Dan Ariely: Why The Next Market Downturn May Quickly Become A Full-Blown Panic

Behavioral economist and author of Predictably Irrational Dan Ariely returns to explain the science underlying the continued mismanagement and mal-investment within our financial system, despite 7 years of opportunity to learn from and address the causal factors of the Great Recession.

Behavioral science shows we are our own worst enemies in this story. In a realm where everything is so quantifiable, measurable and trackable, one would expect exceptionally good decision-making. But it's our human wiring, our proclivity for seeing things as we want them to be rather than as they truly are, that makes us vulnerable to influences we often aren't even conscious of. And the bad decisions -- and bad outcomes -- ensue:

For me, as somebody interested in human behavior, there are two elements that worry me a lot. The first one is Conflicts of interest.

Conflicts of interest is one of those things that get to us without us realizing how powerful it is. Imagine that you invite me to dinner, and you buy me a beer and a sandwich and we talk more and we become friends. To what degree am I going to be able to see the world in an objective way without taking your perspective into account? It turns out conflicts of interest are wonderful because they allow us to create friendship really quite quickly. You can buy someone a beer and a sandwich and they become your friend to some degree. Once you marry this with a complex system like the financial system, all of a sudden some not-so-good things can happen.

I think we really haven't done much to address conflicts of interest in our financial system -- there are lots of places where people get paid in all kinds of ways that have conflicts of interest. There are companies that have divisions within them that create tremendous conflicts of interest. And human nature doesn't help. What happens is that you look at yourself and you ask: Do I have conflicts of interest? You say: No. Of course, not. I evaluate everything objectively; therefore, we don't need regulation. But I think we do, and actually to a much higher degree.

The second element that bothers me about which we have done to little is Trust. There are people who are active in the financial system and they understand it better. And there are people who are not. The people who are not have experienced this tremendous devastation. Many people lost lots of money, especially people close to retirement. Many people pulled out their money and basically have lost trust. Now the question is: Under what conditions will people regain this lost trust? This is extremely important for the financial system's long-term viability. If you think about the financial system as a way to accumulate wealth and be able to retire securely and so on, I think we've lost some of the capacity of that system to serve that function, because people are just not trusting anything.

Imagine if we have another beginning of a catastrophe happening, not something as big as we had, but something smaller. Is people's sensitivity right now is going to be so high that they're going to panic very quickly? I think the answer is: Yes. So we haven't done much to eliminate conflicts of interest, and we haven't done anything to earn back trust. And because of that, I deeply worry.

Click the play button below to listen to Chris' interview with Dan Ariely (41m:53s)

This is a companion discussion topic for the original entry at https://peakprosperity.com/dan-ariely-why-the-next-market-downturn-may-quickly-become-a-full-blown-panic/

 I don’t know but it sounded like this guy wanted more collectivism, the solutions were in the government and how do we invest more in academia. Academia is no more of a growth engine than the oil industry has been prior to the major drop, and housing was before that.  Education is just a bubble that has yet to burst.  There has been more and more money thrown at education and that results in SOME real production, just like the money thrown at the oil industry caused more production, and the money thrown at real estate caused real houses to be built.  But in all cases it was mis-allocation of resources due to incorrectly priced money (low interest rates). 

Here is a great example of the root cause analysis in oil; the same could be said of academia.  He didn’t realize how ironic it was considering his earlier talk about conflicts of interest. 

Aloha! It says it on our "money"! In God We Trust, so that way because our money is blessed by our government and God it can't possibly ever be bad, right? Sorry, but if we did a pyramid of "financial trust issues" at the top would be "money". Without trust in money there is nothing! The reason the S&P 500 has risen so high for so long can be correlated to the value of our money and its purchasing power. In fact if you invert the S&P it becomes a chart of the purchasing power of our money.
Markets exist now to leverage your income and your retirement or at least that is the hope of every trader when they move funds into the market, whatever market it may be. It could be the S&P or the commodities or real estate or art. Lets face it 0% FFR for five years has destroyed the hopes and dreams of many elders in this country. The idea of company fundamentals as a "price discovery" mechanism has been destroyed. Once banks were allowed to enter the stock market when Glass-Stegall was repealed it was the end of fair market values and fair markets.

If only we had Le Chiffre on our side!!!

If this guy ever loses his job at Duke U, he most certainly could find work at the Onion. It is becoming harder and harder to distinguish truth from fiction. The quick observation that Hindsight is 20/20 and foresight tends to be myopic is hardly Noble Prize territory (my recent patent application for a battery operated battery charger was rejected due to the fact that they're already on the market–mine was almost 72% efficient). Can I get an appointment at the Fuqua School of administration; I have 15 or 20 minutes to kill and heard land is going cheap over by the Love Canal. 
Does mankind make stupid decisions – Duh? You need a Phd. to figure that out? In 1929, folks were extending margins based on using trusts to buy trusts. Sure history is destine to repeat itself; that's because we just don't listen. CO2 levels must be rising–lack of oxygen can have that effect.Entertainment value?–2 stars out of 5.

