WITH CHRISTMAS ALMOST HERE, a conversation with a friend about when we stopped believing in Santa Claus gains some pertinence. At the tender age of 5 she was told by a friend that Santa Claus didn't exist. She refused to believe him - not because she thought he was wrong, but because she thought that it just wasn't worth her while to stop believing in Santa Claus (little kids can be devastatingly sensible sometimes!).
I SUSPECT that a very similar argument might apply to many of the investors in the Madoff scam. They felt they they couldn't afford not to believe, because of what they thought they were gaining by believing.
FOR MORE BACKGROUND, see my December 22 post (MADOFF'S WILLING PARTNERS) and my background to game theory (THE CATCH-22 TRAP THAT THREATENS OUR WORLD) (November 9 post).
DON'T FORGET THE FREE ARTICLE (December 19 post) - a GREAT CHRISTMAS PRESENT!!
Tuesday, December 23, 2008
Monday, December 22, 2008
MADOFF'S WILLING PARTNERS
My editorial opinion article in the Washington Post, Saturday, December 20, 2008
THERE SEEMS to be little doubt that Bernard Madoff is a cheat.
His apparent Ponzi scheme, in which capital from new investors
would have been used to pay "dividends" to earlier investors,
ultimately cost the participants many billions of dollars. But
was it all Madoff's fault? I contend that the losses would have
been less severe, and might not have occurred at all, if many of
the Madoff's investors had not been cast from the same mold that
Madoff was ... ...
http://www.washingtonpost.com/wp-dyn/content/article/2008/12/19/AR2008121902977.html
Friday, December 19, 2008
CEOs OF FINANCIAL INSTITUTIONS SHOULD NOW LIGHT THEIR PANTS ON FIRE
FREE ARTICLE
YOU ARE WELCOME to reproduce this article, so long as you include the acknowledgment "Written by and copyright to Len Fisher, author of "Rock, Paper, Scissors: Game Theory in Everyday Life."
CAN GAME THEORY HELP US in the current financial mess? According to some skeptics, the answer is no, because they believe that game theory can be manipulated to explain anything. “If a bank president was standing in the street and lighting his pants on fire” says strategic analyst Richard Rumelt “some game theorist would explain it as rational.”
I AM KEENLY INTERESTED in what game theory has to offer, and Rumelt’s example seems to offer something very practical when it comes to the credit crunch. If the leaders of financial institutions had known that the eventual penalty for offering toxic loans and concealing the true value of their assets would be having to burn their britches behind them, perhaps the crunch could have been avoided.
OK, MAYBE I HAVE MY TONGUE IN MY CHEEK, but the underlying point is that things might have been different if the CEOs involved had had to pay a high personal penalty for failure in the game that they were playing. As it was, the temptation to press on with their gambling strategies was overwhelming, since they figured that the public, rather than themselves, would pay the penalty if those strategies failed. In the words of Citigroup ‘s chief executive officer Charles O. Prince, explaining why Citigroup Inc. wasn't slowing its lending amid the turmoil of the U.S. subprime mortgage market in July 2007: “As long as the music is playing, you've got to get up and dance. We're still dancing.”
PRICE AND OTHERS were dancing to the dangerous music of game theory, which in my view does have a lot to offer, both in understanding the causes of the crunch and in offering long-term escape routes.
THE CRUNCH ITSELF arose, at least in part, from a situation that game theorists know as The Prisoner’s Dilemma (when it involves two parties) or The Tragedy of the Commons (when many parties are involved). Both names refer to situations where the rewards accrue to individuals, but the costs are shared by the community – in this case, in the form of bail-outs that come from our taxes, not to mention the ruined lives of those who have lost everything.
IN SUCH SITUATIONS, cooperation would lead to the best overall outcome, but individual parties are tempted to break the cooperation because this will benefit them more, no matter what the other party does. The dilemma comes from the fact that, when all parties use the same undeniable logic, they somehow end up in a worse situation than if they had maintained the cooperation in the first place.
OUR FINANCIAL INSTITUTIONS have certainly landed themselves in a pretty bad situation. If they had cooperated by revealing the true extent of their underlying assets to each other early on, trust between them might have been maintained. Loss of this trust was one of the principal causes of the crunch.
IN THE SHORT TERM, we can’t do much about it until we have taken the painful steps of isolating the toxic loans and curing the institutional behaviour that led to such loans being made. In the longer term, we face the even more serious issue of rebuilding trust in and between financial institutions. In the latter case, game theory has a great deal to say. In particular, it suggests strategies that make it in the best interests of financial institutions to reveal their assets more openly to each other.
THE BEST of such strategies do not need legislation to drive them, but are self-enforcing. To give one example, if two institutions are linked in such a way that if one falls the other must follow, then transparency and communication between them are become practical necessities.
