PHISHING FOR PHOOLS AND THE FINANCIAL CRISIS

Question:

Explain the idea of “Phishing for Phools” and its main applications in the financial industry.
How important was “Phishing” in causing the Financial Crisis? Compare the role of “Phishing”
other possible major factors, including the repeal of the Glass-Steagall Act, the role of the
Government Sponsored Enterprises Fannie Mae and Freddie Mac, and changes in the risk-taking
of the financial industry in general. Please cover these major factors, and feel free to add others
you think are important.

INTRODUCTION

The majority of the time, our tastes impact the decisions we make. The first concept of "tastes,"
according to Akerlof and Shiller (2015)'s Monkey-on-the-Shoulder Tastes, describes what is
truly good for us. However, like with the capuchins, this does not necessarily serve as the
foundation for all of our decisions. The second type of "taste" is the one that determines how we
actually make our decisions. And those decisions might not be "good for us." Economists and
finance scholars overwhelmingly believe that market exchanges between willing individuals
promote both sides' well-being (Spears, 2016). “There are two ways to make money. The first is
the honest way: give customers something they value at $1; produce it for less. But another way
is to give customers false information or induce them to reach a false conclusion: so they think
that what they are getting for $1 is worth that; even though it is actually worth less” (Akerlof &
Shiller, p. 8). In most occasion one party decided to go for items that are not of his or her interest
but due to the convincing power of the second party. When one group of market participants is
able to manipulate predicted psychological biases on the part of another group of market
participants, or market information asymmetries, the former can influence the latter into making
decisions that are not mutually good for both parties (Spears, 2016). On the psychology of
persuasion, Robert Cialdini provided a list of factors that influence our decisions. We are
phishable, according to his "list," because we want to return gifts and favors; we want to be kind
to people we like; we don't want to disobey authority; we want to follow others in deciding how
to behave; we want our decisions to be internally consistent; and we don't want to take risks.
PHISING FOR PHOOLS AND FINANCIAL INDUSTRY

According to Lades (2016), free markets enable businesses (or "Phisherman") to take advantage
of customer cognitive biases (or "Phools"). Firms who do not participate in exploitation are at a
disadvantage in the marketplace when competing against more exploitative firms. As a result,
only companies willing and capable of exploiting consumers' decision-making biases stay in
business, resulting in a "phishing equilibrium." According to Akerlof and Shiller, free markets
can lead to an equilibrium that satisfies monkey on the shoulder tastes rather than utility-
maximizing preferences. This is known as a "phishing equilibrium," in which preference
gratification promotes profit but not necessarily individual welfare, according to the authors.

The examples of phising for phools illustrated by the author could be the customers' propensity
to spend more when using credit cards than when paying with cash are exploited by credit card
firms “The experiments by Feinberg and by Prelec and Simester tell us why the credit card could
easily play a major role in that mismanagement. For some, it would appear, credit cards are a
trap” (Akerlof & Shiller, p. 70). Other issues raised include car salesmen who take advantage of
buyers' tendencies to focus on the monthly rate rather than the length and amount of the overall
payment, the financial industry, which takes advantage of consumers' aversion to risky
investments by offering ostensibly risk-free investment vehicles with decent payoffs, tobacco
companies, which fund research suggesting that smoking is not linked to reduced health, thus
creating doubt, etc.

ROLE OF PHISING IN FINANCIAL CRISIS

According to Akerlof and Shiller, the global financial crisis that began in 2008 was caused by
"Reputation Mining" by well-known financial institutions and rating agencies. According to their
story, financial organizations sold overvalued financial products to unsuspecting customers, such
as mortgage-backed securities (MBS) and collateralized debt obligations (CDO) (Thornton,
2016). The "free market" began to crumble when this financial shady dealing was uncovered.
Central bankers were the only ones who could save the day.