Thank you for bringing Prof. Ariely back into focus. I Enjoyed the insight that we react differently to risk than to reward.
Somewhere in my past I recall that the largest a Society can be is 1200 people. Any bigger and it splits. The study focused on Paris. How many of us have abandoned our budding social group to move on? I do that repeatedly. The downside is that there is more alienation, the upside is that there is more homogenization.

To me the ideal is to travel with a home that one can go back to. This gives the correct balance. (Those are my ideals. I defend them on the grounds that they fit what we are.)

What chance is there that these ideals will eventuate? There are factors influencing the course of events. Facebook as a dummy society,  the breakdown of the notion of a Nation State with the need to interact with, for example, the Chinese. And they with us. 

Anyhow thanks Prof and Chris, but I am on another mission. I have to tend to my yacht.


There is a very reasonable angst about the ridiculous rise in tuition costs over recent years. I am a professor in academia and a father with a child getting ready to head off to university in the near future, so I get to see both the inside and outside of this problem. The issue is well summarized in this article (link) but the simple answer is that our current economic model is failing faster than the official rate of inflation.

Until recent years, public colleges and universities were subsidized substantially by their respective state governments (they still are although much less so). Why is this the case? Simple, each state benefits from an educated work force and, despite the statements made by a poster above, universities do end up generating many startup companies and inventions from their research (link, link). We (faculty and research scientists) are being pressured to do more of this and have had to sign away all rights to such intellectual property in recent years. Ultimately, state legislatures threw public education under the bus to make up for revenue losses and left colleges and universities to look like the bad guys when they raised tuition.

The sharp rise in tuition is a result of deep cuts in state funding to public colleges and universities after the recession hit. The vast majority of state funding for these schools has yet to recover. States provide about 53% of the revenue used to support public schools, according to the report. Without the funding, many schools are forced to make up the difference with higher tuition.

As a result, 47 states are spending less per student this school year than they did pre-recession, with only Alaska, North Dakota and Wyoming excluded.

The average state is spending 20% less, or $1,805, per student in 2015 than they did in 2008. (link)

It is actually worse than you think in the sense that not only are you having to pay more out of pocket for tuition costs, the universities are actually spending less per student. The way this shows up is having fewer professors per student or classes taught. More classes are taught by 'adjunct' faculty or graduate students. The one place that never seems to lack for money is construction with new buildings being put up even while university staff are being cut.

At sky-high priced private universities the tuition costs haven't increased at the same rate but they too have been going up fast. Why? Private universities rely heavily on 'gifts' from alumni and others. With the economy in the toilet, few are donating money to anyone and the donated amounts are way, way down.

The wildcard in this whole financial shell game is research dollars. Many public and private universities also conduct a large amount of research in addition to their teaching activities. As the financial screws were tightened, nearly all faculty were pressured to bring in more research dollars. This resulted in more and more people chasing fewer and fewer research dollars. Research dollars help pay faculty and staff salaries as well as graduate student tuition but the universities also collect their tithe (indirect costs - 1/3 or more) which support space and facilities on the campus.

However, government is also feeling the squeeze and so the opportunities and money for supporting research are drying up. In order to be competitive you need to leverage better facilities to support your proposals, which is a large driver in the university construction monster.

My sense is that the system is beginning to unravel. Over the years, I have been a cash cow managing millions in research dollars and bringing in more money to the university than I cost but I can see the hand writing on the wall. Going forward the money available for research will be much more modest and the constraints on how it can be used will be much greater. If you think the government is wasteful when its pockets are full, you should see it when it attempts to 'save' money. Penny-wise and pound-foolish is the old term for it.

So the big picture is that state funds and private donations are down by much more than one would expect in a 'recovery'. Tuition costs are a canary in the coal mine on the real state of the economy.



What do you think of the actions of the Chilean government when they soaked corporations for the cost of an educated workforce Mark?
Corporations are people too you know! 


EDIT:I wonder if market forces will cause students to go to Chile, and whether other countries will follow Chiles example in order to secure a well educated population.?

I had not seen this but it is appealing. As for corporations being people, as Orwell said, paraphrasing here:

Some are more equal than others.
They should pay as such too. The corporations eat and excrete our youth, it would make sense if they had a hand in educating them as well. I hold little hope of this though since our government is now a wholly owned subsidiary of the corporations at this point.


We have done the experiment and the evidence is in. This is what Utopia is like.

