joking. Yeah, it's on audio now. Also you could get the versions of him narrating some of his speeches and some stuff. Yeah, his stuff is wonderful. So in some ways, writing this

book wasn't my final act of misbehaving. You know, the title technically refers to the fact that people misbehave according to economists, but a second meaning is that by pointing that out during my career, I was misbehaving. Well, you didn't conform to what reforms they were expecting you do. And then the third act was writing the book the way I did because my publisher assured me that there's no market for a book like this, Right, they're very

bad at predicting these sorts. But that's true in television and film. And you know that's the famous William Goldman line. Nobody knows anything talking about Hollywood that they would make these if it was up to them, they would just make sequels of what was originally successful. But you gotta at least try something to see what's going to be successful. So Synman's book, you know you've read it. It's a bunch of stories, uh, and some of them are very funny.

He's a funny guy. And but but there's no physics. So the book I wanted to write is as it would be if Fynman had tried to explain physics in that book. Got it. I don't know whether you think I achieved that, but that was what I was trying to do. So let me ask you. My next question is what sort of advice would you give to a young economic student or a millennial either just entering grad school or just starting their career today? Find your own problem,

to work on your own problem. Yeah, don't don't be your advisor's research assistant. And it may cost you a year um because it's the easy thing to do is do a variation on your advisor's life work. And uh, that doesn't put you in good standing for the rest of you know, I think you know the My book starts out with this story about Daniel Kheman having a an interview with Roger Lowenstein, the guy who wrote When Another Right, and I just had lunch with him not

too long. He's so insightful. Roger, Yeah, he's a great guy. So the story is that Roger was writing a piece about me for the New York Times magazine. You were in the room while while, Um, Danny was actually having the conversation. So Danny said, you want to stay for this, and I said sure, And then he starts explaining, UH, to Roger, Sailor's best quality, what really makes him special

is that he's lazy. And I'm I'm waving my hands in the air and shaking my head and saying, you know, come on, I admit to being lazy, but is it my best quality? And uh, Danny still sticks to that story. I love that. That's a great story. Professor Taylor, thank you so much for being so generous with your time. Um, we're gonna wrap right here. I know you have a place to go to from here, and I will see

you on the radio tomorrow. For those of you are listening, we've been having a conversation with Professor Richard Taylor of the University of Chicago. Be sure and check out some of our other UH podcast You can look an inch up or an inch down and end up checking them out. Checkout Professor Taylor's Twitter handle at our Underscore Taylor at Twitter. I'm Barry Retults. You've been listening to Masters in Business on Bloomberg Radio