Bear Stearns and Dunning-Kruger
October 26, 2009
Some guys at Bear Stearns ran a hedge fund. They bet that subprime mortgages would pay off big time. During the bubble, they were right. They and their investors made a lot of money.
Last year everything changed. The market started tanking. How did the hedge fund managers respond?
They sent each other some e-mails: "I think the subprime market is completely collapsing." Because the hedge fund managers didn't immediately pull out of the market, federal prosecutors indicted them for fraud. Anyone who sent those e-mails must have intended to cheat investors!
The prosecution is collapsing:
As we’ve written before, only two Wall Street executives have been charged with securities fraud stemming from the credit crisis. The two, former Bear Stearns execs, Ralph Cioffi and Matthew Tannin (pictured), are currently on trial now, in Brooklyn federal court....
So what’s happened? According to Slater, government witnesses keep coming unleashed, providing testimony that seems if not exculpatory, at least helpful to the defense. As Slater puts it: “a case built on provocative e-mail excerpts, bereft of context, can teeter when witnesses appear in court to provide a backdrop, for example, or the surrounding context of a seemingly damning e-mail message excerpt is read before a jury.”
Gee; you think? Who here has never written an e-mail saying something that wasn't a full representation of your beliefs? Who has never written, "This is an impossible case," before winning the case?
You know who lacks doubt? Stupid people, that's whom. Yes, really. This stuff has been studied, and the answer is that the stupider you are, the more confident you are:
The Dunning–Kruger effect is an example of cognitive bias in which "people reach erroneous conclusions and make unfortunate choices but their incompetence robs them of the metacognitive ability to realize it." The unskilled therefore suffer from illusory superiority, rating their own ability as above average, much higher than actuality; by contrast the highly skilled underrate their abilities, suffering from illusory inferiority.
When it seems like the entire stock market is going to go to zero, who wouldn't have doubts about her hedge fund? Stupid people wouldn't. They'd be too stupid to have doubts. That's the curse of humanity. The smarter you are, the less confident you are. Stupid people elbow their way into leadership roles while the smartest people in the room sit quietly and in self-doubt.
In fact, try it: Talk to some lawyers about their cases. The dumb ones only have fantastic cases. They are surely going to win the upcoming motion, trial, or appeal. When possible, avoid working with such people. There will be immediate IQ and competency barriers that usually aren't worth the effort to break down. There are few things more frustrating than a stupid person who considers himself brilliant. Your game suffers when you suffer fools.
At some point a lawyer must put aside doubts. Live in denial. You're the man, 'G. Law is performance art. Yet the dumbest lawyers never seem to have any doubts. The smartest lawyers, by contrast, agonize.
Do you think that the Department of Justice lawyers who are prosecuting the Bear Stearns case are agonizers?