Interesting that Dan grew up in Israel. My strongest takeaway from his interview is the idea of military service as a melting pot. He said "In Israel for example the military service I think really helps a lot. The fact that every boy has to serve for three years, and every woman has to serve for two years, creates this real melting pot in which you meet everybody from the country, and you realize that you're working together and that you have to work together. "
Everyone I've hired over the years with a military background has exceeded my expectations as an employee and many young kids without that experience were still trying to grow up and could not function as employees… The service to the country should have "peace corp" type options as well as standard military pathways, but some core components could be hard work and learning to follow orders. Just getting kids out of the ghetto for 2 years might have a huge rehabilitative effect.  



Given what Israel’s military has been getting up to over the decades since its inception I am not inclined to take that as a vote of confidence in those that have been conditioned by their formative experience in it.

wanting. The religious sect of Joseph Smith send there lads on two year missions. posit a guess as to their drop out rate in college,graduate and professional school? I ain't LDS, just an admirer of their success.

What is your objection to the Peace Corp?

At University of Colorado. Seriously. That seems to symbolize a lot of the bad budget decisions in academia. They spend a lot more money on administration and marketing because they are trying to attract students for the wrong reasons. I just scratch my head at the materials my kids get in the mail from these places. They are travel brochures! Ridiculous.

Would be to lose the green market bias.  As we enter the summertime trading zone in the markets, trading volume will drop and volatility will spike.  Your time in a trade will necessarily shorten.

If/when the market turns down (as it historically does into September/October), don't let yourself be surprised by downturns and instead look to them for trading opportunities.  Just make sure you're trading in the right direction.
Selling naked calls and buying in the money puts in front of a downward move is a good strategy - but pull the trigger and close the positions if it backs up on you.
A full blown panic is a fantastic trading opportunity…if you aren't one of the panicked.
Speaking of  Widespread Panic…

"Ain't Life Grand"…with Nicky Sanders of the Steep Canyon Rangers sitting in on fiddle.

I was spoofing on another post.
I liked the civilian conservation corps as well. they built half the ponds in Amelia county during the depression. CCC,LDS, whats in a name. get the adolescents busy

A true free market would not allow winner-take-all outcomes.   Monopoly requires leveraging regulation to favor incumbent.  We also have the problem of Regulatory Disease where the regulators become myopic and miss big problems developing. 
No costs were cut in the developed world.  Debt levels are higher than in 2008.   What was cut?   A better question is what was transferred.  Ask the bankers.  

Where is the outrage?   The Public Schools System accomplished its job: A Comatose Society.


Hi Kugs,

I have a question regarding true free markets.  When and where has one existed?  I support many aspects of libertarianism, but when I hear purist libertarians talking about how such-and-such would not happen in a true free market, it seems very idealized, even other-worldly.

It reminds me of the sentiments of purist communists.  When shown the horrors of Stalin or Mao, some of these idealistic communists say that such oppression would never happen in a true communist society, because the proletariat would control the means of production fairly and equitably.

Since the 1980's, a lot of free-market ideology has found its way into policy.  Reagan's dereg. of airlines; the Gramm-Leach-Bliley Act, B. Clinton's support for free trade and less regulation of financial markets, Greenspan's & Summer's opposition to CFTC Head Brooksley Born's attempt to regulate derivatives.  Most of these steps were supported by libertarians at the time, and certainly Greenspan cited Ayn Rand while making policy on a number of occasions.

It seems that there is a pretty strong current of libertarianism in American public policy, although you are certainly right that certain corporations have taken advantage of this in the form of trying to form monopolities or by rent-seeking.  And that's maybe one of the problems with libertarian ideology, when taken to the extreme.  

Just as the communist expects that the proletariat will be good when it seized the means of production, the libertarian expects that corporations will act in their financial self-interest (the basis of capitalism) but at the same time that they will be good by not engaging in regulatory capture, unethical advertising (e.g. Joe Camel, targeted to kids), or unethical investment practices.  It may be that the extreme individualism found in libertarian ideology can also lead some entrepreneurs and business people to play the system and otherwise grab for things that they shouldn't…in a so-called true free market.


Yes, but humans are not animals. We have love, art, consciousness yada yada yada. I guess only time will decide if that is true.

Hi Hugh,

I don't identify with the so-called Libertarians.  There is no perfect way to set up society.   The Federal Register is now almost 80K pages.  There is a difference between good regulation and regulation used to box out competition.  If the opportunity to lobby is small, there is not much to grab. 

I am also very worried about the conscription forces at work.  A bankrupt nation conscripting its human capital into the war machine would be a disaster.   Where would Israel be without the U.S. perpetually loaning it money to buy weapons?