The term “phishing” is commonly used to describe Internet‐based scams, such as the Nigerian millionaire who wants to share his wealth with you (in exchange for some of your banking information). Akerlof and Shiller use the term to describe “getting people to do things in the interest of the phisherman, but not in the interest of the target.” Phishermen catch “psychological phools” whose “cognitive” limitations lead them to “misinterpret reality.” Gamblers who don’t understand that the odds are against them are cognitive phools. Gamblers who do know the odds are against them, and other addicts who are “self‐aware” but can’t quit, are “emotional” phools. The “informational phool” is a third variety, duped by dishonesty. According to the authors’ “dual view of our market economy,” Adam Smith isn’t quite right; self‐interest leads the butcher, the brewer, and the baker to produce food and drink that’s consistent with our well‐being, but self‐interest also leads producers to induce consumers to buy more of what’s bad for them.
Overbuying / One reason people are “phishable” is that they respond to storytelling. Akerlof and Shiller object to advertising in the form of a story that diverts us from buying “what we ‘really want,’ or, alternatively stated, … what is good for us.”
They have plenty of criticism for advertising executives, who conjure these stories for a living. Pioneer advertiser Albert Lasker created ads that “told the story” of the Wilson Ear Drum Company, which manufactured tiny tubes that supposedly “restored perfect hearing” when placed in the ear canal. The hard‐of‐hearing bought the story and the company’s inefficacious product. Lasker collaborated with Claude Hopkins to invent the trademark “Sunkist” for an orange‐growers association, popularizing orange juice. To the authors, this proves that “consumers will be influenced by the story that they are ‘Sun Kissed.’ ” David Ogilvy created “the saga of the eye‐patch man,” a print ad campaign featuring an aristocratic man in an eye patch, which boosted sales of C. F. Hathaway dress shirts.
In Akerlof and Shiller’s view, such advertising strategies wrongly prompt consumers to buy too many goods. They say that “advertisers, by statistical tests, can also see what works and what does not.” “If there is a way to make a profit from our monkey on the shoulder tastes [for goods we want that are bad for us] the phishermen will keep trying until they find it.”
If all we had to fear was buying too many oranges and dress shirts, that might be of little concern. However, the stakes are higher on big‐ticket items and when we use credit cards. Akerlof and Shiller reason that when we buy cars, salesmen coax one in three to pay “an extra $2,000 (inflation adjusted)” over the lowest price a salesman would accept. Homebuyers may overpay by thousands of dollars. Akerlof and Shiller focus on “a remarkable example of a rip‐off” related to “initiating the mortgage.” Lenders formerly extended money to borrowers at the closing if the borrowers would “agree to pay an interest rate higher than ‘par’ for the duration of their mortgage.” Lenders first paid this money to the mortgage broker, who kept the majority of it, according to research reported by Akerlof and Shiller, before borrowers received their due. The Dodd‐Frank Act now forbids the practice.
Another example of what they consider wrongful dealing is credit cards, which they say induce consumers to pay higher prices than if they were to pay cash. Akerlof and Shiller cite psychological experiments as evidence for this. They reason that the “cost of credit cards” amounts to “a significant fraction of the bills for our major necessities.” Other researchers estimate the “interchange fees” that burden cardholders and assert that credit cards are a “major cause of personal bankruptcy.”
Phishing has macroeconomic effects. Akerlof and Shiller argue that “reputation mining” explains the last financial crisis: Investment banks and rating agencies historically earned good reputations from their origins. But changes in the housing finance industry changed incentives for how the banks operated. Investment banks sold shares to the public, so “no longer did most [bank] partners have to tremble at the thought of a lawsuit that would make them liable for most of their personal fortunes.” They created mortgage‐backed securities (MBSs), contaminated with bad loans to home buyers with no incomes or down payments. Dividing the interest and principal payments from the MBSs into “tranches” that supposedly protected some investors from nonpayment concealed the bad loans. The incentives of rating agencies, tasked with judging the quality of investments, changed too. Whereas they previously earned income from “book sales and other small fees,” investment banks began paying them for ratings. Akerlof and Shiller explain that rating agencies handed out wrongfully high ratings in order to profit. If they “give a low rating; there will be no more deals,” the authors write. Buyers of MBSs accepted the high ratings; they bought the “myth of the new economy,” as Akerlof and Shiller see it, “that the complex mortgage‐backed securities were tailored in such a way that risk had disappeared.” Although the authors tell a story in which investment banks and rating agencies are the characters that caused the Great Recession, they neglect to mention Fannie Mae, Freddie Mac, and bad government policies.
The chapter “Phishing in Politics” explains government failure. Akerlof and Shiller outline a “winning electoral strategy” whereby a politician tells the masses what they want to hear, tells “campaign donors” what they want to hear in return for their money, and then spends the money on advertising to build support. Lobbyists arrange deals between politicians and donors, who are the largest source of campaign funding. Take the American Jobs Creation Act, which enabled corporations to avoid paying taxes on a substantial share of repatriated profits: A “coalition” of corporations that lobbied for the act, researchers estimate, incurred “$180 million” of “lobbying costs.” In return, they banked “tax savings of $46 billion.” Numbers like these imply that the effect of lobbying is large and harmful to democracy and markets.
