The “Gut Players” Usually Lose

Adam Seitchik

November 2003

Our risk-seeking president describes himself as a “gut player,” trusting his instincts more than rational analysis.  This is sexy but dangerous.  Out here in the suburbs we generally value prudence like his daddy, but occasionally get snookered into taking too much risk as well.  Veterans of the recent stock-market debacle know what it’s like to get swept up by emotion, ignoring inviolate rules about risk and return.  When emotion trumps reason, the gut players usually lose.

Like the markets, foreign policy seemed easy after the Cold War.  But September 11^th destroyed billions of dollars of paper wealth as well as our sense of national invulnerability.  Investors learned hard lessons about finance during the crash.  We were told to diversify away from technology stocks; we didn’t.  We traded calm analysis for gung-ho speculation.  We were unwilling to take early losses as a portent of worse things to come.

While painful financial markets have made most of us more risk averse, in foreign policy the president has taken spectacular chances in the hopes of achieving a valuable, long-term return.  We have invested the blood and treasure of the United States in our biggest military engagement in thirty years.  The returns so far are poor, while the cost of the investment skyrockets.  With so much now riding on a positive outcome in Iraq, can investment theory offer any guidance?

While the best financial thinking is rigorous and analytical, our heart often gets us into trouble.  Time and time again, human beings make the same irrational mistakes, driven by emotion rather than reason.  The sub-specialty of “behavioral investing” studies the pitfalls of being a gut player.  We can usefully apply these lessons to the president’s policies.

• Ridiculous mental accounting.  You value some dollars less than others, such as spending more freely out of one of your bank accounts than the other.  Or gambling more with your winnings than with your initial principal.  For the president, $87 billion on Iraq is his funny money, like your blowing $300 at the casino.  When it comes to domestic programs like health care and education, Dubya’s doing the weekly shopping, worrying about every penny, weighing the tradeoffs between store brand and generic, value pack versus the weekly special.

• Caring too much about sunk costs.  Building the budget-busting addition isn’t necessarily a good idea even though you have just spent $5,000 on architectural plans.  Too often we throw good money after bad.  Iraq did not have weapons of mass destruction.  The Iraqi people consider us to be occupiers, not liberators.  Most Iraqis say that they want some form of Islamist government.  Our prior assumptions were incorrect.  All we have spent there may be a sunk cost, and therefore should be irrelevant to future decision making.  But accepting sunk costs means admitting mistakes, which is hard for anyone, and seemingly impossible for this president.

• Misplaced optimism and overconfidence.  Believing that everything will work out in the end, all news is interpreted through the foggy lens of wishful thinking.  A 200-point drop in the NASDAQ is a buying opportunity.  The American economy is recession proof.  We can impose the first Arab democracy on the Iraqi people, spreading peace throughout the region.  It should raise alarm bells when the president says he discounts independent sources of analysis, getting his “most objective information” from his advisers.  One would think that a people who just endured the internet bubble would know better than to get swept up in the relentless hype of Bush.com.

On the other hand, the gambling Dubya doesn’t suffer from some of the problems afflicting the risk-averse, such as regret-aversion and status-quo bias.  Sometimes we sit on our hands out of fear of making a mistake, or of making a mediocre situation worse.  Not our president.  He seems to have no regrets, a risk-seeker willing to gamble it all for future gains.  The problem is, he’s playing with the house money, and it’s our house that is up for grabs.

The best investment decisions require ignoring prior losses and sunk costs.  Focus on the opportunities going forward.  Admit mistakes, be humble, and have a flexible mind.  Set achievable goals, avoid wishful thinking.  It’s exciting being a gut player, doubling down, getting caught up in flights of fancy.  But in the end, you’re a loser.

Investments that go bad often require a workout period.  We have to ensure that the Baathists don’t return to power and that Iraq’s future does not threaten our security interests.  These are relatively modest, achievable goals which if met will go some way toward restoring our international reputation.  But rather than enduring the five years it took Richard Nixon to declare peace with honor in Vietnam, its time to come up with a reasoned, fact-based exit strategy, and then get the hell out of Baghdad.