Posted by on Sep 18, 2015 in Articles & Advice, Blog, Books, Posts, Video |

Image credit: “Big Fish Eat Little Fish,” engraving, 1557, Pieter van der Heyden, after Pieter Bruegel the Elder and Hieronymus Bosch, National Gallery of Art

By Jason Zweig | Sept. 15, 2015  3:43 p.m. ET

The free market isn’t merely the best mechanism ever devised to provide people with what they want; it is also the best mechanism ever devised to provide people with what they don’t want. That is the thesis of the new book Phishing for Phools: The Economics of Manipulation and Deception, by Nobel laureates in economics George A. Akerlof and Robert J. Shiller.

In their book, a business “phishes” when it exploits the informational and emotional weaknesses of customers in order to sell them goods, services or investments that might be harmful. (Think of cigarettes, gambling, flawed pharmaceuticals such as the withdrawn arthritis drug Vioxx, or complex investments with hidden risks like the mortgage securities that were at the heart of the 2008-2009 financial crisis.) A “phool” is anyone who falls for such phishing.

While some of the argument may seem obvious—surely it isn’t a surprise that some people cheat at least some of the time—“Phishing for Phools” contends that free markets can create fertile opportunities to profit from dishonesty.

Mr. Akerlof is a professor of economics at Georgetown University and the husband of Federal Reserve Chairwoman Janet Yellen; Mr. Shiller, a professor of finance at Yale University and author of Irrational Exuberance. The two discussed the book in a recent interview.

Q: Why do businesses “phish” for “phools”?

Robert Shiller: A fundamental concept of psychology is that people often make decisions they’re not happy about. That’s why people go see therapists! If businesses have a chance to profit by tempting us into making decisions that are good for them but bad for us, they will take it. They have just as powerful an incentive to provide us with what we don’t want as to provide us with what we do want.

Q: What is “reputation mining” and how can it lead to deception?

George Akerlof: Let’s say you have this reputation for selling wonderful avocados. Then you have the opportunity to start selling people awful avocados if that’s more profitable. We think that’s how things [happened] in financial markets [before] the 2008 financial crisis.

RS: Financial markets are a special case because they present, for most people, a very difficult judgment about the future: What is this market going to do? It invites a kind of exploitation of them by storytellers, people who will play tricks on them to get their money to manage. In many cases, they’re more salespeople than market researchers.

Q: Are there different kinds of phools?

RS: An information phool is someone who has been fed a biased set of information so that they then would make erroneous judgments. A psychological phool is someone who is affected by his or her own feelings, emotions and psychological anomalies. Information phools and psychological phools are everywhere, and you might be one of them. We know that we are.

Q: But why isn’t phishing competed away? Why don’t customers do business only with those who treat them fairly?

RS: Often the glitch in your defenses is very subtle and even the phisher doesn’t know exactly how it works. Also, businesses play tricks, and [their] competitors play tricks. Businesses often have tight profit margins. They can’t give money away. So they have to play the same tricks themselves. Professionals develop skills in manipulating people, and there’s a survival of the fittest for them: The very best ones amplify and are everywhere in their impact.

Q: The book argues that incentives will inevitably lead some people to manipulate and cheat others. Doesn’t every five-year-old child learn on the playground that some kids cheat when they trade candy and gum? Doesn’t everybody already know what you’re saying?

GA: Everybody thinks they know it. But people think of manipulation and deception as things that take place on a one-off basis, not as something that’s inevitable. Phishing is as universal as the benevolence of the butcher and the brewer and the baker that Adam Smith talked about.

Q: You ate cat food to research a common way you think consumers may be phished by marketers.

RS: The labels on the cans said things like ‘roast beef paté’; things that we would see in a restaurant. So I said, if they say that, it must be something like that. I tried tasting it, and they all tasted pretty much the same. They tasted like cat food. There is an artificial reality that is created by marketing.

Q: How can investors minimize the risks of being phished for a phool?

GA: They should bear in mind that asset prices reflect the stories being told about those assets. Those stories do not just reflect economic fundamentals; significant parts of them are generated by those whose livelihood depends on making a sale. For this basic reason, financial markets are filled with phishing for phools.

RS: Investors should always remember that a profitable phish is to design investment pitches around their preconceptions. A search of the phrase “stocks have always outperformed” on Google Ngrams shows that the phrase first appeared around the bottom of the market in 1982; its use exploded until the market peak in 2000. Why? Because with a rising market it was advantageous for phishermen to suggest that this up market would continue forever.


Video interview with Akerlof and Shiller: