The Upside of Irrationality and Revenge

To set the economy right, the world's central banks tried to infuse money into the system, give short-term loans to banks. The public remained livid, because the central issue of rebuilding trust was neglected.
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To begin to understand how deeply the human desire for vengeance runs, I invite you to consider a study conducted by a group of Swiss researchers led by Ernst Fehr, who examined revenge using a version of an experimental game we call the Trust Game. Here are the rules, which are explained in detail to all participants.

You are paired with another participant. You are kept in separate rooms, and you will never know each other's identity. The experimenter gives each of you $10. You get to make the first move. You must decide whether to send your money over to the other participant or keep it for yourself. If you keep it, both of you get to keep your $10 and the game is over. However, if you send the other player your money, the experimenter quadruples the amount -- so that the other player has their original $10 plus $40 (the $10 multiplied by four). The other player now has a choice: (a) to keep all the money, which means that they would get $50 and you would get nothing; or (b) to send half the money back to you, which means that each of you would end up with $25.*

The question, of course, is whether you will trust the other person. Do you send them the money -- potentially sacrificing your financial gain? And will the other person justify your trust and share the earnings with you? The prediction of rational economics is very simple: no one would ever give back half of their $50, and, since this behavior is so glaringly predictable from a rational economic perspective, no one would ever send over their $10 in the first place. In this case, the simple economic theory is inaccurate: the good news is that people are more trusting and more reciprocating than rational economics would have us believe. Many people end up passing along their $10, and their partners often reciprocate by sending $25 back.

This is the basic trust game, but the Swiss version included another interesting step: if your partner chooses to keep all $50 for himself, you can use your own money to punish the bastard. For each dollar of your own hard-earned money that you give the experimenter, $2 will be extracted from your greedy partner. This means that if you decide to spend, say, $2 of your own money, your partner will lose $4, and if you decide to spend $25, your partner will lose all his winnings. If you were playing the game and the other person betrayed your trust, would you choose this costly revenge? Would you sacrifice your own money to make the other player suffer? How much would you spend?

The experiment showed that many of the people who had the opportunity to exact revenge on their partners did so, and they punished severely. Yet this finding was not the most interesting part of the study. While making their decisions, the participants' brains were being scanned by positron emission tomography (PET). This way, the experimenters could observe participants' brain activity while they were making their decisions. The results showed increased activity in the striatum, which is a part of the brain associated with the way we experience reward. In other words, according to the PET scan, it looked as though the decision to punish others was related to a feeling of pleasure. What's more, those who had a high level of striatum activation punished others to a greater degree.

All of this suggests that punishing betrayal, even when it costs us something, has biological underpinnings. And this behavior is, in fact, pleasurable (or at least elicits a reaction similar to pleasure).

Not surprisingly, the desire for revenge struck many a citizen in the wake of the financial meltdown of 2008. As a result of the collapse of the mortgage-backed securities market, institutional banks fell like dominoes. In May 2008, JPMorgan Chase acquired Bear Stearns. On September 7, the government stepped in to rescue Fannie Mae and Freddie Mac. A week later, on September 14, Merrill Lynch was sold to Bank of America. The following day, Lehman Brothers filed for bankruptcy. The day after that (September 16), the U.S. Federal Reserve loaned money to AIG to prevent the company's collapse. On September 25, Washington Mutual's banking subsidiaries were partially sold to JPMorgan Chase, and the following day, Washington Mutual's holding company and remaining subsidiary filed for Chapter 11 bankruptcy.

On Monday, September 29, Congress voted against the bailout package proposed by President George W. Bush, resulting in a 778-point drop in the Dow Jones Industrial Average. And while the government worked to build a package that would pass, Wachovia became another casualty as it entered talks with Citigroup and Wells Fargo (the latter bought the bank on October 3).

When I looked around at the outraged public reaction to the $700 billion-plus bank bailout plan, it seemed as if people really wanted to bust the chops of the bankers who had flushed their portfolios down the toilet. One nearly apoplectic friend of mine promoted the idea of an old-fashioned solution: "Instead of taxing us to bail out those crooks," he ranted, "Congress should put them in wooden stocks, with their feet and hands and heads sticking out. I bet everyone in America would give big bucks for the joy of throwing rotten tomatoes at them!"

Now consider what transpired from the perspective of the trust game. We entrusted those bankers with our retirement funds, our savings, and our mortgages. Essentially, they walked away with the $50 (you may want to put a few zeroes behind that). As a consequence, we felt betrayed and angry, and we wanted the bankers to pay dearly. To set the economy right, the world's central banks tried to infuse money into the system, give short-term loans to banks, increase liquidity, buy back mortgage-backed securities, and every other trick in the book. But these extreme measures did not achieve the desired effect in terms of economic recovery, especially if you consider the relatively pitiful impact that the massive injection of money actually had on restoring the economy.** The public remained livid, because the central issue of rebuilding trust was neglected. In fact, I suspect that the public trust was further eroded by three things: the version of the bailout legislation that eventually passed (which involved multiple unrelated tax cuts); the outrageous bonuses paid to people in the financial industry; and the back-to-business-as-usual attitude on Wall Street.

Now just imagine, that instead of assuming that people are perfectly rational, we realized how important trust it, and how it can be easily turned into revenge.

*There are many different versions of this game, with different rules and different amounts of money, but the basic principle is the same.

*** The bailout did help many banks, which quickly returned to profitability and proceeded to pass out large bonuses to their top management. It didn't do as much for the economy.

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