[MUD-Dev] Charlie Munger on the Psychology of Human Misjudgment

[J C Lawrence]

Questions of analysing both player motivation and methods of creating
effective incentives toward desired actions (or away from undesired
actions) are common grist for MUD-Dev's mill.  A critical portion of
motivation is (in)estimation/evaluation by players.

From:

  http://www.tilsonfunds.com/mungerpsych.html

The reference to the Stanford Prison Experiment (see below) is
particularly interesting:

  http://www.prisonexp.org/slide-5.htm

As Phil commented on DevMUD:

  Pelican Bay is California's supermax prison facility.  
  ...  
  Well, the inmates at Pelican Bay are extremely hardened criminals,
  highly organized, highly motivated and with lots of time on their
  hands.  Certain parallels can be drawn between them and certain player
  populations.
  ...
  And hundreds of these criminals have to be monitored and controlled by
  relatively few guards, who are also of dubious honestly.

The parallels to MUDs are striking.

--<cut>--
			 CHARLIE MUNGER ON THE
		    PSYCHOLOGY OF HUMAN MISJUDGMENT

Speech at Harvard Law School (estimated date: June, 1995)

Transcription, comments [in brackets] and minor editing by Whitney
Tilson (feedback at Tilsonfunds.com)

For an article about this speech, see Munger on Human Misjudgments:

  http://www.fool.com/news/foth/2002/foth020821.htm

Moderator: ...and they discovered extreme, obvious irrationality in many
areas of the economy that they looked at. And they were a little bit
troubled because nothing that they had learned in graduate school
explained these patterns. Now I would hope that Mr. Munger spends a
little bit more time around graduate schools today, because we've gotten
now where he was 30 years ago, and we are trying to explain those
patterns, and some of the people who are doing that will be speaking
with you today.

So I think he thinks of his specialty as the Psychology of Human
Misjudgment, and part of this human misjudgment, of course, comes from
worrying about the types of fads and social pressures that Henry Kaufman
talked to us about. I think it's significant that Berkshire Hathaway is
not headquartered in New York, or even in Los Angeles or San Francisco,
but rather in the heart of the country in Nebraska.

When he referred to this problem of human misjudgment, he identified two
significant problems, and I'm sure that there are many more, but when he
said, "By not relying on this, and not understanding this, it was
costing me a lot of money," and I presume that some of you are here in
the theory that maybe it's costing you even a somewhat lesser amount of
money. And the second point that Mr. Munger made was it was
reducing...not understanding human misjudgment was reducing my ability
to help everything I loved. Well I hope he loves you, and I'm sure he'll
help you. Thank you. [Applause]

Munger: Although I am very interested in the subject of human
misjudgment -- and lord knows I've created a good bit of it -- I don't
think I've created my full statistical share, and I think that one of
the reasons was I tried to do something about this terrible ignorance I
left the Harvard Law School with.

When I saw this patterned irrationality, which was so extreme, and I had
no theory or anything to deal with it, but I could see that it was
extreme, and I could see that it was patterned, I just started to create
my own system of psychology, partly by casual reading, but largely from
personal experience, and I used that pattern to help me get through
life. Fairly late in life I stumbled into this book, Influence, by a
psychologist named Bob Cialdini, who became a super-tenured hotshot on a
2,000-person faculty at a very young age. And he wrote this book, which
has now sold 300-odd thousand copies, which is remarkable for
somebody. Well, it's an academic book aimed at a popular audience that
filled in a lot of holes in my crude system. In those holes it filled
in, I thought I had a system that was a good-working tool, and I'd like
to share that one with you.

And I came here because behavioral economics. How could economics not be
behavioral? If it isn't behavioral, what the hell is it? And I think
it's fairly clear that all reality has to respect all other reality. If
you come to inconsistencies, they have to be resolved, and so if there's
anything valid in psychology, economics has to recognize it, and vice
versa. So I think the people that are working on this fringe between
economics and psychology are absolutely right to be there, and I think
there's been plenty wrong over the years. Well let me romp through as
much of this list as I have time to get through:

24 Standard Causes of Human Misjudgment

First: Under-recognition of the power of what psychologists call
'reinforcement' and economists call 'incentives.'

Well you can say, "Everybody knows that." Well I think I've been in the
top 5% of my age cohort all my life in understanding the power of
incentives, and all my life I've underestimated it. And never a year
passes but I get some surprise that pushes my limit a little farther.

One of my favorite cases about the power of incentives is the Federal
Express case. The heart and soul of the integrity of the system is that
all the packages have to be shifted rapidly in one central location each
night. And the system has no integrity if the whole shift can't be done
fast. And Federal Express had one hell of a time getting the thing to
work. And they tried moral suasion, they tried everything in the world,
and finally somebody got the happy thought that they were paying the
night shift by the hour, and that maybe if they paid them by the shift,
the system would work better. And lo and behold, that solution worked.

Early in the history of Xerox, Joe Wilson, who was then in the
government, had to go back to Xerox because he couldn't understand how
their better, new machine was selling so poorly in relation to their
older and inferior machine. Of course when he got there he found out
that the commission arrangement with the salesmen gave a tremendous
incentive to the inferior machine.

And here at Harvard, in the shadow of B.F. Skinner -- there was a man
who really was into reinforcement as a powerful thought, and, you know,
Skinner's lost his reputation in a lot of places, but if you were to
analyze the entire history of experimental science at Harvard, he'd be
in the top handful. His experiments were very ingenious, the results
were counter-intuitive, and they were important. It is not given to
experimental science to do better. What gummed up Skinner's reputation
is that he developed a case of what I always call man-with-a-hammer
syndrome: to the man with a hammer, every problem tends to look pretty
much like a nail. And Skinner had one of the more extreme cases in the
history of Academia, and this syndrome doesn't exempt bright
people. It's just a man with a hammer...and Skinner is an extreme
example of that. And later, as I go down my list, let's go back and try
and figure out why people, like Skinner, get man-with-a-hammer syndrome.

Incidentally, when I was at the Harvard Law School there was a
professor, naturally at Yale, who was derisively discussed at Harvard,
and they used to say, "Poor old Blanchard. He thinks declaratory
judgments will cure cancer."  And that's the way Skinner got. And not
only that, he was literary, and he scorned opponents who had any
different way of thinking or thought anything else was important. This
is not a way to make a lasting reputation if the other people turn out
to also be doing something important.

2. My second factor is simple psychological denial.

This first really hit me between the eyes when a friend of our family
had a super-athlete, super-student son who flew off a carrier in the
north Atlantic and never came back, and his mother, who was a very sane
woman, just never believed that he was dead. And, of course, if you turn
on the television, you'll find the mothers of the most obvious criminals
that man could ever diagnose, and they all think their sons are
innocent. That's simple psychological denial. The reality is too painful
to bear, so you just distort it until it's bearable. We all do that to
some extent, and it's a common psychological misjudgment that causes
terrible problems.

3. Third: incentive-cause bias, both in one's own mind and that of ones
trusted advisor, where it creates what economists call 'agency costs.'