THIS IS NOT TO SAY THAT GAME THEORY HAS ALL THE ANSWERS; that would be a ridiculous claim. But it does provide a new context in which to think about our problems, and theoretical strategies that can often be adapted to real-world situations. These strategies belong to everyone, and should no longer be the exclusive province of experts.
IF ALL ELSE FAILS, we could still get the heads of financial institutions to light their pants on fire. Who knows - it might work. At the least, it would provide some satisfaction to those of us who have suffered the consequences of their decisions.
YOU ARE WELCOME to reproduce this article, so long as you include the acknowledgment "Written by and copyright to Len Fisher, author of "Rock, Paper, Scissors: Game Theory in Everyday Life."
CAN GAME THEORY HELP US in the current financial mess? According to some skeptics, the answer is no, because they believe that game theory can be manipulated to explain anything. “If a bank president was standing in the street and lighting his pants on fire” says strategic analyst Richard Rumelt “some game theorist would explain it as rational.”
I AM KEENLY INTERESTED in what game theory has to offer, and Rumelt’s example seems to offer something very practical when it comes to the credit crunch. If the leaders of financial institutions had known that the eventual penalty for offering toxic loans and concealing the true value of their assets would be having to burn their britches behind them, perhaps the crunch could have been avoided.
OK, MAYBE I HAVE MY TONGUE IN MY CHEEK, but the underlying point is that things might have been different if the CEOs involved had had to pay a high personal penalty for failure in the game that they were playing. As it was, the temptation to press on with their gambling strategies was overwhelming, since they figured that the public, rather than themselves, would pay the penalty if those strategies failed. In the words of Citigroup ‘s chief executive officer Charles O. Prince, explaining why Citigroup Inc. wasn't slowing its lending amid the turmoil of the U.S. subprime mortgage market in July 2007: “As long as the music is playing, you've got to get up and dance. We're still dancing.”
PRICE AND OTHERS were dancing to the dangerous music of game theory, which in my view does have a lot to offer, both in understanding the causes of the crunch and in offering long-term escape routes.
THE CRUNCH ITSELF arose, at least in part, from a situation that game theorists know as The Prisoner’s Dilemma (when it involves two parties) or The Tragedy of the Commons (when many parties are involved). Both names refer to situations where the rewards accrue to individuals, but the costs are shared by the community – in this case, in the form of bail-outs that come from our taxes, not to mention the ruined lives of those who have lost everything.
IN SUCH SITUATIONS, cooperation would lead to the best overall outcome, but individual parties are tempted to break the cooperation because this will benefit them more, no matter what the other party does. The dilemma comes from the fact that, when all parties use the same undeniable logic, they somehow end up in a worse situation than if they had maintained the cooperation in the first place.
OUR FINANCIAL INSTITUTIONS have certainly landed themselves in a pretty bad situation. If they had cooperated by revealing the true extent of their underlying assets to each other early on, trust between them might have been maintained. Loss of this trust was one of the principal causes of the crunch.
IN THE SHORT TERM, we can’t do much about it until we have taken the painful steps of isolating the toxic loans and curing the institutional behaviour that led to such loans being made. In the longer term, we face the even more serious issue of rebuilding trust in and between financial institutions. In the latter case, game theory has a great deal to say. In particular, it suggests strategies that make it in the best interests of financial institutions to reveal their assets more openly to each other.
THE BEST of such strategies do not need legislation to drive them, but are self-enforcing. To give one example, if two institutions are linked in such a way that if one falls the other must follow, then transparency and communication between them are become practical necessities.
THIS IS NOT TO SAY THAT GAME THEORY HAS ALL THE ANSWERS; that would be a ridiculous claim. But it does provide a new context in which to think about our problems, and theoretical strategies that can often be adapted to real-world situations. These strategies belong to everyone, and should no longer be the exclusive province of experts.
IF ALL ELSE FAILS, we could still get the heads of financial institutions to light their pants on fire. Who knows - it might work. At the least, it would provide some satisfaction to those of us who have suffered the consequences of their decisions.
Monday, December 1, 2008
JUNK MAIL IS JUNKING OUR LIVES
ACCORDING TO AN ASSOCIATED PRESS REPORT, former North Carolina mailman Steven Padgett refused to deliver junk mail, and buried it in his backyard instead.
THE U.S. POSTAL SERVICE did not receive a single complaint about the missing pizza circulars, oil change discounts and Chinese restaurant specials.
JUNK MAIL, JUNK EMAILS, SPAM AND COLD PHONE CALLS are all surprising examples of the Tragedy of the Commons - a situation where the benefits accrue to the individual, but the costs are borne by the community. There are many more serious examples, including resource depletion, pollution, and global warming.
AS MR. PADGETT SHOWED, individuals can make a difference. Congratulations, Mr. Padgett, for showing that individuals can take action to break this vicious nexus.
FOR MORE BACKGROUND ON GAME THEORY IN EVERYDAY LIFE, see my November 9 post:
THE CATCH-22 LOGICAL TRAP THAT THREATENS OUR WORLD
Thursday, November 27, 2008
GAME THEORY IN THE ARCTIC COLD (WAR)
IN A SCENE REMINISCENT OF THE COLD WAR, U.S F-15 jet fighters have today been tailing Russian bombers in the Arctic skies. According to a report from the Interfax news agency "Russia has stepped up its military presence in the Arctic, as international competition and tension over the resource-rich region has increased."
DISPUTES OVER RESOURCES are the most common cause of war. In this case, which is concerned among other things with competing claims to undersea oil exploration rights, Nobel Prize winning game theorist Robert Aumann has provided a neat solution in the form of "equal division of the contested sum" - i.e. agree by negotiation on sovereign rights to specific areas, and where there is disagreement, divide the disputed area equally among the disputants.
AMERICA AND RUSSIA are not the only nations involved, but the principle still holds true, in personal matters as much as in the international arena. Try it. As I show in "Rock, Paper, Scissors", it's mathematically proven to be the fairest way!
FOR MORE BACKGROUND, see my November 9 post:
THE CATCH-22 LOGICAL TRAP THAT THREATENS OUR WORLD
Wednesday, November 26, 2008
GAME THEORY AND THE CUBA QUESTION
A REVIEW of “Rock, Paper, Scissors” in this week’s Newsweek (SECTION: PERISCOPE; PAGE TURNER; Pg. 13 Vol. 152 No. 22 BYLINE: Jeneen Interlandi) brilliantly summarizes what the book is about. The author calls it The Science of Working Together, which is a heading that I wish I had thought of. “The trick” she says, in summarizing my conclusions “is to establish an agreement where everyone's self-interest is best served by cooperating.”
ONE STORY from today’s news that illustrates the point concerns an interview with Cuban President Raul Castro conducted by US actor Sean Penn for The Nation. Castro suggests in this interview that that US oil companies could be invited to explore for petroleum reserves in offshore projects in return for the trade embargo being lifted. This is a perfect example of the game theory strategy highlighted in Interlandi’s review.
WILL OBAMA follow the strategy? He has already promised some positive, humanitarian action with regard to Cuba. According to a Reuter’s report by reporter Patrick Markey “Mr Obama has said he will reverse the Bush administration's policies that restricted Cuban Americans visiting Cuba and sending cash to their families there.”
ACCORDING TO THE REUTERS REPORT, Obama is willing to talk to Castro, but would keep the 46-year-old trade embargo as leverage to influence democratic changes in the one-party state. Castro has his own lever, though, in the promise of oil exploration rights. If the two levers combine forces to produce cooperation, then game theory will have done its job.
SEE OTHER POSTS BELOW (AND DO PLEASE COMMENT - YOUR IDEAS AND CRITICISMS WILL BE HIGHLY VALUED, AND WILL BE RESPONDED TO):
ONE STORY from today’s news that illustrates the point concerns an interview with Cuban President Raul Castro conducted by US actor Sean Penn for The Nation. Castro suggests in this interview that that US oil companies could be invited to explore for petroleum reserves in offshore projects in return for the trade embargo being lifted. This is a perfect example of the game theory strategy highlighted in Interlandi’s review.
WILL OBAMA follow the strategy? He has already promised some positive, humanitarian action with regard to Cuba. According to a Reuter’s report by reporter Patrick Markey “Mr Obama has said he will reverse the Bush administration's policies that restricted Cuban Americans visiting Cuba and sending cash to their families there.”
ACCORDING TO THE REUTERS REPORT, Obama is willing to talk to Castro, but would keep the 46-year-old trade embargo as leverage to influence democratic changes in the one-party state. Castro has his own lever, though, in the promise of oil exploration rights. If the two levers combine forces to produce cooperation, then game theory will have done its job.
SEE OTHER POSTS BELOW (AND DO PLEASE COMMENT - YOUR IDEAS AND CRITICISMS WILL BE HIGHLY VALUED, AND WILL BE RESPONDED TO):
- GAME THEORY AND THE CREDIT CRUNCH
- THE CATCH-22 LOGICAL TRAP THAT THREATENS OUR WORLD
Wednesday, November 19, 2008
GAME THEORY AND THE CREDIT CRUNCH
ACCORDING TO AN EMAIL from Bloomberg.com reviewer Jim Pressley "Your book has incredible relevance on a day when U.S. stocks have fallen to their lowest levels since 2003." He was talking especially about the Ten Top Tips that I offer for using game theory strategies to promote cooperation.
