Economic Behavior Is Rational

I tend to think that economic behavior is rational, even when it is wrong, it is rational. For example, some people have said that discriminating against Blacks is anti-capitalistic. I thought, and still think, for example, not allowing Blacks to eat in a restuarant, was "good business" because, at the time, white people didn't want to eat with Blacks if the Blacks weren't the people serving the food. It was rational to have that model and get white people into your restaruant, then not discriminate and go out of business.

I mention this because of this opinion piece by David Ignatius in The Washington Post:

So Roubini knew two things: Housing prices wouldn't keep going up forever, and when they went down, they would take a big piece of the financial system with them. From then on, it was a matter of watching the data.

But everyone else had those same numbers. Why did Roubini act? The answer is that he decided to trust his gut, which told him there was trouble ahead, rather than Wall Street's "wisdom of the crowd," which -- as reflected in stock prices -- said everything was rosy. He concluded that the markets were not pricing in the degree of risk that was actually present in housing.

"The rational man theory of economics has not worked," Roubini said last month at a session of the World Economic Forum at Davos. That's why he and other prominent economists are paying more attention to behavioral economics, which starts from the premise that economic decisions, like other aspects of human behavior, are influenced by irrational psychological factors.

The most compelling rebuttal of the rational model, paradoxically, was delivered by the ultimate rationalist, Alan Greenspan. "I made a mistake in presuming that the self-interests of organizations, specifically banks and others, were such that they were best capable of protecting their own shareholders," the former Fed chairman told Congress last October.

That's why Greenspan didn't see it coming, argues Daniel Kahneman, a Princeton professor who is often described as the father of behavioral economics. His rational-actor model wouldn't let him.

Roubini's "gut" was rational thinking in opposition to the crowd. From my take, the "crowd" was also thinking rationally when it was thought the upward trend in housing would continue. They were wrong, but being wrong doesn't mean being irrational.

In fact, is it rational or irrational to try to make as much money as you can? I think that is rational. However, they were wrong to not assume things would take a down turn.