Here, my early experience was a doctor who sent bushel baskets full of
normal gall bladders down to the pathology lab in the leading hospital
in Lincoln, Nebraska. And with that quality control for which community
hospitals are famous, about five years after he should've been removed
from the staff, he was. And one of the old doctors who participated in
the removal was also a family friend, and I asked him: I said, "Tell me,
did he think, 'Here's a way for me to exercise my talents'" -- this guy
was very skilled technically-- "'and make a high living by doing a few
maimings and murders every year, along with some frauds?'" And he said,
"Hell no, Charlie. He thought that the gall bladder was the source of
all medical evil, and if you really love your patients, you couldn't get
that organ out rapidly enough."

Now that's an extreme case, but in lesser strength, it's present in
every profession and in every human being. And it causes perfectly
terrible behavior. If you take sales presentations and brokers of
commercial real estate and businesses... I'm 70 years old, I've never
seen one I thought was even within hailing distance of objective
truth. If you want to talk about the power of incentives and the power
of rationalized, terrible behavior: after the Defense Department had had
enough experience with cost-plus percentage of cost contracts, the
reaction of our republic was to make it a crime for the federal
government to write one, and not only a crime, but a felony.

And by the way, the government's right, but a lot of the way the world
is run, including most law firms and a lot of other places, they've
still got a cost-plus percentage of cost system. And human nature, with
its version of what I call 'incentive-caused bias,' causes this terrible
abuse. And many of the people who are doing it you would be glad to have
married into your family compared to what you're otherwise going to
get. [Laughter]

Now there are huge implications from the fact that the human mind is put
together this way, and that is that people who create things like cash
registers, which make most [dishonest] behavior hard, are some of the
effective saints of our civilization. And the cash register was a great
moral instrument when it was created. And Patterson knew that, by the
way. He had a little store, and the people were stealing him blind and
never made any money, and people sold him a couple of cash registers and
it went to profit immediately. And, of course, he closed the store and
went into the cash register business...

And so this is a huge, important thing. If you read the psychology
texts, you will find that if they're 1,000 pages long, there's one
sentence. Somehow incentive-caused bias has escaped the standard survey
course in psychology.

4. Fourth, and this is a superpower in error-causing psychological
tendency: bias from consistency and commitment tendency, including the
tendency to avoid or promptly resolve cognitive dissonance. Includes the
self-confirmation tendency of all conclusions, particularly expressed
conclusions, and with a special persistence for conclusions that are
hard-won.

Well what I'm saying here is that the human mind is a lot like the human
egg, and the human egg has a shut-off device. When one sperm gets in, it
shuts down so the next one can't get in. The human mind has a big
tendency of the same sort. And here again, it doesn't just catch
ordinary mortals; it catches the deans of physics. According to Max
Planck, the really innovative, important new physics was never really
accepted by the old guard. Instead a new guard came along that was less
brain-blocked by its previous conclusions. And if Max Planck's crowd had
this consistency and commitment tendency that kept their old inclusions
intact in spite of disconfirming evidence, you can imagine what the
crowd that you and I are part of behaves like.

And of course, if you make a public disclosure of your conclusion,
you're pounding it into your own head. Many of these students that are
screaming at us, you know, they aren't convincing us, but they're
forming mental change for themselves, because what they're shouting out
[is] what they're pounding in. And I think educational institutions that
create a climate where too much of that goes on are...in a fundamental
sense, they're irresponsible institutions. It's very important to not
put your brain in chains too young by what you shout out.

And all these things like painful qualifying and initiation rituals
pound in your commitments and your ideas. The Chinese brainwashing
system, which was for war prisoners, was way better than anybody
else's. They maneuvered people into making tiny little commitments and
declarations, and then they'd slowly build. That worked way better than
torture.

5. Fifth: bias from Pavlovian association, misconstruing past
correlation as a reliable basis for decision-making.

I never took a course in psychology, or economics either for that
matter, but I did learn about Pavlov in high school biology. And the way
they taught it, you know, so the dog salivated when the bell rang. So
what? Nobody made the least effort to tie that to the wide world. Well
the truth of the matter is that Pavlovian association is an enormously
powerful psychological force in the daily life of all of us. And,
indeed, in economics we wouldn't have money without the role of
so-called secondary reinforcement, which is a pure psychological
phenomenon demonstrated in the laboratory.

Practically...I'd say 3/4 of advertising works on pure Pavlov. Think how
association, pure association, works. Take Coca-Cola company (we're the
biggest share-holder). They want to be associated with every wonderful
image: heroics in the Olympics, wonderful music, you name it. They don't
want to be associated with presidents' funerals and so-forth. When have
you seen a Coca-Cola ad...and the association really works.

And all these psychological tendencies work largely or entirely on a
subconscious level, which makes them very insidious. Now you've got
Persian messenger syndrome. The Persians really did kill the messenger
who brought the bad news. You think that is dead? I mean you should've
seen Bill Paley in his last 20 years. [Paley was the former owner,
chairman and CEO of CBS; see
http://www.kcmetro.cc.mo.us/pennvalley/biology/lewis/crosby/paley.htm
for his bio.] He didn't hear one damn thing he didn't want to
hear. People knew that it was bad for the messenger to bring Bill Paley
things he didn't want to hear. Well that means that the leader gets in a
cocoon of unreality, and this is a great big enterprise, and boy, did he
make some dumb decisions in the last 20 years.

And now the Persian messenger syndrome is alive and well. I saw, some
years ago, Arco and Exxon arguing over a few hundred millions of
ambiguity in their North Slope treaties before a superior court judge in
Texas, with armies of lawyers and experts on each side. Now this is a
Mad Hatter's tea party: two engineering-style companies can't resolve
some ambiguity without spending tens of millions of dollars in some
Texas superior court? In my opinion what happens is that nobody wants to
bring the bad news to the executives up the line. But here's a few
hundred million dollars you thought you had that you don't. And it's
much safer to act like the Persian messenger who goes away to hide
rather than bring home the news of the battle lost.

Talking about economics, you get a very interesting phenomenon that I've
seen over and over again in a long life. You've got two products;
suppose they're complex, technical products. Now you'd think, under the
laws of economics, that if product A costs X, if product Y costs X minus
something, it will sell better than if it sells at X plus something, but
that's not so. In many cases when you raise the price of the alternative
products, it'll get a larger market share than it would when you make it
lower than your competitor's product. That's because the bell, a
Pavlovian bell -- I mean ordinarily there's a correlation between price
and value -- then you have an information inefficiency. And so when you
raise the price, the sales go up relative to your competitor. That
happens again and again and again. It's a pure Pavlovian phenomenon. You
can say, "Well, the economists have figured this sort of thing out when
they started talking about information inefficiencies," but that was
fairly late in economics that they found such an obvious thing. And, of
course, most of them don't ask what causes the information
inefficiencies.

Well one of the things that causes it is pure old Pavlov and his
dog. Now you've got bios from Skinnerian association: operant
conditioning, you know, where you give the dog a reward and pound in the
behavior that preceded the dog's getting the award. And, of course,
Skinner was able to create superstitious pigeons by having the rewards
come by accident with certain occurrences, and, of course, we all know
people who are the human equivalents of superstitious pigeons. That's a
very powerful phenomenon. And, of course, operant conditioning really
works. I mean the people in the center who think that operant
conditioning is important are very much right, it's just that Skinner
overdid it a little.

