Rather than read all the copious analysis pieces in the press about the financial crash, I've been reading Nassim Nicholas Taleb's Fooled by Randomness which, even though it was written well before the crash, contains some prescient perspectives. Taleb (himself a derivatives trader of some considerable experience) judges the world in a probabilistic way, believing that we are often victims of perceptual biases, underestimating the share of randomness in just about everything and compounding this with a false belief in determinism. Most notable in this is our tendency to interpret data in ways that confirm our prejudices and post-rationalise deterministic meanings into our view of our personal and circumstantial histories.
Rational thinking, says Taleb, has little to do with risk avoidance – much of what it seems to do is rationalize one's actions by fitting some form of logic to them. Part of the problem is that we over-estimate what we knew at the time of the event (hindsight bias). Another part is that we are not very good at discerning between noise and information ("The wise man listens to meaning; the fool only gets the noise"), which is important since the process of looking at and perceiving the world is "an active process of meaning-making that shapes and biases the rest of the decision making chain."
This great NY Times piece by David Brooks (Hat Tip to Gareth) sums it up nicely, suggesting that perhaps one legacy of the financial crash will be that this will be the moment when we alter our view of decision-making – when we shift our focus away from the significance of the rational calculation part of making decisions and more onto how we perceive situations:
I too am a believer that the value and significance of unpredictability is consistently under-estimated, and that we often think we know more than we actually do. This manifests itself not least in the fact that those who are very good at analysing (predicting) the past will think of themselves as good at predicting the future. Probability, says Taleb, is not a mere computation of odds, it is the acceptance of the lack of certainty in our knowledge and the development of methods for dealing with our ignorance.
So in thinking about the crash and the subsequent desire to spend and regulate our way out of trouble, I'm reminded of that quote by Einstein: "We cannot solve our problems with the same thinking we used when we created them". The movements of the markets are often caused by factors of which we know little, yet we consistently seek to rationalise them. If we are re-establishing a system without changing the decision-making framework within that system we are in danger of making the same mistakes all over again. David Brooks again:
Perceptual bias is not limited to the financial markets. The same is apparent in many other markets (including advertising). Perhaps it is time that we should not only be more focused on how we arrive at our perceptions but more accepting of our level of ignorance.