MANY ECONOMISTS have commented on the need for rebuilding trust (in this case, between financial institutions). The trust needs to have a genuine basis of credible commitment from all sides, which means (as the economists have pointed out) that in this case that there needs to be transparency in revealing the true value of the assets used to back loans. But how might it be achieved?
GAME THEORY has a lot to say on this topic, and many of my Ten Top Tips could come into play. Here is one suggestion, based on my Number Ten Top Tip - divide large groups into smaller ones (and build co-operation up from this base). Game theory shows that very large groups of individuals or institutions have a lower chance than smaller groups of coordinating their actions to produce a cooperative outcome, because repeated interactions between individual pairs within the group are less common, and other restraints on cheating are often less powerful. One way to re-establish trust, then, is to begin with groups consisting of a small number of institutions. Trust is easier to establish in such a small group. Maybe, for example, a pair of institutions will be more willing to reveal their assets to each other because they have a relationship that extends beyond the market. If one of them had a similar relationship with a third institution, then the group could be enlarged from two to three (cf. my Tip Two - bring an extra player in) and so on progressively. If, at any stage, trust in one of those institutions turned out to be misplaced, my Tip One - Stay if you Win, Shift if you Lose comes into play, which in this case means cutting the offending institution out of the network. Keeping the network to a finite size would also mean that repeated interactions would be more common (Tip Three - set up some form of reciprocity), and an institution’s reputation within the network would suffer if it did not deliver (Tip Four - restrict your own future options so that you will lose out if you defect on cooperation). Finally, negotiators in the not-too-distant future may be able to use the remarkable properties of quantum computers (as I describe in chapter eight of "Rock, Paper, Scissors) to “read each others' minds” – the ultimate in transparency, and perhaps the ultimate in removing incentives to cheat.
ALL OF THIS is not to say that game theory provides complete answers, but it does suggest sensible directions AND PROVIDES GOOD REASONS FOR FOLLOWING THEM, BASED ON THE REAL WAY IN WHICH PEOPLE BEHAVE IN PURSUIT OF THEIR OWN BEST INTERESTS. Maybe this is the best that we can hope for.
FOR MORE BACKGROUND, see my November 9 post:
ACCORDING TO AN EMAIL from Bloomberg.com reviewer Jim Pressley "Your book has incredible relevance on a day when U.S. stocks have fallen to their lowest levels since 2003." He was talking especially about the Ten Top Tips that I offer for using game theory strategies to promote cooperation.
MANY ECONOMISTS have commented on the need for rebuilding trust (in this case, between financial institutions). The trust needs to have a genuine basis of credible commitment from all sides, which means (as the economists have pointed out) that in this case that there needs to be transparency in revealing the true value of the assets used to back loans. But how might it be achieved?
GAME THEORY has a lot to say on this topic, and many of my Ten Top Tips could come into play. Here is one suggestion, based on my Number Ten Top Tip - divide large groups into smaller ones (and build co-operation up from this base). Game theory shows that very large groups of individuals or institutions have a lower chance than smaller groups of coordinating their actions to produce a cooperative outcome, because repeated interactions between individual pairs within the group are less common, and other restraints on cheating are often less powerful. One way to re-establish trust, then, is to begin with groups consisting of a small number of institutions. Trust is easier to establish in such a small group. Maybe, for example, a pair of institutions will be more willing to reveal their assets to each other because they have a relationship that extends beyond the market. If one of them had a similar relationship with a third institution, then the group could be enlarged from two to three (cf. my Tip Two - bring an extra player in) and so on progressively. If, at any stage, trust in one of those institutions turned out to be misplaced, my Tip One - Stay if you Win, Shift if you Lose comes into play, which in this case means cutting the offending institution out of the network. Keeping the network to a finite size would also mean that repeated interactions would be more common (Tip Three - set up some form of reciprocity), and an institution’s reputation within the network would suffer if it did not deliver (Tip Four - restrict your own future options so that you will lose out if you defect on cooperation). Finally, negotiators in the not-too-distant future may be able to use the remarkable properties of quantum computers (as I describe in chapter eight of "Rock, Paper, Scissors) to “read each others' minds” – the ultimate in transparency, and perhaps the ultimate in removing incentives to cheat.
ALL OF THIS is not to say that game theory provides complete answers, but it does suggest sensible directions AND PROVIDES GOOD REASONS FOR FOLLOWING THEM, BASED ON THE REAL WAY IN WHICH PEOPLE BEHAVE IN PURSUIT OF THEIR OWN BEST INTERESTS. Maybe this is the best that we can hope for.
FOR MORE BACKGROUND, see my November 9 post:
THE CATCH-22 LOGICAL TRAP THAT THREATENS OUR WORLD
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