Where you see in business just perfectly horrible results from
psychologically-rooted tendencies is in accounting. If you take
Westinghouse, which blew, what, two or three billion dollars pre-tax at
least loaning developers to build hotels, and virtually 100% loans? Now
you say any idiot knows that if there's one thing you don't like it's a
developer, and another you don't like it's a hotel. And to make a 100%
loan to a developer who's going to build a hotel... [Laughter] But this
guy, he probably was an engineer or something, and he didn't take
psychology any more than I did, and he got out there in the hands of
these salesmen operating under their version of incentive-caused bias,
where any damned way of getting Westinghouse to do it was considered
normal business, and they just blew it.

That would never have been possible if the accounting system hadn't been
such but for the initial phase of every transaction it showed wonderful
financial results. So people who have loose accounting standards are
just inviting perfectly horrible behavior in other people. And it's a
sin, it's an absolute sin. If you carry bushel baskets full of money
through the ghetto, and made it easy to steal, that would be a
considerable human sin, because you'd be causing a lot of bad behavior,
and the bad behavior would spread. Similarly an institution that gets
sloppy accounting commits a real human sin, and it's also a dumb way to
do business, as Westinghouse has so wonderfully proved.

Oddly enough nobody mentions, at least nobody I've seen, what happened
with Joe Jett and Kidder Peabody. The truth of the matter is the
accounting system was such that by punching a few buttons, the Joe Jetts
of the world could show profits, and profits that showed up in things
that resulted in rewards and esteem and every other thing... Well the
Joe Jetts are always with us, and they're not really to blame, in my
judgment at least. But that bastard who created that foolish accounting
system who, so far as I know, has not been flayed alive, ought to be.

6. Sixth: bias from reciprocation tendency, including the tendency of
one on a roll to act as other persons expect.

Well here, again, Cialdini does a magnificent job at this, and you're
all going to be given a copy of Cialdini's book. And if you have half as
much sense as I think you do, you will immediately order copies for all
of your children and several of your friends. You will never make a
better investment.

It is so easy to be a patsy for what he calls the compliance
practitioners of this life. At any rate, reciprocation tendency is a
very, very powerful phenomenon, and Cialdini demonstrated this by
running around a campus, and he asked people to take juvenile
delinquents to the zoo. And it was a campus, and so one in six actually
agreed to do it. And after he'd accumulated a statistical output he went
around on the same campus and he asked other people, he said, "Gee,
would you devote two afternoons a week to taking juvenile delinquents
somewhere and suffering greatly yourself to help them," and there he got
100% of the people to say no. But after he'd made the first request, he
backed up a little, and he said, "Would you at least take them to the
zoo one afternoon?" He raised the compliance rate from a third to a
half. He got three times the success by just going through the little
ask-for-a-lot-and-back-off.

Now if the human mind, on a subconscious level, can be manipulated that
way and you don't know it, I always use the phrase, "You're like a
one-legged man in an ass-kicking contest." I mean you are really giving
a lot of quarter to the external world that you can't afford to
give. And on this so-called role theory, where you tend to act in the
way that other people expect, and that's reciprocation if you think
about the way society is organized.

A guy named Zimbardo had people at Stanford divide into two pieces: one
were the guards and the other were the prisoners, and they started
acting out roles as people expected. He had to stop the experiment after
about five days. He was getting into human misery and breakdown and
pathological behavior. I mean it was...it was awesome. However, Zimbardo
is greatly misinterpreted. It's not just reciprocation tendency and role
theory that caused that, it's consistency and commitment tendency. Each
person, as he acted as a guard or a prisoner, the action itself was
pounding in the idea. [For more on this famous experiment:
http://www.prisonexp.org/]

Wherever you turn, this consistency and commitment tendency is affecting
you. In other words, what you think may change what you do, but perhaps
even more important, what you do will change what you think. And you can
say, "Everybody knows that." I want to tell you I didn't know it well
enough early enough.

7. Seventh, now this is a lollapalooza, and Henry Kaufman wisely talked
about this: bias from over-influence by social proof -- that is, the
conclusions of others, particularly under conditions of natural
uncertainty and stress.

And here, one of the cases the psychologists use is Kitty Genovese,
where all these people -- I don't know, 50, 60, 70 of them -- just sort
of sat and did nothing while she was slowly murdered. Now one of the
explanations is that everybody looked at everybody else and nobody else
was doing anything, and so there's automatic social proof that the right
thing to do is nothing. That's not a good enough explanation for Kitty
Genovese, in my judgment. That's only part of it. There are
microeconomic ideas and gain/loss ratios and so forth that also come
into play. I think time and time again, in reality, psychological
notions and economic notions interplay, and the man who doesn't
understand both is a damned fool.

Big-shot businessmen get into these waves of social proof. Do you
remember some years ago when one oil company bought a fertilizer
company, and every other major oil company practically ran out and
bought a fertilizer company?  And there was no more damned reason for
all these oil companies to buy fertilizer companies, but they didn't
know exactly what to do, and if Exxon was doing it, it was good enough
for Mobil, and vice versa. I think they're all gone now, but it was a
total disaster.

Now let's talk about efficient market theory, a wonderful economic
doctrine that had a long vogue in spite of the experience of Berkshire
Hathaway. In fact one of the economists who won -- he shared a Nobel
Prize -- and as he looked at Berkshire Hathaway year after year, which
people would throw in his face as saying maybe the market isn't quite as
efficient as you think, he said, "Well, it's a two-sigma event." And
then he said we were a three-sigma event. And then he said we were a
four-sigma event. And he finally got up to six sigmas -- better to add a
sigma than change a theory, just because the evidence comes in
differently. [Laughter] And, of course, when this share of a Nobel Prize
went into money management himself, he sank like a stone.

If you think about the doctrines I've talked about, namely, one, the
power of reinforcement -- after all you do something and the market goes
up and you get paid and rewarded and applauded and what have you,
meaning a lot of reinforcement, if you make a bet on a market and the
market goes with you. Also, there's social proof. I mean the prices on
the market are the ultimate form of social proof, reflecting what other
people think, and so the combination is very powerful. Why would you
expect general market levels to always be totally efficient, say even in
1973-74 at the pit, or in 1972 or whatever it was when the Nifty 50 were
in their heyday? If these psychological notions are correct, you would
expect some waves of irrationality, which carry general levels, so
they're inconsistent with reason.

8. Nine [he means eight]: what made these economists love the efficient
market theory is the math was so elegant.

And after all, math was what they'd learned to do. To the man with a
hammer, every problem tends to look pretty much like a nail. The
alternative truth was a little messy, and they'd forgotten the great
economists Keynes, whom I think said, "Better to be roughly right than
precisely wrong."

