Morningstar Advisor - October/November 2009 - 44

Spotlight Kahneman and Amos Tversky, who were studying how people make decisions and judgments and how those judgments aren’t consistent with what economists call rational. The three of us ended up spending a year together at Stanford in 1977–78. They didn’t really know anything about economics, and I didn’t know anything about psychology, and we spent the year educating one another. That was the beginning. Rekenthaler: Obviously, when you started, you didn’t really have a vision of where this would be 30 years later. Are there parts to the development of behavioral economics that might have seemed predictable to you at the time? And are there branches that have surprised you? financial markets are the most efficient markets. They are markets in which many of the traders are professionals. The stakes are huge. So if there’s something that’s not working right, people can make tons of money exploiting that and making it go away. It was a surprise that it turned out to be pretty easy to find puzzles in financial markets. Perhaps because they were so surprising, and because the data is so rich in financial markets, this branch of the enterprise really has been the most successful to date— successful in the sense of attracting a fairly large group of academics who consider that’s what they do for a living and attracting the interest of practitioners like you. Rekenthaler: It’s my sense that under the Orszag, the director, has written extensively about behavioral economics. Another guy in the OMB, [executive associate director] Jeff Liebman, from Harvard, has as well. There are other people around the administration, too, most notably Michael Barr, who’s an assistant secretary of the Treasury in charge of consumer regulation. Even Larry Summers wrote some early papers on behavioral finance. Neither he nor I would call him a behavioral economist primarily, but he is a very eclectic guy, and he is certainly happy to use behavioral economics when it seems to be the appropriate tool at hand. Rekenthaler: Can you give an example of ideas that you and Sunstein worked on that are making their way into policy? Thaler: I think finance is the biggest surprise. Obama administration, behavioral economics now has an official link into policy-making. It is more directly connected with what goes on in Washington than ever before. Thaler: Yes. It’s funny. About five years ago, Thaler: One of the first things that the But let me come back to that. I think that in some ways the things we started working with back then are still very important. I was interested in things like self-control and loss aversion and what came to be called mental accounting. Those have remained big themes today. So in some sense, I think we knew what was important early on. As for the role of markets, it was clear that a question that needed to be asked was: Well, look, if people do dumb things in the privacy of their homes, like they watch the wrong television show or what have you, that’s one thing. What happens in markets? I think it was clear that there was going to have to be a lot of attention paid to that. I started writing papers about it. The first ones were published in 1985. But I certainly never would have expected that the branch of behavioral economics that would really take off first was behavioral finance. Our expectation was that finance would be the least likely place that we’d find big anomalies, and the reason is that I organized a session at the American Economists Association meeting called “Memos to the Chairman of the Council of Behavioral Economic Advisors.” It was meant to be sort of a whimsical title and science fiction. If there were such a group, what would people be thinking about? Now, here we are, and it’s not that there’s a Council of Behavioral Economic Advisors, but in some sense, it’s even more than that. There are behavioral economists scattered through the administration, including the co-author of Nudge, Cass Sunstein, who, let’s hope, by the time this article is published will be confirmed in his job as the director of the Office of Information and Regulatory Affairs. It’s in the Office of Management and Budget, and it’s the most important job in Washington that no one’s ever heard of. It essentially has to give approval for any new regulation. So OMB has really become the Council of Behavioral Economic Advisors, because Peter administration did was announce a carbon emissions inventory. Starting in 2010, firms will have to announce what their emissions are. The idea—and we talk about this in the book—is that simply by having to announce their emissions, companies will be shamed into greening up their act a little bit. If you have the dirtiest factory in town, maybe people will get on your back. This is in preparation for some sort of cap-and-trade system where we’ll need those data anyway, but the idea was let’s just start with this. In some other fields, this “announcement effect” has been helpful. Something more finance related is an idea that we talk about in the book that has been picking up a lot of steam. We call it RECAP— Record, Evaluate, and Compare Alternative Prices. The idea is that firms would be required to give two kinds of data to their customers. Let’s think about it from the perspective of credit cards. Once a year, every credit-card holder would get two electronic files from their credit-card company. One would be usage data. The file would list all the ways you’ve used your credit card in the past year that are capable of incurring charges. The basic principle is that as 44 Morningstar Advisor October/November 2009

Morningstar Advisor - October/November 2009

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