Battling schemers / After providing many examples of phishing, Akerlof and Shiller discuss antidotes. Their prescriptions will likely frustrate readers predisposed to markets. “Standard economics (the ‘purely economic model’) presumes no civil society,” they claim, “but in fact we live in a community of people who care about one another.” This gives the false impression that Adam Smith and his followers ignore ethics. “It is not the unadulterated actions of markets that bring us the cornucopia we enjoy,” Akerlof and Shiller allege, “for that same free‐market system brings ever more sophisticated manipulations and deceptions.” First, proponents of markets recognize the importance of institutions, including democracy, rule of law, and voluntary associations. Second, scamming is not only a market phenomenon: Akerlof and Shiller portray what happened in the Garden of Eden as a scam, but that predates markets by eons. And today’s Nigerian millionaire scam (which the authors don’t mention) did not come from a bastion of economic freedom. Nevertheless the authors rightfully exalt the “heroes” who battle schemers and set standards of acceptable practice.
Among their heroes are Harvey Washington Wiley, who initially headed the U.S. Food and Drug Administration, as well as Stuart Chase and Frederick Schlink, whose accomplishments include what is now the Consumers Union, publisher of Consumer Reports. “Business Heroes” participate in Better Business Bureaus and Chambers of Commerce all over America.
Under the heading “Government Heroes,” Akerlof and Shiller tell us of the 1817 “Supreme Court case, Laidlaw v. Organ, [which] established the joint principle of caveat emptor/caveat venditor (buyer beware/seller beware) as a foundation of U.S. commercial law.” Knowing that the U.S. Senate had recently ratified the Treaty of Ghent that officially ended the War of 1812, Organ speculated that the price of tobacco would rise and bought an enormous quantity from Laidlaw. Laidlaw queried Organ about the large order, but Organ “parried”; when tobacco prices soared, Laidlaw felt cheated. Legal wrangling over the deal reached the U.S. Supreme Court, where a unanimous majority decided in favor of Organ. Akerlof and Shiller criticize the decision, charging, “Since that time a line of legal heroes have been whittling away at it, making the law more flexible (and more reasonable).” Letting the buyer beware, they charge, “gives license to phish.” Perhaps, but that ignores the likelihood that buyers and sellers responsible for their own negotiating become better negotiators. Put differently, why didn’t Laidlaw delay selling and find out why Organ wanted to buy so much?
The section “Regulator Heroes and the Question of Regulatory Capture” is revealing. Akerlof and Shiller review theories of regulatory capture and endorse a version dubbed “weak capture: there is influence by the Interests, but regulation does impose constraints and, on balance, serves the public good.” They admit that regulators can be “phished.” According to them, “The FDA leaves itself vulnerable to being phished by the companies it regulates by giving them five degrees of freedom in designing clinical trials and reporting the results.” The authors object to calls for deregulation “just because regulation has problems,” but they do not explain how to stop regulators from being phished.
During most of the previous century, according to Akerlof and Shiller, Americans assumed “that government, used effectively, can be genuinely beneficial.” That is no longer the case, in their view. Now people buy the “New Story” that markets are utopia and “government is the problem.” This tale that grips so many, the authors argue, “is itself a phish for phools.” They provide case studies to contrast markets and government.
“Our national system of Social Security,” Akerlof and Shiller state, “greatly reduces the poverty of the aged.” If the intended effect is to transfer income, it accomplishes that. But the job of an economist is to reveal unintended consequences. Akerlof and Shiller neglect to mention that demographic changes jeopardize the program. Instead they add, “Social Security thus goes a considerable distance in offsetting phishing for phools overspending.” That means that people who can’t “make a budget and stick to it” need not learn how; the government will tax others to take care of them. Dedicated economists would warn the public that Social Security induces workers to save less. Akerlof and Shiller instead offer this frivolous justification, “Older Americans can afford an occasional present to the grandchildren.”
Given their “more expansive view of the role of government,” they state, “Securities regulation is one of the most essential government functions.” If so, one wonders why the Securities and Exchange Commission failed to expose Bernie Madoff. The authors’ answer is “budgetary deficiency.” They tell how Harry Markopolos, an independent financial investigator who first detected Madoff’s chicanery, tried for years to inform SEC officials that Madoff’s performance “defied the laws of finance,” but they couldn’t appreciate Markopolos’s sophisticated “quant” analysis. “This misunderstanding,” they write, “could have been cleared up if [the SEC meetings] had included someone with a background in finance.” But if SEC officials cannot find such a person on their staff, perhaps their “deficiency” is not a “budgetary” one.
That brings us to the authors’ third example of why so many are stupefied by the “New Story” that markets are good and government is bad. The U.S. Supreme Court decision Citizens United “explicitly denied the distinction between free speech by individuals and free speech by corporations.” Although Akerlof and Shiller assure us that free speech is “critical,” the reader should not be surprised that they waver: “But just as phishing for phools yields a downside to free markets, similarly, it yields a downside to free speech.” They echo Justice John Paul Stevens, who argued that allowing corporations to speak freely enables them to influence whom we will vote for. In their view of the political process, Politician A votes to benefit Corporation X, which returns the favor with politically helpful speech. Their view is correct, so far as it goes, but they omit the role of competition, whereby Corporation Y or Nonprofit Z raises money to speak out against Politician A. And it misses the point that the way to stop Corporation X from wanting to give money to Politician A is to deny A so much authority to tax, spend, and regulate.
Akerlof and Shiller are likely to convince many readers that phishing is omnipresent. Their stories will help readers become savvier consumers and investors. If this reviewer’s understanding is correct, they will achieve their goal of incorporating a “phishing equilibrium” into economic theory when their “new variable,” which is “the story that people are telling themselves,” becomes the view that markets don’t work so well. Let’s hope markets prevail.