9. Nine: bias from contrast-caused distortions of sensation, perception
and cognition.

Here, the great experiment that Cialdini does in his class is he takes
three buckets of water: one's hot, one's cold and one's room
temperature, and he has the student stick his left hand in the hot water
and his right hand in the cold water. Then he has them remove the hands
and put them both in the room temperature bucket, and of course with
both hands in the same bucket of water, one seems hot, the other seems
cold because the sensation apparatus of man is over-influenced by
contrast. It has no absolute scale; it's got a contrast scale in it. And
it's a scale with quantum effects in it too. It takes a certain
percentage change before it's noticed.

Maybe you've had a magician remove your watch -- I certainly have --
without your noticing it. It's the same thing. He's taking advantage of
contrast-type troubles in your sensory apparatus. But here the great
truth is that cognition mimics sensation, and the cognition manipulators
mimic the watch-removing magician. In other words, people are
manipulating you all day long on this contrast phenomenon.

Cialdini cites the case of the real estate broker. And you've got the
rube that's been transferred into your town, and the first thing you do
is you take the rube out to two of the most awful, overpriced houses
you've ever seen, and then you take the rube to some moderately
overpriced house, and then you stick him. And it works pretty well,
which is why the real estate salesmen do it. And it's always going to
work.

And the accidents of life can do this to you, and it can ruin your
life. In my generation, when women lived at home until they got married,
I saw some perfectly terrible marriages made by highly desirable women
because they lived in terrible homes. And I've seen some terrible second
marriages which were made because they were slight improvements over an
even worse first marriage. You think you're immune from these things,
and you laugh, and I want to tell you, you aren't.

My favorite analogy I can't vouch for the accuracy of. I have this
worthless friend I like to play bridge with, and he's a total
intellectual amateur that lives on inherited money, but he told me once
something I really enjoyed hearing. He said, "Charlie," he say, "If you
throw a frog into very hot water, the frog will jump out, but if you put
the frog in room temperature water and just slowly heat the water up,
the frog will die there." Now I don't know whether that's true about a
frog, but it's sure as hell true about many of the businessmen I know
[laughter], and there, again, it is the contrast phenomenon. But these
are hot-shot, high-powered people. I mean these are not fools. If it
comes to you in small pieces, you're likely to miss, so if you're going
to be a person of good judgment, you have to do something about this
warp in your head where it's so misled by mere contrast.

10. Bias from over-influence by authority.

Well here, the Milgrim experiment, as it's called -- I think there have
been 1,600 psychological papers written about Milgrim. And he had a
person posing as an authority figure trick ordinary people into giving
what they had every reason to expect was heavy torture by electric shock
to perfectly innocent fellow citizens. And he was trying to show why
Hitler succeeded and a few other things, and so this really caught the
fancy of the world. Partly it's so politically correct, and
over-influence by authority...

You'll like this one: You get a pilot and a co-pilot. The pilot is the
authority figure. They don't do this in airplanes, but they've done it
in simulators. They have the pilot do something where the co-pilot,
who's been trained in simulators a long time -- he knows he's not to
allow the plane to crash -- they have the pilot to do something where an
idiot co-pilot would know the plane was going to crash, but the pilot's
doing it, and the co-pilot is sitting there, and the pilot is the
authority figure. 25% of the time the plane crashes. I mean this is a
very powerful psychological tendency. It's not quite as powerful as some
people think, and I'll get to that later.

11. Eleven: bias from deprival super-reaction syndrome, including bias
caused by present or threatened scarcity, including threatened removal
of something almost possessed, but never possessed.

Here I took the Munger dog, a lovely, harmless dog. The only way to get
that dog to bite you is to try and take something out of its mouth after
it was already there. And you know, if you've tried to do takeaways in
labor negotiations, you'll know that the human version of that dog is
there in all of us. And I have a neighbor, a predecessor who had a
little island around the house, and his next door neighbor put a little
pine tree on it that was about three feet high, and it turned his 180
degree view of the harbor into 179 3/4. Well they had a blood feud like
the Hatfields and McCoys, and it went on and on and on...

I mean people are really crazy about minor decrements down. And then, if
you act on them, then you get into reciprocation tendency, because you
don't just reciprocate affection, you reciprocate animosity, and the
whole thing can escalate. And so huge insanities can come from just
subconsciously over-weighing the importance of what you're losing or
almost getting and not getting.

And the extreme business case here was New Coke. Coca-Cola has the most
valuable trademark in the world. We're the major shareholder -- I think
we understand that trademark. Coke has armies of brilliant engineers,
lawyers, psychologists, advertising executives and so forth, and they
had a trademark on a flavor, and they'd spent the better part of 100
years getting people to believe that trademark had all these intangible
values too. And people associate it with a flavor. And so they were
going to tell people not that it was improved, because you can't improve
a flavor. A flavor is a matter of taste. I mean you may improve a
detergent or something, but don't think you're going to make a major
change in a flavor. So they got this huge deprival super-reaction
syndrome.

Pepsi was within weeks of coming out with old Coke in a Pepsi bottle,
which would've been the biggest fiasco in modern times. Perfect
insanity. And by the way, both Goizuetta [Coke's CEO at the time] and
Keough [an influential former president and director of the company] are
just wonderful about it. I mean they just joke. Keough always says, "I
must've been away on vacation."  He participated in every single
decision -- he's a wonderful guy. And by the way, Goizuetta is a
wonderful, smart guy -- an engineer. Smart people make these terrible
boners. How can you not understand deprival super-reaction syndrome? But
people do not react symmetrically to loss and gain. Well maybe a great
bridge player like Zeckhauser does, but that's a trained
response. Ordinary people, subconsciously affected by their inborn
tendencies...

12. Bias from envy/jealousy.

Well envy/jealousy made, what, two out of the ten commandments? Those of
you who have raised siblings you know about envy, or tried to run a law
firm or investment bank or even a faculty? I've heard Warren say a half
a dozen times, "It's not greed that drives the world, but envy."

Here again, you go through the psychology survey courses, and you go to
the index: envy/jealousy, 1,000-page book, it's blank. There's some
blind spots in academia, but it's an enormously powerful thing, and it
operates, to a considerable extent, on the subconscious level. Anybody
who doesn't understand it is taking on defects he shouldn't have.

13. Bias from chemical dependency.

Well, we don't have to talk about that. We've all seen so much of it,
but it's interesting how it'll always cause this moral breakdown if
there's any need, and it always involves massive denial. See it just
aggravates what we talked about earlier in the aviator case, the
tendency to distort reality so that it's endurable.

14. Bias from mis-gambling compulsion.

Well here, Skinner made the only explanation you'll find in the standard
psychology survey course. He, of course, created a variable
reinforcement rate for his pigeons and his mice, and he found that that
would pound in the behavior better than any other enforcement
pattern. And he says, "Ah ha!  I've explained why gambling is such a
powerful, addictive force in this civilization." I think that is, to a
very considerable extent, true, but being Skinner, he seemed to think
that was the only explanation, but the truth of the matter is that the
devisors of these modern machines and techniques know a lot of things
that Skinner didn't know.

For instance, a lottery. You have a lottery where you get your number by
lot, and then somebody draws a number by lot, it gets lousy play. You
have a lottery where people get to pick their number, you get big
play. Again, it's this consistency and commitment thing. People think if
they have committed to it, it has to be good. The minute they've picked
it themselves it gets an extra validity. After all, they thought it and
they acted on it.

