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Could a Quirk in Human Brain Wind Up Costing Taxpayers $700 Billion Dollars?

The bailout plan is likely to pass, not because it's good, but simply because all of us -- Senators included -- are vulnerable of a potent cognitive fallacy known as anchoring.
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By all accounts, Paulson's bailout plan is a stinker: no oversight, no fairness, and no serious analysis of whether it will actually work. You don't have to be an economist to see it as a welfare program for the greedy people who got us into this mess in the first place.

Unfortunately, the human mind being what it is, it's probably going to pass. Maybe not exactly as written -- some important alterations may be added. But the basic substance of the plan, dreadful as it is, is likely to make it through.

Not because it's good, but simply because all of us -- Senators included -- are vulnerable of a potent cognitive fallacy known as anchoring.

Anchoring got its name from experiments by Amos Tversky and Daniel Kahneman. In one of their famous studies, and an experimenter spun a wheel of fortune, with numbers from 1-100, and then asked people a question that had absolutely nothing to do with the wheel: "what percent of African countries are in the UN?" The outcome on the wheel should have been totally irrelevant, but instead people succumbed to a strategy known as "anchoring and adjustment", which is to say people started with the irrelevant number from the wheel, and adjusted their answers from there. When the wheel came up 10, a typical response to the UN question was 25 percent, whereas when the wheel came up 65, a typical response was 45 percent.

Shopkeepers take advantage of the same thing when they put up a sign saying "limit 12." Nobody really buys 12, but telling people that they can't buy more than 12 leads them to think that they might need several.

Anchoring is good business for grocery stores, but it's a terrible way for a nation to do business. But that's exactly what's happening. Almost all of the discussion has been about the Paulson proposal, and how we might tweak it -- not about whether there might be altogether better ways to spend such an enormous sum of cash.

When Paulson tells us (as he said in yesterday's testimony) that his plan "is much better than the alternative," the only real alternative he is considering is having no bailout plan at all.

But how about a plan in which a bipartisan commission (rather than Paulson and Bernanke) made all decisions? Or a plan in which banks could bid against one other for government funds? Or a plan in which relief for individuals in jeopardy of losing their homes was as substantial as relief for those who trafficked in dubious commodities like mortgage-backed securities and CDOs? If yesterday's hearings are typical of what's come, no alternative will ever be seriously considered.

Perhaps the biggest tragedy of all is the way in which the whole discussion has been anchored around a fallacious notion of time. Paulson says we need to decide in 7 days, but that number, too, is made up. Does it really matter if we take two weeks rather than one?

With so much at stake, it's well worth taking the time we need to make a good plan, not just the first thing that pops to mind.

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