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Nonmonetary Currencies and Dishonesty

by Colin Gustafson
Tue, 5 Feb 2008 at 10:39 AM

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A behavioral economist at the Massachusetts Institute of Technology (Predictably Irrational) has a unique theory about how rogue trader Jerome Kerviel may have rationalized making billions of dollars in allegedly fraudulent stock transactions while his employer, Société Générale, incurred staggering losses: He wasn't dealing in hard currency.

"It's much easier for us to be dishonest when we are one step removed from cash," Professor Daniel Ariely writes. "After all, he was dealing with stock derivatives that are multiple steps removed from cash." Mr. Ariely theorizes that people are inclined to cheat when dealing with more abstract, nonmonetary currencies.

To test his theory, he set up an experiment in which a large group of Harvard University and MIT students were given the opportunity to cheat on a 20-question math test. Some test-takers were offered a cash reward for correct answers, while others received tokens that they could later exchange for currency.

Which group cheated the most? Mr. Ariely found that students who were offered noncurrency tokens cheated on twice as many questions as those who were offered cash up front. The reason, he concluded, is that people feel more guilt about cheating for cash than for noncurrencies.

"This, I suspect, is why Jerome Kerviel was able to erase $7.14 billion" from the second largest bank in France, Mr. Ariely writes.

CREDIT BOOMS AND LENDING STANDARDS

Is the recent turmoil in the American economy the direct result of a rapid expansion in the subprime mortgage market — evidence of a credit boom gone bad?

Most economists think so, but until recently few have had solid empirical evidence to point to.

In a new paper posted online yesterday (VOX), International Monetary Fund economists argue that recent spikes in subprime mortgage delinquencies are, as suspected, closely related to the rapid growth in the credit market during the past decade.

Historically, not all credit booms have been followed by banking crises. But in this case, nationwide increases in loan delinquencies have been the greatest in areas where more loans were issued, researchers found.

The culprit, they argue, is a loosening of lending standards that has accompanied rapid credit growth — resulting in fewer denials and more mortgage defaults. "Rapid credit growth episodes … might create vulnerabilities in the financial system," the authors write. As a result, "even highly-developed financial markets are not immune to problems associated with credit booms."

For more insight from the country's leading economics blogs, go to nysun.com/blogs.php.

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