Then if you take the slot machines, you get bar, bar, walnut. And it
happens again and again and again. You get all these near misses. Well
that's deprival super-reaction syndrome, and boy do the people who
create the machines understand human psychology. And for the high-IQ
crowd they've got poker machines where you make choices. So you can play
blackjack, so to speak, with the machine. It's wonderful what we've done
with our computers to ruin the civilization.

But at any rate, mis-gambling compulsion is a very, very powerful and
important thing. Look at what's happening to our country: every Indian
has a reservation, every river town, and look at the people who are
ruined by it with the aid of their stock brokers and others. And again,
if you look in the standard textbook of psychology you'll find
practically nothing on it except maybe one sentence talking about
Skinner's rats. That is not an adequate coverage of the subject.

15. Bias from liking distortion, including the tendency to especially
like oneself, one's own kind and one's own idea structures, and the
tendency to be especially susceptible to being misled by someone
liked. Disliking distortion, bias from that, the reciprocal of liking
distortion and the tendency not to learn appropriately from someone
disliked.

Well here, again, we've got hugely powerful tendencies, and if you look
at the wars in part of the Harvard Law School, as we sit here, you can
see that very brilliant people get into this almost pathological
behavior. And these are very, very powerful, basic, subconscious
psychological tendencies, or at least party subconscious.

Now let's get back to B.F. Skinner, man-with-a-hammer syndrome
revisited. Why is man-with-a-hammer syndrome always present? Well if you
stop to think about it, it's incentive-caused bias. His professional
reputation is all tied up with what he knows. He likes himself and he
likes his own ideas, and he's expressed them to other people --
consistency and commitment tendency. I mean you've got four or five of
these elementary psychological tendencies combining to create this
man-with-a-hammer syndrome.

Once you realize that you can't really buy your thinking -- partly you
can, but largely you can't in this world -- you have learned a lesson
that's very useful in life. George Bernard Shaw had a character say in
The Doctor's Dilemma, "In the last analysis, every profession is a
conspiracy against the laity." But he didn't have it quite right,
because it isn't so much a conspiracy as it is a subconscious,
psychological tendency.

The guy tells you what is good for him. He doesn't recognize that he's
doing anything wrong any more than that doctor did when he was pulling
out all those normal gall bladders. And he believes his own idea
structures will cure cancer, and he believes that the demons that he's
the guardian against are the biggest demons and the most important ones,
and in fact they may be very small demons compared to the demons that
you face. So you're getting your advice in this world from your paid
advisor with this huge load of ghastly bias. And woe to you.

There are only two ways to handle it: you can hire your advisor and then
just apply a windage factor, like I used to do when I was a rifle
shooter. I'd just adjust for so many miles an hour wind. Or you can
learn the basic elements of your advisor's trade. You don't have to
learn very much, by the way, because if you learn just a little then you
can make him explain why he's right. And those two tendencies will take
part of the warp out of the thinking you've tried to hire done. By and
large it works terribly. I have never seen a management consultant's
report in my long life that didn't end with the following paragraph:
"What this situation really needs is more management consulting." Never
once. I always turn to the last page. Of course Berkshire doesn't hire
them, so I only do this on sort of a voyeuristic basis. Sometimes I'm at
a non-profit where some idiot hires one. [Laughter]

16. Seventeen [he means 16]: bias from the non-mathematical nature of
the human brain in its natural state as it deal with probabilities
employing crude heuristics, and is often misled by mere contrast, a
tendency to overweigh conveniently available information and other
psychologically misrouted thinking tendencies on this list.

When the brain should be using the simple probability mathematics of
Fermat and Pascal applied to all reasonably obtainable and correctly
weighted items of information that are of value in predicting outcomes,
the right way to think is the way Zeckhauser plays bridge. It's just
that simple. And your brain doesn't naturally know how to think the way
Zeckhauser knows how to play bridge. Now, you notice I put in that
availability thing, and there I'm mimicking some very eminent
psychologists [Daniel] Kahneman, Eikhout[?] (I hope I pronounced that
right) and [Amos] Tversky, who raised the idea of availability to a
whole heuristic of misjudgment. And they are very substantially right.

I mean ask the Coca-Cola Company, which has raised availability to a
secular religion. If availability changes behavior, you will drink a
helluva lot more Coke if it's always available. I mean availability does
change behavior and cognition. Nonetheless, even though I recognize that
and applaud Tversky and Kahneman, I don't like it for my personal system
except as part of a greater sub-system, which is you've got to think the
way Zeckhauser plays bridge. And it isn't just the lack of availability
that distorts your judgment. All the things on this list distort
judgment. And I want to train myself to kind of mentally run down the
list instead of just jumping on availability. So that's why I state it
the way I do.

In a sense these psychological tendencies make things unavailable,
because if you quickly jump to one thing, and then because you jumped to
it the consistency and commitment tendency makes you lock in, boom,
that's error number one. Or if something is very vivid, which I'm going
to come to next, that will really pound in. And the reason that the
thing that really matters is now unavailable and what's extra-vivid wins
is, I mean, the extra-vividness creates the unavailability. So I think
it's much better to have a whole list of things that would cause you to
be less like Zeckhauser than it is just to jump on one factor.

Here I think we should discuss John Gutfreund. This is a very
interesting human example, which will be taught in every decent
professional school for at least a full generation. Gutfreund has a
trusted employee and it comes to light not through confession but by
accident that the trusted employee has lied like hell to the government
and manipulated the accounting system, and it was really equivalent to
forgery. And the man immediately says, "I've never done it before, I'll
never do it again. It was an isolated example."  And of course it was
obvious that he was trying to help the government as well as himself,
because he thought the government had been dumb enough to pass a rule
that he'd spoken against, and after all if the government's not going to
pay attention to a bond trader at Salomon, what kind of a government can
it be?

At any rate, this guy has been part of a little clique that has made,
well, way over a billion dollars for Salomon in the very recent past,
and it's a little handful of people. And so there are a lot of
psychological forces at work, and then you know the guy's wife, and he's
right in front of you, and there's human sympathy, and he's sort of
asking for your help, which encourages reciprocation, and there's all
these psychological tendencies are working, plus the fact he's part of a
group that had made a lot of money for you. At any rate, Gutfreund does
not cashier the man, and of course he had done it before and he did do
it again. Well now you look as though you almost wanted him to do it
again. Or God knows what you look like, but it isn't good. And that
simple decision destroyed Jim Gutfreund, and it's so easy to do.

Now let's think it through like the bridge player, like Zeckhauser. You
find an isolated example of a little old lady in the See's Candy
Company, one of our subsidiaries, getting into the till. And what does
she say? "I never did it before, I'll never do it again. This is going
to ruin my life. Please help me." And you know her children and her
friends, and she'd been around 30 years and standing behind the candy
counter with swollen ankles. When you're an old lady it isn't that
glorious a life. And you're rich and powerful and there she is: "I never
did it before, I'll never do it again."  Well how likely is it that she
never did it before? If you're going to catch 10 embezzlements a year,
what are the chances that any one of them -- applying what Tversky and
Kahneman called baseline information -- will be somebody who only did it
this once? And the people who have done it before and are going to do it
again, what are they all going to say? Well in the history of the See's
Candy Company they always say, "I never did it before, and I'm never
going to do it again." And we cashier them. It would be evil not to,
because terrible behavior spreads.

