Fear, Greed, and Financial Crises:
A Cognitive Neurosciences Perspective∗

Andrew W. Lo† First Draft: August 28, 2011

Latest Revison: October 12, 2011

Abstract

Historical accounts of financial crises suggest that fear and greed are the common denom- inators of these disruptive events: periods of unchecked greed eventually lead to excessive leverage and unsustainable asset-price levels, and the inevitable collapse results in unbridled fear, which must subside before any recovery is possible. The cognitive neurosciences may provide some new insights into this boom/bust pattern through a deeper understanding of the dynamics of emotion and human behavior. In this chapter, I describe some recent re- search from the neurosciences literature on fear and reward learning, mirror neurons, theory of mind, and the link between emotion and rational behavior. By exploring the neuroscien- tific basis of cognition and behavior, we may be able to identify more fundamental drivers of financial crises, and improve our models and methods for dealing with them. 

And you'll get pages more with a simple Google search on fear, greed, markets and economics.  Fear and greed will be present in free markets - try as we might to eradicate those human responses we are, after all, just human.

So as an aside during a private conversation, it's not unreasonable to say jokingly, as we enter a time of great uncertainty with iron ore and coal markets in China, that our responses will be driven by fear and greed. Ho, ho, ho.  It's a banker joke with more than a hint of truth in it.

But here are the smart-arses at Fairfax beating up a private conversation between consenting adults at the Prime Minister's home during the G20 last year.

'Fear and greed' drive Australia's China policy, Tony Abbott tells Angela Merkel

Tony Abbott has admitted at the highest international level that Australia's policies towards China are driven by two emotions: "fear and greed".

The Prime Minister's candid appraisal of Australia's primordial motivations, given with a grin in private conversation with Germany's Angela Merkel last November, is a long way from the prolix platitudes of official documents.

And it sits in awkward contrast with Mr Abbott's personal assertions of friendship, such as the one that he made to his Chinese counterpart the following day.

The fear-and-greed comment was made in a private conversation with Ms Merkel at Kirribilli House on Sunday, November 16. 

Mr Abbott was answering a surprise opening question from Ms Merkel about what drives Australia's China policy, according to sources on both sides of the conversation.

It sounds like a neat, succinct, honest, light-hearted and entirely uncontroversial comment to me.  But step one - Fairfax beat it up into a story on the front page, then step two, get he-whose-knowledge-of-money-comes-from-marrying-it to stand in judgement over the PM.

Right on queue, out comes economic boxhead Bill

Opposition Leader Bill Shorten has attacked as “ill-informed and irresponsible,” a comment attributed to Prime Minister Tony Abbott on what drives Australia’s policies on China.

Mr Shorten said: “It’s a sad day for our nation when we see the Prime Minister talking down Australia.

“This isn’t the first time Tony Abbott has put his foot in his mouth on the world stage. Sadly, I don’t imagine it will be the last.”

He added that China is a great friend of Australia, “and I can assure you that when Tony Abbott says things like this, he certainly doesn’t speak on behalf of all Australians.”

Economics is scarcity theory.   When markets are drying up - like our iron ore and coal markets in China - fear and greed are likely to be real factors driving free market behaviours.   We are still a mob of free marketeers Bill.

And it's a bit rich for the Labor Party leader to have a go at greed and fear after the ignominious utterances of Kevin Rudd on our great and powerful friends in Beijing when he didn't get his way at the Climate Change Conference in Copenhagen -

"Those Chinese ratfuckers are trying to rat fuck us",

whatever that means.

Here is some more fear and loathing headed China's way from the Labor Party Leader, the Glorious Rudd.