Phishing for phools played a critical role in this financial bubble and bust. Without due
suspicion, the tragedy of 2008 was inevitable; just as, if we were in denial regarding phishing on
our computer, we would in due course suffer the consequences (Akerlof & Shiller, p. 25). On
the veg of collapse of Lehman brothers Dick Fuld did all he could to rescue the company to no
avail. In the movie, “too big to fail,” the new Lehman precident and COO, Bart McDade, was
negotiating termswith the Koreans. He had earlier told Dick to be their missing man. “But then,
in the financial turmoil surrounding the failure of Lehman Brothers in September 2008, AIG
could not raise the credit for the called-for collateral” (Akerlof & Shiller, p. 39). Dick fuld in the
processes of trying to apply the principle of phising for phools on Min destroy the negotiation.
Bart tried to convince Min further, so as to proceed with the negotiation, but Min no longer has
interest. Min said, “It is not about the price. It is about the way you have conducted this” while
talking to Bart. There are many case of phish for phools narracted in the book with a particular
case of custmer getting loads and need to pay more interest on the loan. The need to reaally
becareful when dealing with marketers is important because open market may look appealing but
in the real sense it is a trap.

THE REPEAL OF THE GLASS-STEAGALL ACT AND THE FINANCIAL CRISIS

More than 80 years after the stock market crash of 1929, the reasons of the Great Depression are
still being argued (Borough, 2011). As a result, for many years to come, the reasons of the
present Great Recession will undoubtedly be disputed. The Glass-Steagall Act required banks to
choose between being a commercial bank or an investment bank, effectively erecting a barrier
between the two types of banking. The abolition of the Glass-Steagall Act has been a major topic
of discussion recently. Some researchers and legislators feel the repeal was one of the primary
causes of the financial crisis, while others believe it mitigated its impact. Byron Dorgan said, "I
thought reversing Glass-Steagall would set us up for dramatic failure and that is exactly what has
happened. To fuse together the investment banking functions with the F.D.I.C. banking function
has proven to be a profound mistake." (Dorgan, 2009). The proponents of repealing the Glass-
Steagall Act were far more numerous and passionate than the opponents. "Today Congress voted
to reform the rules that have regulated financial services since the Great Depression and replace
them with a system for the twenty-first century," Treasury Secretary Lawrence Summers stated
after the bill was passed. This landmark measure would make it easier for American businesses
to compete in the new economy." Rep. Jim Leach, one of the authors of the Gramm-Leach-
Bliley Act, which repealed the GlassSteagall Act, argues that the repeal lessened the severity of
the current crisis by allowing commercial banks to take over failing investment banks. "If you
didn't have commercial banks ready to step in, you'd have a substantially greater catastrophe
today," he said in a Time Magazine piece on September 17, 2008. (Fox, 2008).

The question of whether the removal of the Glass-Steagall Act contributed to the current
financial crisis is unanswerable. Both sides' arguments are persuasive and informative. The
financial community and policymakers may be able to determine the causes that contributed to
the financial catastrophe through prolonged debate. They may be able to create a regulatory
reform structure based on this understanding that permits the US financial industry to remain a
world leader while being protected against financial volatility. The action took by government to
rectify the depression is a great one.

ROLE OF GOVERNMENT SPONSORED ENTERPRISES

Housing finance was solely the domain of the private sector prior to the Great Depression of the
1930s. The majority of housing financing was made up of short-term renewable loans. The hefty
down payments (about half the home's purchase price), short maturities (10 years or fewer), and
huge balloon payments associated with these loans posed significant barriers to widespread home
ownership (Bernanke, 2007). The great depression that saw the employment rate rise to 23.6%
with a mortgage home debt of about 20 – 25% gave birth to enactment of the Federal Home
Loan Bank Act (the Bank Act) in 1932. The Fannie Mae and Freddie Mac was established as
result of this occurrence to help manage the situation and reduce the debts. Fannie Mae and
Freddie Mac purchase mortgages from lenders and either keep them in their portfolios or bundle
them into sellable mortgage-backed securities (MBS). Fannie Mae and Freddie Mac entice
investors to the secondary mortgage market by packaging mortgages into MBS and guaranteeing
the timely payment of principle and interest on the underlying mortgages, thereby boosting the
source of money available for housing (FHFA, 2021).