Remember...what was it? Serpico? I mean you let that stuff...you've got
social proof, you've got incentive-caused bias, you've got a whole lot
of psychological factors that will cause the evil behavior to spread,
and pretty soon the whole damn...your place is rotten, the civilization
is rotten. It's not the right way to behave. And I will admit that I
have...when I knew the wife and children, I have paid severance pay when
I fire somebody for taking a mistress on an extended foreign trip. It's
not the adultery I mind, it's the embezzlement. But there, I wouldn't do
it like Gutfreund did it, where they'd been cheating somebody else on my
behalf. There I think you have to cashier. But if they're just stealing
from you and you get rid of them, I don't think you need the last ounce
of vengeance. In fact I don't think you need any vengeance. I don't
think vengeance is much good.

17. Now we come to bias from over-influence by extra-vivid evidence.

Here's one that...I'm at least $30 million poorer as I sit here giving
this little talk because I once bought 300 shares of a stock and the guy
called me back and said, "I've got 1,500 more," and I said, "Will you
hold it for 15 minutes while I think about it?" And the CEO of this
company -- I have seen a lot of vivid peculiarities in a long life, but
this guy set a world record; I'm talking about the CEO -- and I just
mis-weighed it. The truth of the matter was the situation was
foolproof. He was soon going to be dead, and I turned down the extra
1,500 shares, and it's now cost me $30 million. And that's life in the
big city. And it wasn't something where stock was generally
available. So it's very easy to mis-weigh the vivid evidence, and
Gutfreund did that when he looked into the man's eyes and forgave a
colleague.

18. Twenty-two [he means 18]: Mental confusion caused by information not
arrayed in the mind and theory structures, creating sound
generalizations developed in response to the question "Why?" Also,
mis-influence from information that apparently but not really answers
the question "Why?" Also, failure to obtain deserved influence caused by
not properly explaining why.

Well we all know people who've flunked, and they try and memorize and
they try and spout back and they just...it doesn't work. The brain
doesn't work that way. You've got to array facts on the theory
structures answering the question "Why?" If you don't do that, you just
cannot handle the world.

And now we get to Feuerstein, who was the general counsel with Salomon
when Gutfreund made his big error, and Feuerstein knew better. He told
Gutfreund, "You have to report this as a matter of morality and prudent
business judgment." He said, "It's probably not illegal, there's
probably no legal duty to do it, but you have to do it as a matter of
prudent conduct and proper dealing with your main customer." He said
that to Gutfreund on at least two or three occasions. And he
stopped. And, of course, the persuasion failed, and when Gutfreund went
down, Feuerstein went with him. It ruined a considerable part of
Feuerstein's life.

Well Feuerstein, [who] was a member of the Harvard Law Review, made an
elementary psychological mistake. You want to persuade somebody, you
really tell them why. And what did we learn in lesson one? Incentives
really matter? Vivid evidence really works? He should've told Gutfreund,
"You're likely to ruin your life and disgrace your family and lose your
money." And is Mozer worth this? I know both men. That would've
worked. So Feuerstein flunked elementary psychology, this very
sophisticated, brilliant lawyer. But don't you do that. It's not very
hard to do, you know, just to remember that "Why?" is very important.

19. Other normal limitations of sensation, memory, cognition and
knowledge.

Well, I don't have time for that.

20. Stress-induced mental changes, small and large, temporary and
permanent.

Here, my favorite example is the great Pavlov. He had all these dogs in
cages, which had all been conditioned into changed behaviors, and the
great Leningrad flood came and it just went right up and the dog's in a
cage. And the dog had as much stress as you can imagine a dog ever
having. And the water receded in time to save some of the dogs, and
Pavlov noted that they'd had a total reversal of their conditioned
personality. And being the great scientist he was, he spent the rest of
his life giving nervous breakdowns to dogs, and he learned a helluva lot
that I regard as very interesting.

I have never known any Freudian analyst who knew anything about the last
work of Pavlov, and I've never met a lawyer who understood that what
Pavlov found out with those dogs had anything to do with programming and
de-programming and cults and so forth. I mean the amount of elementary
psychological ignorance that is out there in high levels is very
significant[?].

21. Then we've got other common mental illnesses and declines, temporary
and permanent, including the tendency to lose ability through disuse.

22. And then I've got development and organizational confusion from
say-something syndrome.

And here my favorite thing is the bee, a honeybee. And a honeybee goes
out and finds the nectar and he comes back, he does a dance that
communicates to the other bees where the nectar is, and they go out and
get it. Well some scientist who is clever, like B.F. Skinner, decided to
do an experiment. He put the nectar straight up. Way up. Well, in a
natural setting, there is no nectar where they're all straight up, and
the poor honeybee doesn't have a genetic program that is adequate to
handle what he now has to communicate. And you'd think the honeybee
would come back to the hive and slink into a corner, but he doesn't. He
comes into the hive and does this incoherent dance, and all my life I've
been dealing with the human equivalent of that honeybee. [Laughter] And
it's a very important part of human organization so the noise and the
reciprocation and so forth of all these people who have what I call
say-something syndrome don't really affect the decisions.

----------------------------------------------------------------------------

Now the time has come to ask two or three questions. This is the most
important question in this whole talk:

1. What happens when these standard psychological tendencies combine? What
happens when the situation, or the artful manipulation of man, causes
several of these tendencies to operate on a person toward the same end at
the same time?

The clear answer is the combination greatly increases power to change
behavior, compared to the power of merely one tendency acting
alone. Examples are:

   - Tupperware parties. Tupperware's now made billions of dollars out
   of a few manipulative psychological tricks. It was so schlocky that
   directors of Justin Dart's company resigned when he crammed it down
   his board's throat. And he was totally right, by the way, judged by
   economic outcomes.

   - Moonie [as in Sun Myung Moon and the Unification Church] conversion
   methods: boy do they work. He just combines four or five of these
   things together.

   - The system of Alcoholics Anonymous: a 50% no-drinking rate outcome
   when everything else fails? It's a very clever system that uses four
   or five psychological systems at once toward, I might say, a very
   good end.

   - The Milgrim experiment. It's been widely interpreted as mere
   obedience, but the truth of the matter is that the experimenter who
   got the students to give the heavy shocks in Milgrim, he explained
   why. It was a false explanation. "We need this to look for scientific
   truth," and so on. That greatly changed the behavior of the
   people. And number two, he worked them up: tiny shock, a little
   larger, a little larger. So commitment and consistency tendency and
   the contrast principle were both working in favor of this
   behavior. So again, it's four different psychological
   tendencies. When you get these lollapalooza effects you will almost
   always find four or five of these things working together.

When I was young there was a whodunit hero who always said, "Cherche la
femme." [In French, "Look for the woman."] What you should search for in
life is the combination, because the combination is likely to do you in. Or,
if you're the inventor of Tupperware parties, it's likely to make you
enormously rich if you can stand shaving when you do it.

