self-interest and the financial meltdown, part 1

It is with considerable embarrassment that I offer some thoughts related to the financial meltdown.  The main reason for this sheepishness is that I’m afraid that analysis isn’t worth much right now.  The real task is to offer a way forward, one that staves off economic catastrophe and hopefully doesn’t reward the miscreants (who, it should be stressed, can not only be found in Washington and on Wall Street, but on Main Street as well: while some borrowers were undoubtedly tricked by fraudulent lending practices, the main story seems to be one where borrowers were overwhelmingly unable to turn down deals that common sense should have told them were too good to be true).  But I have no solutions to offer.  Given that I spent a good deal of my career analyzing financial markets, one might think that I should feel guilty about this.  What saves me from such feelings is that, as a sociologist, no one is looking to me for solutions.  And certainly no one can blame me or my disciplinary kin for having provided any aid or succor to those who got us in this mess.  To the contrary, anyone who knows me knows that I have long been a bear.  But this is an occasion where having been right really sucks.  I am deeply concerned that family and friends will soon be in dire economic straits, and so I wish I knew of a way out.

My avowed concern for others is a useful segue into one of the key themes that this crisis has evoked for me: what is myth and what is fact about the premise that human beings are motivated by self-interest.  A related topic came up recently on this blog (the discussion Teppo flagged today seems relevant too) and this discussion was helpful to me, at least in part because it led me to read Dale Miller’s essay “The Norm of Self-Interest”.

This essay develops the very interesting and compelling thesis that we should be skeptical about the premise that human beings are motivated by self-interest because much apparent evidence supporting this premise may be an artifact of its self-fulfilling features. The last paragraph of the essay summarizes the argument very well:

Evidence that material self-interest is powerful, therefore, may speak more to the power of social norms than to the power of innate proclivities. Interpreting the presence of self-interested behavior to suggest that self-interest is inevitable and universal rather than historically and culturally contingent only serves to strengthen the layperson’s belief that pursuing self-interest is normatively appropriate, rational, and enlightened. The result of this is a positive feedback loop: The more powerful the norm of self- interest, the more evidence there is for the theory of self- interest, which, in turn, increases the power of the self-interest norm ( Schwartz, 1997 ). None of this is to say that self-interest, even narrowly defined, is an insubstantial force in human affairs. But, however strong the disposition to pursue material self- interest may be, it is likely not as strong as the prevalence of self-interested behavior in everyday life suggests. Homo economicus, it should not be forgotten, inhabits a social world.

As I said, I think Miller’s essay is compelling.  And it dovetails nicely with Swidler’s observations in Talk of Love, about “individualist/voluntarist American culture, wherein individuals can only justify their decisions by framing them as the result of autonomous, voluntary action” (p.176).” But I think it is limited in at least two critical ways (that don’t apply as much to Swidler).

To quickly get to the heart of these two issues, it is instructive to consider this quote from Friday’s NYT from James Cox of Duke Law School, who apparently supported the SEC’s disastrous 2004 decision to roll-back capital controls on investment banks:

We foolishly believed that the firms had a strong culture of self-preservation and responsibility, and would have the discipline not to be excessively borrowing… Letting the firms police themselves made sense to me because … I foolishly thought the market would impose its own-self discipline. We’ve all learned a terrible lesson.” (emphasis added)

I like this quote because his admission of past foolishness and culpability is a breath of fresh air right now. I also like it because: (a) he points to two different mechanisms that promote the pursuit of self-interest—organizational culture and market discipline, only the first of which is related to the mechanism highlighted by Miller; and (b) he reminds us that while there are indeed positive feedback loops which reinforce the tendency to act on the basis of self-interest, there are also negative feedback loops, by which the pursuit of self-interest tragically leads to self-defeating actions. In a sense, there is both more and less basis for expecting self-interested action than Miller supposes.


Since this post has become ridiculously long already, I’ll say a word about the implications of point a (the basis for expecting of self-interestedness), and develop point b (why the pursuit of self-interest can be self-defeating) in an upcoming post.


Why should we expect self-interested action, in the first instance?  Miller suggests that the alternative to his norm-based account is one rooted in human nature, and he suggests that this alternative is weak because we appear to have other, non-self-interested inclinations. So for the moment, let us turn off that mechanism by assuming that there is no natural inclination towards self-interestedness. But let us also assume that the norms promoting self-interest often do not have much teeth behind them, as Miller admits may be the case (see his section on “Why Does Self-Interest Predict Behavior Better Than Attitudes?”). Would we then have a world of altruists, as Miller’s argument seems to imply?