The kind of money that government is using to fund Fannie and Freddie made many investor to
believe that the system cannot collapse. The visit of the Treasury secretary to Tokyo in the movie
“too big to fail” indicates the kind of popularity that government sponsored enterprises (GSEs)
such as Fannie and Freddie has. When the crisis of Lehman started people believe that
government will step in and give a bailout to help the failing bank. However, this is not the case
as the treasury secretary was not willing to continually give bailout to banks.
People are all drawing line from Bear and Fannie and Freddie as they believed the way
government took over of these banks will be the same for Lehman brothers. Hanks Paulson
according to the breaking news said in July, 2008 that he wanted the power to step in, but he
probably wouldn’t use it. Different suggestion to Dick Fuld including a call to Warren Buffet by
Paulson was abortive. Warren is very familiar with economy and wouldn’t be phished for phool.
However, Lehman collapse and market continues to go down with lot of panics. In response to
the financial crisis Citicorp, Wells Fargo, and JP Morgan each received $25 billion; Bank of
America received $15 billion; Goldman Sachs, Merrill Lynch, and Morgan Stanley each received
$10 billion; Bank of New York Mellon received $3 billion; and State Street received $2
billion, totaling $125 billion. Treasury purchases of preferred stock by Paulson prevented the
global financial system from collapsing. The banks will pay 5% for the first five years and then
9% after that. Long Term Capital Management's famous 1998 Fed-organized rescue added
greatly to the impression that politically connected institutions were "Too Big to Fail" (Thornton,
2016).

As things stand, this liberalization has been accompanied with ever-increasing government and
Federal Reserve bailouts, culminating in the present financial catastrophe. To be clear,
deregulation did not cause the financial crisis; but, it did amplify its impact. According to the
movie “Inside Job”, the decisions of the financial industries have significant effects. Iceland that
has good structure of modern society was soon affected by certain risk-taking. The broad policy
of deregulation by the Iceland government has disastrous consequences on the environment and
on the economy. Nothing comes without consequences. Iceland government also privatized three
of the larger banks. The decisions made by these banks by borrowing out money and other
money market funds led to the collapse of the banks. The problem of fund management is
universal and United States was free from economic crisis for 40 years after great depression.

CONCLUSION

Our choices tend to affect our standard of living. The banks took risks without counting the
consequences that could follow and lead to the crisis which affected the economy. A man's
standard of living could be affected if proper choices are not considered. Customers that allowed
themselves to be phish for phools will live their lives in debt. People have the freedom to choose
thanks to open marketplaces. They do, however, render them free to phish and to be phished.
Ignorance of those facts is a calamity waiting to happen. Many people that are not aware of the
marketer’s strategies are encouraged to develop their purchasing power skills so that they would
not be manipulated and deceived.

References
Akerlof, G. A., & Shiller, R. J. (2015). Phishing for Phools the economics of manupulation and
deception. New Jersey: Princeton University Press.
Bernanke, B. S. (2007, August 31). “Housing, Housing Finance, and Monetary Policy,” The
Federal Reserve Bank of Kansas City’s Economic Symposium. Jackson Hole. Retrieved
November 9, 2021, from
https://www.federalreserve.gov/newsevents/speech/bernanke20070831a.htm
Borough, C. C. (2011). The Repeal Of The Glass- Steagall Act And The Current Financial
Crisis. Journal of Business & Economics Research, 9(1).
Dorgan, B. (2009, 12 11). “10 Years Later, Looking at Repeal of Glass-Steagall”. The New York
Times.
FHFA, F. H. (2021). FANNIE MAE AND FREDDIE MAC. ABOUT FANNIE MAE &
FREDDIE MAC. Retrieved November 9, 2021, from https://www.fhfa.gov/about-fannie-
mae-freddie-mac
Fox, J. (2008, 9 17). “While the Regulators Fiddled . . .”. Time. Retrieved from
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doi:doi:10.1007/s10818-016-9236-5
Spears, T. (2016). Phishing for Phools: The Economics of Manipulation & Deception.
Quantitative Finance, 17(2), 165-167. doi:10.1080/14697688.2016.1252193
Thornton, M. (2016). Phishing for Phools: The Economics of Manipulation and Deception.
Review Essay. The Quarterly Journal of Austrian Economics, 19(1), 85-100.