Dec

27

 As a psychiatrist and medical doctor it would be improper to diagnose Bernard Madoff without interviewing him directly and having him take various psychological tests.

However what is not off limits and just as relevant is not what his behavior says about him, but what it says about us. What is there about human nature that makes some of the smartest and supposedly shrewdest financial minds ignore red flags and abandon judgment?

"How" Madoff was able to do it is can be explained by social psychology and "why" he was able to do it can be explained by neuropsychology.

Social psychology is the study of how people and groups interact. Robert B. Cialdini is a social psychologist, Professor of Psychology at Arizona State University and author of Influence: Science and Practice. He is one of the leading researchers in the field of influence and persuasion. His work is compelling, convincing and so powerful that he vigorously decries its use in any exchange that lacks integrity and ethics. Unfortunately too often, people with impure motives have learned to apply this effective approach to their impure ends. I don't know if Madoff was a student of this approach, but his behavior indicates that he followed all of Cialdini's principles.

Cialdini's six "weapons of influence":

Reciprocation - People tend to return a favor. Thus, Madoff's offer to clients to be part of an exclusive list of wealthy clients and institutions, caused clients to be grateful for this special invitation and return the favor by investing more money than common sense would dictate.

Commitment and Consistency– Also referred to as "confirmation bias," if people commit, orally or in writing, to an idea or goal, they are more likely to honor that commitment and be inclined to keep saying, "Yes" to reinforce their believing they have made the best judgment call to begin. With Madoff, the more that people originally invested, the more they continued to invest and the more they invited their friend to invest. This all served to reinforce their believing they had made the best decision to begin with. Finally, this also caused people to overlook or negate any facts to the contrary and made them all too willing to take a "don't ask (Madoff), (Madoff) don't tell" position.

Social Proof- People will do things that they see other people are doing. So when people discovered that others who they thought were smart and wise were investing, that increased their confidence that it was safe for them to do so.

Authority- People will tend to obey authority figures, even if they are asked to perform suspicions or even objectionable acts. Madoff was a former Chairman of the NASDAQ and philanthropist. So it was assumed that if anyone could understand the potential opportunities and risks of younger growth companies, it would be he.

Liking -People are easily persuaded by and buy from other people that they like. It was easy to confuse Madoff's sly smile as a shrewd one. Also we tend to like people who demonstrate swagger and exude confidence. They trigger swagger and confidence envy in others who would also like to possess those qualities.

Scarcity- Perceived scarcity will generate demand. Madoff's reserving his offering for elite investors and by invitation only, made more people want to be part of his exclusive club.

Neuropsychology is the applied scientific discipline that studies the structure and function of the brain related to specific psychological processes and overt behaviors and may explain why Madoff was able to trick us. One area of neuroscience that has generated a great deal of interest and study in the past two decades is the discovery of an area in the premotor and parietal cortices referred to as the mirror neuron system.

In the late 1980s this region of neurons was discovered in Macaque monkeys. These neurons which were first referred to as "monkey see, monkey do" neurons were activated when a monkey watched another monkey perform a behavior and when the first monkey performed the behavior that it saw. When the discovery was also applied to humans, the region also fired when a person imagined doing that activity in his mind's eye. So when a golfer imagines the flight of a ball before he hits it, this part of the brain actually thinks it's hitting the ball.

Further research including fMRI scans (which show what is happening to the brain as it is thinking or doing an activity) have indicated this site might be the prime location for where imitation, learning and empathy develop and when dysfunctional, a possible site that might lead to autism.

The significance of this discovery is that people not only have a reaction when they respond/react to the people around them; they also have a very positive and satisfying reaction when people are mirroring them or "getting where they're coming from." That is why many people cry and feel disarmed when someone is kind to and understands them without it being solicited.

This neurological region may be the underpinning for why Cialdini's "weapons of influence" are so powerful, i.e. applying them causes the other person to feel empathized with and understood. When people feel that way, they lower their guard and lean into the relationship and trust it more. In essence when people really feel that you get where they're coming from, they're much more likely to trust you to take them where you'd like them to go.

Just as guns do not kill people, people kill people empathically mediated persuasion techniques do not manipulate people for evil, people do that. Hitler and Osama bin Laden were both extremely empathic in that they both knew all too well how terrorizing people can almost paralyze them with fear or at least completely disrupt their ability to function.

What it comes down to is a person's values. It's their values that determine whether they will use persuasion and empathy in the best interest of their clients (as medical doctors who are sworn to "first do no harm" do with their patients) to do good or to greedily exploit their fears, insecurities and yes, their clients' own greed to violate ethics and morality.

How can all of us use these findings from social psychology and neuropsychology to be more fortified against the charming manipulators and psychopaths in life? First, go into any meeting with any person who is pitching you, knowing explicitly what you want and need from them. When you don't know these, the charm of these people can cause you to be vulnerable to their persuading you to need and want what they are offering. Second, make certain that whatever they are offering makes sense, feels right and seems actually doable. Third, realize that whatever they're offering is a good deal for them, so push them to tell you why it's a good deal for them.

Finally, be prepared to walk away, no matter what they say. If they say, "Take it or leave it," leave it. If it feels too good to be true, it is.


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4 Comments so far

  1. Steve Leslie on December 28, 2008 11:27 am

    Dr. Goulston is one of the exceptional people who write for this website and his work is one to be appreciated and embraced. I have read and admired him for years via this website and his e-mail updates. I am reluctant to add anything to his offering on my part as my effort would fall embarrassingly short.

    However, there is an article in the recent Atlantic Monthly by Henry Blodget, former hammer at Merrill Lynch and now discredited securities analyst.

    Here is the beginning of the article:

    WHY WALL STREET ALWAYS BLOWS IT

    Well, we did it again. Only eight years after the last big financial boom ended in disaster, we’re now in the migraine hangover of an even bigger one—a global housing and debt bubble whose bursting has wiped out tens of trillions of dollars of wealth and brought the world to the edge of a second Great Depression.

  2. Alice Allen on December 28, 2008 1:36 pm

    The importance of Cialdini’s work in understanding Madoff’s appeal cannot be overstated. In the category of Liking influences, I would only stress the “halo effect” as well as the tendency to like people who are like you. The extent to which Madoff operated within his own social group made his despicable appeal all the more powerful to his investors. However, I must take issue with one of your suggestions to screen out investment in future schemes: …”make certain that whatever they are offering makes sense, feels right and seems actually doable.” That’s just the problem: Madoff represented the perfect stereotype of the successful, experienced, apparently trustworthy investor. To individuals and even other professional investors, Madoff “made sense and felt right.” To the professional who invested with Madoff, it may have seemed “actually doable” because they were willing to assume that his methods were beyond their understanding, notwithstanding the tiny variability in his consistent annual returns. In my opinion, the only person who is safe from a Madoff, whose faked records appear to have fooled the SEC, is to learn to enjoy investing or trading for themselves through study, trial, and error.

  3. ivar on December 30, 2008 12:18 pm

    Thanks!

  4. Jim Davis on December 30, 2008 9:24 pm

    From what I have read, there was a considerable amount of skepticism about Madoff for many years prior to his unmasking.

    However, these skeptics were profoundly sophisticated , certainly as compared with the Madoff victims. They were fellow ‘players’ in that they knew what was possible and what was not in terms of performance. The % return and consistency in all markets seemed beyond ludicrous, unless some ‘magic’ was afoot.

    The supposedly sophisticated fund of fund managers and the other ‘enablers’ of Madoff should be held to some account for their failure to demand ACTUAL proof of performance. The average investor, even those of means, could not be expected to have seen through this LONG RUNNING scam. Their only failing as far as I can tell was putting way too much of their net worth into one entity.

    I think 10% (other than govt insured) is about the practical limit for ANY investment. 50-60-90 %? Insanity.

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