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Shiller's Subprime Solution(s)

The intellectual value in studying business opportunity fraud is that if we are able to understand these exercises in simple frauds, we might be able to short circuit errors of judgments in investments - in which the underlying purchase is not inherently fraudulent.

The purchaser of a business opportunity is almost certainly being defrauded, but it remains a mystery to regulators how to prevent these schemes from gaining traction.

The regulator's response to pretend that if the purchase just had more information, a more rational choice would be made.

The regulator's response is wrong: providing more objective information to purchasers already under the sway of the phantom dream being sold by the con criminal pushes them to make irrational decisions quicker.

Robert Cialdini explained this version of cognitive dissonance over twenty years ago, but we still haven't learned how to integrate this finding into fraud prevention.

But the message is clear: if the mark has bought into the phantom fraud, providing systemic evidence showing that the dream is a fraud, will likely have the unfortunate effect of closing the deal. Marks striving for consistency will close faster if they believe that their rational self will scuttle the deal.

We should be very skeptical about the curative powers of rationality, if there is no critical discussion about when the information will be disclosed to the purchaser.

Ian Ayers may be making a similar point, when discussing one of Shiller's solutions to the sub-prime mortgage problem.

"Shiller also thinks that the ultimate buyers of the mortgages were making systematic errors.

He wants improved disclosure about financial securities to help the ultimate mortgage buyers from making ill-advised purchases:

The subprime residential-mortgage backed securities were grossly misjudged because no one outside the rating agencies understood the information to correctly gauge the soundness of the mortgages on which they were based.

The stage was perfectly set for unscrupulous mortgage originators to lend to low-income people who were likely to default, and for mortgage securitizers to sell the soon-to-default mortgages to unsuspecting investors. (P. 136)

I'm skeptical about Shiller's claim that the ultimate buyers lacked sufficient information or the sophistication to understand the data.

Or even if they did, this is not an error they are likely to make again. Once bitten, twice shy."

The latter claim about not making the error again is overly optimistic.

But, it is unrealistic to expect a person in the grip of buying their dream home, for no money down, to avoid the regret of not being "in", will process information from criminal mortgage originators in a rational manner.

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Full post as published by Misleading Advertising Law on October 14, 2008 (boomark / email).