Is Everyone Cheating? Dan Ariely ponders Bernie Madoff's Impact on His Peers

MIT professor, Dan Ariely, author of the pioneering best seller, Predictably Irrational, and of the blog by the same name has a post up called, "3 irrational lessons from the Bernie Madoff scandal."

His third lesson provokes in us a flow of questions that we have been mulling over, post-mortem to Madoff's jailing last week. Consider what he says about the lesson regarding the propensity people have to cheat under different circumstances.
...A third bad lesson that I think people will take from this concerns the way we define acceptable levels of cheating. In a study that may parallel Madoff’s egregious dishonesty, we again gave the participants the opportunity to cheat, while solving a puzzle quiz — but this time we hired an actor. This actor, posing as a fellow participant, stood up at the start of the session and declared that he had solved all the puzzles. Now the question is how his behavior would influence the other participants in the room — the ones who were watching him.

What we found is that when the actor wore a plain T-shirt, which made him part of the student group, cheating increased. On the other hand, when the actor wore a T-shirt of the rivaling university, cheating decreased. What this means is that when someone who is part of our own social group cheats, we find it more acceptable to cheat, but when people who are not part of our social group cheat, we want to distance ourselves from these people and cheat less.

Madoff was part of the financial elite — part of an in-group of our financial leaders. Think of all these people who were in his house, who knew him well. So now, when other people in this circle see him cheating, think about the long-term consequences: Would these other people in this financial industry now be more likely to take the immoral path? It doesn’t have to be another Ponzi scheme. It just means that, now that they have been exposed to this extreme level of dishonesty, they might adopt slightly lower moral scruples. Maybe they will start not letting their clients know exactly what they own and what they don’t own, or change a little bit the interest rate that they’re charging them … I don’t think that those in his circle will necessarily become more Madoff-like people, but I do suspect that they will get a substantial relief from their moral shackles. Sadly, that’s his legacy.

So, Chapter One of the Madoff scandal is over, but I worry that the negative downstream consequences of this experience are just starting …
Ariely already insinuates that we ought not be happy to have grabbed the low hanging fruit -- the big perpetrator -- when the smaller cheats in the game will do us much more harm.

He wraps up his post with this extension of his research. Since Madoff is wearing the plain T-shirt, everyone else on Wall Street now has permission to cheat.

Just that this bothers us because it is so darned theoretical. Where is the actual history or biography here? Isn't it really important to go back to the time that Bernie first saw the other guy in the plain T-shirt cheating? Somehow he gave himself permission along the way to cheat. Only he stepped off the cliff and couldn't climb back up.

We try to think average here at Tzvee's blog. We believe that's why people come back to read more here. We try to be not too clever and not too hip, and just a bit Talmudic.

Look at this thought experiment. Let's say our livelihood depended on us convincing you to give us your money to invest so we could get a commission, buy a nice house, send our kids to nice schools, take nice vacations and the rest to the drill.

Remember. We only make more money if you invest more money. If you sell and go to cash, we suffer.

What's that? You say that gives us a big incentive to lie to you that the market will always go up and no incentive to tell you the truth that sometimes you should sell because the market is going down?

We do have stories from inside. The big firms do know six months to a year before the big declines. Do they tell you, the investor, to sell? Of course not.

The brokers (excuse me, Financial Advisers) get prizes for bringing in the most net new assets to the firm. Can those folk tell you to keep your money in cash?

Let's be honest. We average guys are convinced right here and right now that the game is rigged. Not because of Madoff who was just the world's biggest goniff. But because of all the smaller ones. That takes us back to Ariely's second lesson - look out for the smaller cheats.
Another non-useful lesson that I think we will adopt is to start searching with more vigor for other bad apples. On one hand, it is clearly important to prevent more Madoffs, but at the same time I worry that as a consequence of searching for bad apples, we won’t pay enough attention to other financial behavior that might not be as badly wrong but that can actually have larger financial consequences.

In our research on dishonesty, we found that when we give people the opportunity to cheat, many of them cheat by a little bit, while very few cheat by a lot. In our experiments, we lost about $100 to the few people who cheated a lot — but lost thousands of dollars to the many people who each cheated by a bit. I suspect that this is a good reflection of cheating in the stock market, where the real financial cost of the egregious cheating by Madoff is actually a tiny fraction of all the “small” cheating carried out by “good” bankers.

The risk here is that if we pay too much attention to chasing bad apples, we might pay too little attention to the situations where the small dishonesties of many people can have large consequences (such as paying slightly higher salaries to cronies, making small changes to financial reports, doctoring documents, being slightly dishonest about mortgage terms), and in the process neglect the real economic source of the trouble we are in.
In the context of this research, our own thought experiments and the realities of the past year, we think it is fair to ask our readers, just how cynical should we be?

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