No. The reason is straightforward (and suggested by Cox’s invoking of market discipline): competition. Like all organisms, human beings need resources to survive, and such resources are typically under the control of other human beings who could provide those resources to others instead of to us. In highly competitive environments, we are forced “to look out for no.1” regardless of whether this might have been our natural inclination and regardless of whether norms promote this behavior. (In fact, we have many norms that limit self-interested behavior, but Miller ignores these in his essay). In short, homo economicus does not just “inhabit a social world,” as Miller would have it (where such inhabiting implies the need to adhere to society’s norms), he is a creature of highly competitive social worlds. Remove the competition, and you remove the structural underpinning for self-interestedness.


We need to find no better example of such self-interestedness than the current liquidity trap, where banks– and everyone else for that matter– hoard capital in a bid to save themselves, thereby digging a deeper hole. Meanwhile, Zimbabweans are suffering even more than we can imagine, not from deflation but from hyperinflation (on top of everything else they have suffered recently), which has created a “Darwinian” struggle for survival, according to the NYT. One does not need human nature or norms to explain self-interested behavior in conditions like these.


There seem to be two potential objections to this (I’m sure you will raise others!). One is that, especially insofar as we are trying to account for American individualism, it seems awkward to attribute it to the fact that America is a resource-scarce environment. The short answer to this is that the culture of individualism reflects the intense status competition of American life; and as a positional good (see Fred Hirsch’s excellent book The Social Limits to Growth), status is an inherently limited (zero-sum) resource. (Put differently, Miller misfires when he focuses on material interest as the locus of individualism). Of course, one might argue that nothing is forcing Americans to engage in status competition, and so our tendency to pursue status must be due, either to natural proclivities or to the kinds of norms that Miller describes. I don’t have the space to develop the point here (I will try to do it in a book I’m slowly writing), but I would argue that this is wrong, and that in fact, the pursuit of status should be seen, in the first instance, as a defensive move, which is necessitated whenever we find ourselves in an environment where resources are allocated on the basis of status, and especially where the failure to attain some status brings about social death (i.e., elimination from certain interactions/contexts). To quickly make the point: while I am willing to believe that most sociologists have no natural need for status, this has little effect on the behavior we see at the ASA (or in the job market, citation patterns, etc.). Such an environment effectively demands status-seeking.

The second objection will be addressed in my upcoming post: Why do people– and financial market participants in particular– engage in self-defeating behavior even when environmental factors would seem to discipline them to act self-interestedly? Put differently, why was Cox wrong when he (reasonably, and consistently with Chicago-style economic theory about how regulation is unnecessary) presumed that both market discipline and norms of self-preservation would prevent the investment banks from taking suicidal actions?

Written by EWZS

October 6, 2008 at 4:59 pm

11 Responses

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  1. “We foolishly believed that the firms had a strong culture of self-preservation and responsibility, and would have the discipline not to be excessively borrowing…”

    Why do people– and financial market participants in particular– engage in self-defeating behavior even when environmental factors would seem to discipline them to act self-interestedly?

    Well, in many cases what happened was that people were making highly-leveraged bets with other people’s money, and taking as their reward a cut of the resulting profit as commissions — with the knowledge that when the wheels came off further down the road, the money they earned was not going to be at risk. It’s hard enough to convince people to be careful with their own money, given the promise of jam today and with the prospect of disaster safely off in the distance. But why expect them to be careful under similar circumstances with other people’s cash? Those incentives (and lack of controls) are entirely removed from any alleged “culture of self-preservation” operating at the level of the firm.



    October 6, 2008 at 8:01 pm

  2. I struggle with Miller’s self-fulfilling mechanism. First, the self-fulfilling mechanism assumes that there are no stable factors related to human behavior/nature (much of psychology would differ — though Miller of course also is a psychologist). Second, it seems to be implied that the self-fulfilling mechanism applies to any ‘content’ (even false content about self-interestedness — see extensions by Ferraro, Pfeffer & Sutton, 2005): if the norm was reciprocity, would that fulfill itself? Early anthropology work said, yes; later work has shown these findings to be very problematic — “myth of the noble savage.”

    Also, the strong situational logic discounts person-effects (bad barrel versus apples), while there clearly are person effects and person-situation interaction effects as well.



    October 6, 2008 at 9:29 pm

  3. Your status argument seems to break down to a story of material self-interest, doesn’t it? If we engage in status competition to gain entry to the game, aren’t we in effect being motivated by some base need to acquire material resources?

    I guess I’m not sure that people don’t have some natural need to acquire status, independent of the resources attached to it. If people like to feel esteemed relative to their peers, status is one way they can do this. Moreover, sometimes having status helps alleviate the pain of having resource inequality. Professors may not have the high salaries of other professions, but the status associated with being a professor compensates at a purely subjective level.

