The use of psychological terms by economists is effectively contributing to holding the wrong people responsible for the financial crisis
By Thomas Geuken and Farzin Farahmand
"The financial crisis is a psychological phenomenon," says the headline of an article from newsletter of the Financial Services Union Denmark (#7/2009). This article is one of many articles written about the current economic crisis, wherein economists and other financial actors refer to the psychological effect as a very central parameter in understanding the development of the financial crisis. We hear experts speak sentences that make psychology appear to be just about the most important thing in keeping a society going - like: "The drop in housing prices isn't dangerous in itself … it is rather the psychological effect it has." Implicitly: drops engender more drops. This is psychology.
But what exactly is 'the psychological effect' - seen psychologically?
'The psychological effect' isn't a technical term, but rather an approximation to a phenomenon. It refers to the quite fundamental urge people have to put experiences, messages and actions into contexts in order to make them meaningful. When we put news and events into contexts, we are provided by a rationale with which to understand the world, but it also makes way for the irrational: the affective action, which many economists fear in times of crisis - and rides high on in prosperous times.
In good times, this strengthens a movement that can be explained rationally and economically, while in bad times, the reverse happens; the descending spiral is strengthened beyond what it should be if we solely look at numbers and act rationally.
Economists hence see 'the psychological effect' as a dynamic that strengthens already extant trends. It has become a layman's term, embedded in both economy and investment, and it plays on two strong emotions in people: fear and greed.
Both fear and greed feed on media coverage. Dire economic predictions in the media tickle our fears of losing what we have, while positive news makes us gleefully rub our hands. How many were comforted in the years 2003-2007 by the thought of growing equity in the bricks of their houses - and hence bought a small, extra flat as investment, since things were going so well? How many are sitting today with a somewhat too large mortgage in their houses and fear technical insolvency? Perhaps the mortgage loan was used to buy stocks that are worth less now than then. You never know where the market ends … greed gives way to fear. Perhaps things will turn around again and result in new greed? Time will tell. Memory is usually short. Unlike work, where many earn their money in the transaction 'one day's pay for one day's work', investments are about speculating yourself to money. Hence, investments are very much based on notions of how big fluctuations there will be on a given market - whether housing or stock. For this reason, the 'image of the market' is a vital issue that is being fought about. Just like with the weather forecast, we are on a daily basis fed with data about the newest economic winds and rainstorms. Which stocks are going up or down? What are the numbers for housing sales in the second quarter? What are the forecasts for interest rates and unemployment?
Investment experts have their own TV shows in prime time on the big American networks - like "Mad Money" with Jim Cramer on CNBC, with the slogan "we have the financial expertise you need". The problem is that Jim Cramer has an agenda. For instance, he admitted in 2006  that he manipulated the market for his hedge funds through various tricks. His former partner, Nicholas W. Maier, accuses him of 'Pump and Dump'. This is when you buy stock at very low prices and then pump up their values by mailing hysterical newsletters about how this stock will skyrocket. Then you sell your stock when the price rises - and the 'normal' investors are left with worthless stocks.
Mad Money Jim has long since realized that investments can be optimised through media coverage. FOR THIS REASON he is an actor on both markets. The media have become the faithful servants of the market and rarely live up to their roles as 'society's watchdogs'. It is economic SPIN. The most efficient example of such spin comes from the former Director of the US Central Bank, Alan Greenspan. It is well known  that he was a master of manipulation, and with his position at the front of the global economy, he had considerable influence and responsibility. The difference between him and Jim Cramer may simply be that he - most likely - didn't make his spin for the sake of his personal profit.
We know similar tendencies in Denmark, albeit in the political sphere, in the TV show "Jersild og spin" on DR TV. The show is about smart opinions, political positions, and 'spin on spin' - not about what constitutes good politics or what the political initiatives actually mean. The program's experts primarily discuss what other commentators hope to achieve by what they are saying - not what they are saying. Our modern lives have in this way exchanged reality and meaning with a mediatainted 'image of reality'. Our society and its financial actors have been caught in - and are dependent on - the media's twisted, sensation-hungering interpretations of reality. They have lost contact with the true reality on which the interpretations are based.
In retrospect, the financial actors have perhaps been more interested in the battle for the media image (there's money in it) than handling the real problems with, for example, sub-prime loans, rating systems, etc. Hence, when reality finally breaks through the media image, it does so with unrestrained, violent force. A perfect storm requires that it can grow quietly in strength before it hits us. And when the crisis hit us unexpectedly, it might have been because the economists looked away from the numbers and believed in the fantastic prize and the psychological market forces that would make the curves keep going up forever.
The economists' tales about 'the psychological effect' can be seen as an interpretational schematic that shapes and organizes and contributes to create cohesion and meaning in our recovery actions. The problem is that the psychological factor is exaggerated and indirectly ignores the severity of the real problems by moving the crisis to a psychological universe where it strictly speaking doesn't belong.