One of my favorite cases is the McDonald-Douglas airliner evacuation
disaster. The government requires that airliners pass a bunch of tests, one
of them is evacuation: get everybody out, I think it's 90 seconds or
something like that. It's some short period of time. The government has
rules, make it very realistic, so on and so on. You can't select nothing but
20-year-old athletes to evacuate your airline. So McDonald-Douglas schedules
one of these things in a hangar, and they make the hangar dark and the
concrete floor is 25 feet down, and they've got these little rubber chutes,
and they've got all these old people, and they ring the bell and they all
rush out, and in the morning, when the first test is done, they create, I
don't know, 20 terrible injuries when people go off to hospitals, and of
course they scheduled another one for the afternoon.

By the way they didn't read[?] the time schedule either, in addition to
causing all the injuries. Well...so what do they do? They do it again in the
afternoon. Now they create 20 more injuries and one case of a severed spinal
column with permanent, unfixable paralysis. These are engineers, these are
brilliant people, this is thought over through in a big bureaucracy. Again,
it's a combination of [psychological tendencies]: authorities told you to do
it. He told you to make it realistic. You've decided to do it. You'd decided
to do it twice. Incentive-caused bias. If you pass you save a lot of
money. You've got to jump this hurdle before you can sell your new
airliner. Again, three, four, five of these things work together and it
turns human brains into mush. And maybe you think this doesn't happen in
picking investments? If so, you're living in a different world than I am.

Finally, the open-outcry auction. Well the open-outcry auction is just made
to turn the brain into mush: you've got social proof, the other guy is
bidding, you get reciprocation tendency, you get deprival super-reaction
syndrome, the thing is going away... I mean it just absolutely is designed
to manipulate people into idiotic behavior.

Finally the institution of the board of directors of the major American
company. Well, the top guy is sitting there, he's an authority figure. He's
doing asinine things, you look around the board, nobody else is objecting,
social proof, it's okay? Reciprocation tendency, he's raising the directors
fees every year, he's flying you around in the corporate airplane to look at
interesting plants, or whatever in hell they do, and you go and you really
get extreme dysfunction as a corrective decision-making body in the typical
American board of directors. They only act, again the power of incentives,
they only act when it gets so bad it starts making them look foolish, or
threatening legal liability to them. That's Munger's rule. I mean there are
occasional things that don't follow Munger's rule, but by and large the
board of directors is a very ineffective corrector if the top guy is a
little nuts, which, of course, frequently happens.

2. The second question: Isn't this list of standard psychological tendencies
improperly tautological compared with the system of Euclid? That is, aren't
there overlaps? And can't some items on the list be derived from
combinations of other items?

The answer to that is, plainly, yes.

3. Three: What good, in the practical world, is the thought system indicated
by the list? Isn't practical benefit prevented because these psychological
tendencies are programmed into the human mind by broad evolution so we can't
get rid of them? [By] broad evolution, I mean the combination of genetic and
cultural evolution, but mostly genetic.

Well the answer is the tendencies are partly good and, indeed, probably much
more good than bad, otherwise they wouldn't be there. By and large these
rules of thumb, they work pretty well for man given his limited mental
capacity. And that's why they were programmed in by broad evolution. At any
rate, they can't be simply washed out automatically and they shouldn't
be. Nonetheless, the psychological thought system described is very useful
in spreading wisdom and good conduct when one understands it and uses it
constructively.

Here are some examples:

   - One: Karl Braun's communication practices. He designed oil
   refineries with spectacular skill and integrity. He had a very simple
   rule. Remember I said, "Why is it important?" You got fired in the
   Braun company. You had to have five Ws. You had to tell Who, What you
   wanted to do, Where and When, and you had to tell him Why. And if you
   wrote a communication and left out the Why you got fired, because
   Braun knew it's complicated building an oil refinery. It can blow
   up...all kinds of things happen. And he knew that his communication
   system worked better if you always told him why. That's a simple
   discipline, and boy does it work.

   - Two: the use of simulators in pilot training. Here, again,
   abilities attenuate with disuse. Well the simulator is God's gift
   because you can keep them fresh.

   - Three: The system of Alcoholics Anonymous, that's certainly a
   constructive use of somebody understanding psychological
   tendencies. I think they just wandered into it, as a matter of fact,
   so you can regard it as kind of an evolutionary outcome. But just
   because they've wandered into it doesn't mean you can't invent its
   equivalent when you need it for a good purpose.

   - Four: Clinical training in medical schools: here's a profoundly
   correct way of understanding psychology. The standard practice is
   watch one, do one, teach one. Boy does that pound in what you want
   pounded in. Again, the consistency and commitment tendency. And that
   is a profoundly correct way to teach clinical medicine.

   - Five: The rules of the U.S. Constitutional Convention: totally
   secret, no vote until the whole vote, then just one vote on the whole
   Constitution. Very clever psychological rules, and if they had a
   different procedure, everybody would've been pushed into a corner by
   his own pronouncements and his own oratory and his own... And no
   recorded votes until the last one. And they got it through by a
   whisker with those wise rules. We wouldn't have had the Constitution
   if our forefathers hadn't been so psychologically acute. And look at
   the crowd we got now.

   - Six: the use of granny's rule. I love this. One of the
   psychologists who works for the Center gets paid a fortune running
   around America, and he teaches executives to manipulate
   themselves. Now granny's rule is you don't get the ice cream unless
   you eat your carrots. Well granny was a very wise woman. That is a
   very good system. And so this guy, a very eminent psychologist, he
   runs around the country telling executives to organize their day so
   they force themselves to do what's unpleasant and important by doing
   that first, and then rewarding themselves with something they really
   like doing. He is profoundly correct.

   - Seven: the Harvard Business School's emphasis on decision
   trees. When I was young and foolish I used to laugh at the Harvard
   Business School. I said, "They're teaching 28-year-old people that
   high school algebra works in real life?" We're talking about
   elementary probability. But later I wised up and I realized that it
   was very important that they do that, and better late than never.

   - Eight: the use of post-mortems at Johnson & Johnson. At most
   corporations if you make an acquisition and it turns out to be a
   disaster, all the paperwork and presentations that caused the dumb
   acquisition to be made are quickly forgotten. You've got denial,
   you've got everything in the world. You've got Pavlovian association
   tendency. Nobody even wants to even be associated with the damned
   thing or even mention it. At Johnson & Johnson, they make everybody
   revisit their old acquisitions and wade through the
   presentations. That is a very smart thing to do. And by the way, I do
   the same thing routinely.