    Re your next question: It seems to me like a bit of a collective action problem. The financial meltdown may have actually intensified individuals’ self-interest for survival, while at the same time they neglected to do anything to warn the common stockholder. Once the top executives at these banks realized they had liquidity problems, they quickly turned into individual wealth maximizers (or loss minimizers is probably more accurate), ignoring the collective interests of their banks. This NY Times article gets into this a bit, noting that Lehman managers were issuing massive bonuses to their executives even though they realized their ship was inevitably sinking.



    October 6, 2008 at 10:58 pm

  4. Thanks for the useful reactions.

    Kieran: Not sure exactly the scenario you have in mind. When you say “other people’s money,” not sure who you mean– the IBanks’ clients?

    Teppo: Even if there is a self-fulfilling mechanism, that doesn’t mean that there are not also “stable factors related to human nature.” Multiple mechanisms could be operating, and he acknowledges that. He just says that if you remove the norm of self-interestedness, there would be less ‘natural’ self-interestedness than you might think. And I agree completely re the norm of reciprocity. For my money, Leifer’s 1988 ASR article (“Interaction Preludes to Role Setting”) effectively debunks the myth of a norm of reciprocity (in this case theoretically rather than empirically.

    Brayden: Sorry if I was unclear– when I say that one is trying to avoid social death (i.e., being eliminated from desired interactions/contexts), that doesn’t necessarily mean that one seeks material resources from such interaction (at least if by material we mean monetary rather than physical). And yes, I think it is widely assumed that there is some drive to seek status. For instance, that is baked in to the Leifer paper I just cited, as well as Gould’s 2002 AJS piece on status hierarchies. I think it’s wrong though, or at least I’d say that a lot of variation in status-seeking can be explained without assuming such a drive (note that Podolny explicitly brackets this assumption in his work, though that’s mostly because he focuses on firms, for which it is awkward to think of as pursuing status per se), but by attending to the nature of the structure that the actors find themselves in. As I said, this thought is not yet well-developed, so I won’t try to defend it in this forum.



    October 7, 2008 at 5:01 am

  5. Ezra, the discussion following Miller is very compelling, but I have an issue with defining competition as an extra-social factor. Isn’t completion also a product of the same structuration process that brings about self-interested social agents? In fact, we have quite a lot of evidence that competition is path-dependent (that is, socially, technologically constructed). Well, in any case have a Shana Tova and Hatima Tova.



    October 7, 2008 at 1:25 pm

  6. Hi Yuval. Shana Tova and Hatima Tova to you too.

    (For the baffled reader, these are traditional Jewish greetings this time of year– this first is ‘happy new year’ the second is rougly ‘may God decide on a good fate for you in the coming year’, where such fate is determined or ‘sealed’ on Yom Kippur, which is this Wed night/Thursday day)

    Re competition– that was basically my point. I was saying that Miller seems to be using “social” in a narrow way, to mean “influenced by norms.” Competition is a more general force that is inherent in interacting with others. Insofar as your (desired) interaction partners have alternatives to you, you are competing.



    October 7, 2008 at 4:15 pm

  7. Yuval: Isn’t your point precisely (counter to Ezra’s interpretation of your comment) that competition is NOT necessarily ‘inherent’ to social interaction?



    October 7, 2008 at 4:40 pm

  8. Ezra, very good explanation of the High Holidays!
    But, yes, as Teppo mentioned, this is the concern I’m having with defining competition as something that is embedded in the nature of human interaction. Would you say that competition is context-specific and therefore is norm-dependent? I am sure that you’d agree that competition in ancient Egypt, where food was distributed by the king was different from the competition we witness now, say, in the car market. This is the point, if we simplify things, that Polanyi was making in The Great Transformation.



    October 7, 2008 at 5:19 pm

  9. I’d say that competition takes different forms in different times and places (with norms and institutions shaping such forms), and that the intensity of competition varies depending on how many and fungible the alternatives are, to the point that sometimes we are not competing. (Though I’d caution that people need not be aware of the fact that they are in competition with others). But by definition, whenever there are alternatives to you, you are competing.



    October 7, 2008 at 5:29 pm

  10. […] a comment » As discussed in part I of this series, there has lately been a lot of talk that paradoxically suggests that markets […]


  11. Fascinating conversation
    please allow me to join in

    I think we need to separate some of the specifics from the generalities.

    The specifics of this financial meltdown were an unfortunate intersection of (short-term) greed, moral hazard and enabling legislation.

    to the generalities – I think if we can regain our appreciation of long-term consequences to our actions, we will learn to avoid these situations, but so long as we are rewarded for the bag of profit and not questioned on its character – this will repeat itself.

    The problem as you can see is – who will lead us in defining that character.

    Self interest working within a homogeneous environment will have ‘enough’ inherent checks/balances. But our world is lumpy and so self interest can/will be subverted unless there are shared higher order values to put natural brakes on the positive feedback loops.



    October 15, 2008 at 11:18 am

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