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Making Markets Safer (Excerpt)

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The following is excerpted from Minding the Markets: An Emotional Finance View of Financial Instability.

The financial crisis of 2008 was ruinous. It has provoked many commentaries, articles and books. But will it produce change and can this change make a difference? Is there anything much we can do to make financial markets work better and be safer?

One temptation is to breathe a great sigh of relief and forget all about it. It has happened before. "There can be few fields of human endeavor in which history counts for so little as in the world of finance", wrote J.K. Galbraith in his historical study. "Past experience", he continued, "to the extent that it is part of memory at all, is dismissed as the primitive refuge of those who do not have the insight to appreciate the incredible wonders of the present".

Another temptation is to blame a few bankers and mortgage salesman as perpetrators of a great deception or in other ways to find other culprits. However, in the long run blame only works adaptively if it correctly identifies causes...

Emotional Finance suggests the problem is much more fundamental than deception. To build up to the point where there was the kind of asset price bubble we had before 2008, very many people in markets had at some level to have joined in the excited state and become trusting about the latest phantastic objects, even if they did not fully realize it. Until the panic phase most rode the wave of excitement and rising prices and very few bet against or withdrew their assets from the system. At the same time prestigious international regulatory agencies expressed satisfaction (IMF 2006; 2007). In effect, all groups embraced a "convincing" covering story about new financial engineering and judged the validity and safety of that story positively. In this way the crisis was caused by those creating the new phantastic objects (investment banks), licensing and rating their credit-worthiness (rating agencies and regulators), buying them and holding them on client and institutional accounts (private investors and institutional pension and savings funds), authorizing all the extra lending (retail and investment banks) and overseeing the system (regulators and governments). Onlookers were fascinated and warnings were not heeded.

Once crisis hits and losses happen blame is emotionally easy. But understanding and allocating responsibility when you have been involved in failure is emotionally more difficult. If we want to adapt and learn from what has gone wrong then rather than indict a few banks or rule-breaking individuals, it will be more useful to recognize there has been a widespread failure and to consider responsibility in more subtle ways.

In summary my argument is that what happened in the recent financial crisis (like in many before) was the product of a shift in mental states. It had its origin in a failure both to understand and to organize markets in a way that adequately controls the outbreak of risky and unrealistic decision-making states that the desire to trade financial assets must inevitably unleash. If this is right, future prevention must rely on better understanding -- taking beliefs and emotional states seriously and allowing them a much more central place in economic models and regulatory thinking -- and then using it to design and regulate the way markets are organized.

My interviews showed how markets are dangerously structured around stimulating the belief in phantastic objects, divided state thinking and groupfeel. In fact many people working in markets believe they really are phantastic objects themselves.

I consider that the organizational failures followed from the power phantastic objects exert on mental states and the way institutions have increasingly stimulated this power for advantage and then increasingly become ruled by it. Having offered exceptionality they have at least to appear to provide it. It follows that to make markets safer we have to examine the institutional context in which financial assets are first gathered up and then traded and in that context to consider steps to reduce the potential for markets to be seriously captured by phantastic objects, divided states and groupfeel.....

The core Concepts of Emotional Finance

Unconscious Phantasies: The stories (saturated with emotion) we tell ourselves in our minds about what we are doing with other people (and "objects") and what they are doing with us, of which we have only partial awareness.

Object relationship: The affective relationships of attachment and attraction we establish in our minds with "objects" -- that is people, ideas or things, of which we are only partially aware.

Phantastic Object: Subjectively very attractive "objects" (people, ideas or things) which we find highly exciting and idealize, imagining (feeling rather than thinking) they can satisfy our deepest desires, the meaning of which we are only partially aware.

Ambivalent Object Relationship: A relationship in our mind with an object to which we are quite strongly attracted by opposed feelings, typically of love and hate, of which we are only partially aware.

Divided State: An alternating incoherent state of mind marked by the possession of incompatible but strongly held beliefs and ideas; this inevitably influences our perception of reality so that at any one time a significant part of our relation to an object is not properly known (felt) by us. The aspects which are known and unknown can reverse but the momentarily unknown aspect is actively avoided and systematically ignored by our consciousness.

Groupfeel: A state of affairs where a group of people (which can be a virtual group) orient their thoughts and action to each other based on a powerful and not fully conscious wish not to be different and to feel the same.

David Tuckett is a Fellow of the Institute of Psychoanalysis and Professor at University College London, UK.