The Smartest Guys in the Room by McLean and Elkind.
Subject: Enron.
Lessons: Hiding from reality becomes an ever-downward-spiraling habit as you have to hide the results of failures from last time. Incentive structures are everything. Selecting for verbal smartness and sparkle can just get you spectacularly complicated, charming failure. Complexity is used to hide the truth from both outsiders and yourself.
This has not been given enough attention in our current financial crisis. People were given huge bonuses if their big risks paid off, but not given huge penalties if they tanked. So it was rational for them to make investments that had negative expected return for the people whose money it actually was.
This is important because pundits say that our current crisis proves that the markets need more regulation, because relying on self-interest failed. Actually, self-interest succeeded. The markets need more intelligent regulation, not more regulation. People failed to foresee the collapse (if they did) because humans are highly skilled at hiding the truth from themselves when properly incentivized to do so.
I don’t buy this account of Enron, which has become the standard fable. There was a lot there that was more like straight-up fraud than smart people overcomplicating things and missing the down-home common sense.
Edit: I agree with the “hiding from reality = downward spiral” part strongly.
The book does represent that in the endgame it was spectacularly complicated, charming fraud. But they do seem to have slid into fraud more than having started with that directly in mind—at least so the book alleges. Complication eases the path into fraud, and other downward spirals.
I thought that the standard fable focused on the straight-up fraud of the endgame.
I focus on the incentives to the sales staff. As I understand it, their exit was well-timed, so the situation wasn’t that hard to unravel. But this leaves the question of whether the guys at the top understood what was going on, let alone intended it.
The Smartest Guys in the Room by McLean and Elkind.
Subject: Enron.
Lessons: Hiding from reality becomes an ever-downward-spiraling habit as you have to hide the results of failures from last time. Incentive structures are everything. Selecting for verbal smartness and sparkle can just get you spectacularly complicated, charming failure. Complexity is used to hide the truth from both outsiders and yourself.
This has not been given enough attention in our current financial crisis. People were given huge bonuses if their big risks paid off, but not given huge penalties if they tanked. So it was rational for them to make investments that had negative expected return for the people whose money it actually was.
This is important because pundits say that our current crisis proves that the markets need more regulation, because relying on self-interest failed. Actually, self-interest succeeded. The markets need more intelligent regulation, not more regulation. People failed to foresee the collapse (if they did) because humans are highly skilled at hiding the truth from themselves when properly incentivized to do so.
Incentive structures are everything. What incentives do the regulators face?
I don’t buy this account of Enron, which has become the standard fable. There was a lot there that was more like straight-up fraud than smart people overcomplicating things and missing the down-home common sense.
Edit: I agree with the “hiding from reality = downward spiral” part strongly.
The book does represent that in the endgame it was spectacularly complicated, charming fraud. But they do seem to have slid into fraud more than having started with that directly in mind—at least so the book alleges. Complication eases the path into fraud, and other downward spirals.
Also see Eliezer’s earlier post.
I thought that the standard fable focused on the straight-up fraud of the endgame.
I focus on the incentives to the sales staff. As I understand it, their exit was well-timed, so the situation wasn’t that hard to unravel. But this leaves the question of whether the guys at the top understood what was going on, let alone intended it.