Bankers Will Be Boys

Apparently, Horst Siebert has written an article at VoxEU describing three types of bad behavior committed by bankers that helped produce the crisis:

They committed cognitive errors involving biases towards their own prior beliefs; too many male bankers high on testosterone took too much risk, and a flawed compensation structure rewarded perceived short-term competency rather than long-run results.

I say “apparently” because I can’t get through to VoxEU despite trying three different browsers and two different computers (can’t ping it, either). But there’s a long summary over at naked capitalism.

Everything he says sounds right, although the classification of three behaviors is a little frustrating, because they fall into three different categories. Confirmation bias is just part of the human condition; I’m not sure what we can do about that, short of inventing Cylons (and we know where that leads). Testosterone is part of the male branch of the human condition; so the potential solution is to have more female bankers. And flawed compensation structures are completely human creations, so we can definitely do something about them.

Yves Smith hones in on that last point:

The “bad incentives” turn of phrase, while narrowly correct, does not put blame where blame was due. The industry’s leadership designed the compensation schemes; they were not visited upon them by a mysterious outside force.

I’m familiar with confirmation bias (I suffer from it myself, of course) and with flawed incentive structures, but I found the second point the most interesting. Here’s an interesting excerpt from Siebert:

In a fascinating and innovative study, Coates and Herbert (2008) advance the notion that steroid feedback loops may help explain why male bankers behave irrationally when caught up in bubbles. These authors took samples of testosterone levels of 17 male traders on a typical London trading floor (which had 260 traders, only four of whom were female). They found that testosterone was significantly higher on days when traders made more than their daily one-month average profit and that higher levels of testosterone also led to greater profitability – presumably because of greater confidence and risk taking. The authors hypothesise that if raised testosterone were to persist for several weeks the elevated appetite for risk taking might have important behavioural consequences and that there might be cognitive implications as well; testosterone, they say, has receptors throughout the areas of the brain that neuro-economic research has identified as contributing to irrational financial decisions.

Let’s say you could provide reasonably convincing evidence that you would get better long-term results by using a team that had an even balance of men and women. Could you get away with an affirmative action policy that instituted a quota for female traders? According to the Supreme Court’s extremely mushy and frustrating “intermediate scrutiny” standard for gender discrimination, you would have to show that the policy is “substantially related” to the achievement of “important governmental objectives.” (I assume that there’s enough of a state-action component here, since we’re dealing with major, federally-regulated financial institutions.) Reducing systemic risk sounds like an important objective to me.

About James Kwak 133 Articles

James Kwak is a former McKinsey consultant, a co-founder of Guidewire Software, and currently a student at the Yale Law School. He is a co-founder of The Baseline Scenario.

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