   - Nine: the great example of Charles Darwin is he avoided
   confirmation bias. Darwin probably changed my life because I'm a
   biography nut, and when I found out the way he always paid extra
   attention to the disconfirming evidence and all these little
   psychological tricks. I also found out that he wasn't very smart by
   the ordinary standards of human acuity, yet there he is buried in
   Westminster Abbey. That's not where I'm going, I'll tell you. And I
   said, "My God, here's a guy that, by all objective evidence, is not
   nearly as smart as I am and he's in Westminster Abbey? He must have
   tricks I should learn." And I started wearing little hair shirts like
   Darwin to try and train myself out of these subconscious
   psychological tendencies that cause so many errors. It didn't work
   perfectly, as you can tell from listening to this talk, but it
   would've been even worse if I hadn't done what I did. And you can
   know these psychological tendencies and avoid being the patsy of all
   the people that are trying to manipulate you to your disadvantage,
   like Sam Walton. Sam Walton won't let a purchasing agent take a
   handkerchief from a salesman. He knows how powerful the subconscious
   reciprocation tendency is. That is a profoundly correct way for Sam
   Walton to behave.

   - Ten: Then there is the Warren Buffett rule for open-outcry
   auctions: don't go. We don't go to the closed-bid auctions too
   because they...that's a counter-productive way to do things
   ordinarily for a different reason, which Zeckhauser would understand.

4. Four: What special knowledge problems lie buried in the thought
system indicated by the list?

Well one is paradox. Now we're talking about a type of human wisdom that
the more people learn about it, the more attenuated the wisdom
gets. That's an intrinsically paradoxical kind of wisdom. But we have
paradox in mathematics and we don't give up mathematics. I say damn the
paradox. This stuff is wonderfully useful. And by the way, the granny's
rule, when you apply it to yourself, is sort of a paradox in a
paradox. The manipulation still works even though you know you're doing
it. And I've seen that done by one person to another. I drew this
beautiful woman as my dinner partner a few years ago, and I'd never seen
her before. Well, she's married to prominent Angelino, and she sat down
next to me and she turned her beautiful face up and she said, "Charlie,"
she said, "What one word accounts for your remarkable success in life?" 
And I knew I was being manipulated and that she'd done this before, and
I just loved it. I mean I never see this woman without a little lift in
my spirits. And by the way I told her I was rational. You'll have to
judge yourself whether that's true. I may be demonstrating some
psychological tendency I hadn't planned on demonstrating.

How should the best parts of psychology and economics interrelate in an
enlightened economist's mind? Two views: that's the thermodynamics
model. You know, you can't derive thermodynamics from plutonium, gravity
and laws of mechanics, even though it's a lot of little particles
interacting. And here is this wonderful truth that you can sort of
develop on your own, which is thermodynamics. And some economists -- and
I think Milton Friedman is in this group, but I may be wrong on that --
sort of like the thermodynamics model. I think Milton Friedman, who has
a Nobel prize, is probably a little wrong on that. I think the
thermodynamics analogy is over-strained. I think knowledge from these
different soft sciences have to be reconciled to eliminate
conflict. After all, there's nothing in thermodynamics that's
inconsistent with Newtonian mechanics and gravity, and I think that some
of these economic theories are not totally consistent with other
knowledge, and they have to be bent. And I think that these behavioral
economics...or economists are probably the ones that are bending them in
the correct direction.

Now my prediction is when the economists take a little psychology into
account that the reconciliation will be quite endurable. And here my
model is the procession of the equinoxes. The world would be simpler for
a long-term climatologist if the angle of the axis of the Earth's
rotation, compared to the plane of the Euclyptic, were absolutely
fixed. But it isn't fixed. Over every 40,000 years or so there's this
little wobble, and that has pronounced long-term effects. Well in many
cases what psychology is going to add is just a little wobble, and it
will be endurable. Here I quote another hero of mine, which of course is
Einstein, where he said, "The Lord is subtle, but not malicious." And I
don't think it's going to be that hard to bend economics a little to
accommodate what's right in psychology.

5. Fifth: The final question is: If the thought system indicated by this
list of psychological tendencies has great value not recognized and
employed, what should the educational system do about it?

I am not going to answer that one now. I like leaving a little mystery.

Have I used up all the time so there's no time for questions?

----------------------------------------------------------------------------

Moderator: I think that what we're going to do is we're going to borrow
a little bit of time from the end of the day questions, and we're going
to move it and allocate it to Charles Munger, if that's acceptable to
everybody.

Munger: By the way, the dean of the Stanford Law School is here today,
Paul Brest, and he is trying to create a course at the Stanford Law
School that tries to work stuff similar to this into worldly wisdom for
lawyers, which I regard as a profoundly good idea, and he wrote an
article about it, and you'll be given a copy along with Cialdini's
book. [The article Mr. Munger is referring to is called "On Teaching
Professional Judgment" by Paul Brest and Linda Krieger. It was published
in the July 1994 edition of the Washington Law Review.] Questions?

Audience Member #1: Will we be able to get a copy of that list of 24
[standard causes of human misjudgment]?

Munger: Yes. I presumed there would be one curious man [laughter], and I
have it and I'll put it over there on the table, but don't take more
than one, because I didn't anticipate such a big crowd. And if we run
short, I'm sure the Center is up to making other copies.

Audience Member #2: If I had listened to this talk I might have thought
that Charles Munger was a psychology professor operating in a business
school. Every once in a while a micro-issue -- you told us how you
would've deal with one of these issues, for example with the unfortunate
lady See's -- but you didn't tell us how these tendencies affected you
and what's probably the most important, or one of the most important
elements of your success, which was deciding where to invest your
money. And I'm wondering if you might relate some of these principles to
some of your past decisions that way.

Munger: Well of course an investment decision in the common stock of a
company frequently involves a whole lot of factors interacting. Usually,
of course, there's one big, simple model, and a lot of those models are
microeconomic. And I have a little list of -- it wouldn't be nearly 24,
of those -- but I don't have time for that one. And I don't have too
much interest in teaching other people how to get rich. And that isn't
because I fear the competition or anything like that -- Warren has
always been very open about what he's learned, and I share that
ethos. My personal behavior model is Lord Keynes: I wanted to get rich
so I could be independent, and so I could do other things like give
talks on the intersection of psychology and economics. I didn't want to
turn it into a total obsession.

Audience Member #3: Out of those 24, could you tell us the one rule
that's most important?

Munger: I would say the one thing that causes the most trouble is when
you combine a bunch of these together, you get this lollapalooza
effect. And again, if you read the psychology textbooks, they don't
discuss how these things combine, at least not very much. Do they
multiply? Do they add? How does it work? You'd think it'd be just an
automatic subject for research, but it doesn't seem to turn the
psychology establishment on. I think this is a man from Mars approach to
psychology.

I just reached in and took what I thought I had to have. That is a
different set of incentives from rising in an economic establishment
where the rewards system, again, the reinforcement, comes from being a
truffle hound. That's what Jacob Viner, the great economist called it:
the truffle hound -- an animal so bred and trained for one narrow
purpose that he wasn't much good at anything else, and that is the
reward system in a lot of academic departments. It is not necessarily
for the good. It may be fine if you want new drugs or something. You
want people stunted in a lot of different directions so they can grow in
one narrow direction, but I don't think it's good teaching psychology to
the masses. In fact, I think it's terrible.
--<cut>--

--
J C Lawrence
---------(*)                Satan, oscillate my metallic sonatas.
claw at kanga.nu               He lived as a devil, eh?
http://www.kanga.nu/~claw/  Evil is a name of a foeman, as I live.


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