The crisis originates in the economic sphere, among economists, investors, house owners, and speculators. When the financial crisis is reduced to a psychological phenomenon, the involved actors can quickly brush off their responsibility and lay the blame at the recipients of the services. "The citizens should not react in affect - don't let psychology win," is the underlying rationale when real estate brokers, bank economists and mortgage company spokesmen tries to talk up the market. A comfortable psychological error that effectively maintains an unsteady foundation for our society's economy, since perhaps there ARE imbalances in the system that cannot be explained through psychology. Perhaps we really need zero growth (or worse) right now to make the overheated boilers cool down, before the train again hurtles forward. Perhaps it is time that more money is earned as 'one day's pay for one day's work' - or through regular company operations - and less as returns on investment. This will move the focus from 'psychology' to 'economy', since psychology as a tool and model of explanation largely is unimportant for these simpler forms. Here, economy suffices brilliantly as a model of explanation.
In existential psychology, you see crises as an integral part of life, and it is a lifelong task to handle such adversity. Crises are important and natural parts of human growth, and they are triggered by events - usually connected with losses.
The definition of a crisis is interesting, since it very clearly describes the financial crisis. Crises arise when you suddenly find yourself in a life situation where all your previous experiences and tools cease to be effective. They become powerless. You can't fully grasp the new life situation and lack concepts with which to nail the world down. You also suffer from a lack of meaning.
In a crisis, there are two concurrent agendas or tasks you have to consider in a therapeutic perspective. The most fundamental is to respond quickly to the situation you're in. Once chock sets in, you become paralyzed. Hence, You need to calm in the short term. In the financial crisis, this was done through bailout plans, state guarantees, etc. to ease the extent of the crisis.
Later, the violent reactions and great swings set in. You slowly begin to treat the difficult experiences by examining and understanding the prerequisites, mechanisms, dynamics and conditions that caused the crisis.
At least in the ideal case. For only through actively taking responsibility for a future life, a new orientation is created for the actor. It is a necessary part of the process of ending a crisis, and successful crisis management thus always changes the fundamental assumptions you used to take for granted. However, hocus-pocus explanations of the psychological kind don't suffice, and we have to ask ourselves where and when the main actors of the financial crisis - the speculators, hedge funds, banks, mortgage companies, etc. - have made the necessary soul searching? Where is the process that deals with the difficult reflections? Where is the well-considered and sustainable model of explanation? And where in the political system is it expressed? "Spend more," was the political message following the release in Denmark of the otherwise frozen SP (special pension) assets. "And remember, our tax cuts will improve your economy next year," it was added. Once again, an expression of psychology that had to be turned around: the affective fear reactions had to be stopped.
However, the winning agenda is a proactive vision that must be able to answer the question: What does it mean? What should life look like from now on - and what can we realistically do? In relation to the economic crisis, the questions are: what should our future society look like? And how do we organize the financial market so it supports us in this movement? The winning agenda is a visionary, meaningful agenda that can provide direction for the fundamental agenda while an unsustainable situation is straightened out. Otherwise, you act in a shortsighted manner. However, many have a tendency to use already familiar tools to quickly end the 'undesirable' crisis - taking the easy way out. But a good psychological rule of thumb is that the tools that got you into a crisis However, the winning agenda is a proactive vision that must be able to answer the question: What does it mean? What should life look like from now on - and what can we realistically do? In relation to the economic crisis, the questions are: what should our future society look like? And how do we organize the financial market so it supports us in this movement? The winning agenda is a visionary, meaningful agenda that can provide direction for the fundamental agenda while an unsustainable situation is straightened out. Otherwise, you act in a shortsighted manner. However, many have a tendency to use already familiar tools to quickly end the 'undesirable' crisis - taking the easy way out. But a good psychological rule of thumb is that the tools that got you into a crisis can't get you out again. So if economists and other good people really believe in psychology in crisis, this might be the place to start. Further speculation will hardly help end the financial crisis; most likely, the opposite.
When you hear economists and real estate brokers mutter "it isn't the financial crisis itself that is the problem, but rather the story of it," this is a truth with modifications. It is true enough that a negative tale about the economy creates uncertainty, which makes people hold back on consumption and investments. However, this way of viewing everything - the market as story and psychology - is a reactive approach. This is because (as described above) you then continue using the same tools that got us into the period with overheating and bubbles. We thus lock the work towards a solution in the twisted and spin-controlled media image instead of fundamentally addressing the problem-causing system: our society and its financial and economic subsystems.
In reality, the primary explanation for the financial crisis may simply be that things were overestimated in relation to their real values; and that the checks and balances were eroded, driven by the aforementioned greed. We can't say that for sure, since we aren't economists - and the economists don't say anything (not very many of them, in any case).
This is slightly absurd. Usually, economists are the first to say that you should stick to facts, objectivity, rationality, and the numbers. Economics has long desired to become an exact science - this has been the goal since World War II. However, when the crisis comes along, when the systems turn out to be wrong, the economists are the first shout that psychological factors are to blame. And now, two psychologists are writing this article, asking for economic solutions to economic problems. This goes to show that something needs to be changed in our understanding of it all. That we need to get psychology back where it belongs - and get economy back as the framework within which our society's economical problems are solved. In the meanwhile, we will do what we can to take care of some of the people that have real human problems as a result of the current economic morass.
 TheStreet.com, Aaaron Task, 2006
 "Superbobler og ninja-lån", Jesper Vind Jensen, Weekendavisen, October 16th 2008.
FARZIN FARAHMAND and THOMAS GEUKEN are state-authorized psychologists and partners in their own firm. In addition, Thomas Geuken is associated project manager at the Copenhagen Institute for Futures Studies