Behavioral Finance and Government Regulation

Are you familiar with a field of study called behavioral finance? It focuses on psychological explanations for market behavior. Researchers who specialize in the field believe that personal (and often irrational) attitudes, beliefs, and emotions drive judgments and decisions, which in turn determine how individuals act when responding to events.

So if attitudes determine actions, then conversely, actions should reflect attitudes … shouldn’t they? In other words, if we observe consistent trends in the choices and actions of individuals, we should be able to intuit the underlying beliefs and emotions that have inspired them.

With this relationship in mind, let’s ponder the recent choices and actions of traders in global finance. Last summer, the manipulations of the Libor interest rate exploded across the news headlines; they continue to be the focus of numerous regulatory and criminal investigations.

And within the past two weeks, other long term trends have emerged as well. For instance, several firms are now under investigation for manipulating prices in the energy industry through the use of decades-old tactics that were originally pioneered by Enron Corporation.

Furthermore, the London Metal Exchange is now under fire for enabling Goldman Sachs to manipulate commodity metals prices by purchasing and storing massive amounts of industrial aluminum. The strategy is reminiscent of the schemes that were employed by the Hunt Brothers to “corner” the metals market for silver three decades ago, a plot that ended disastrously on Silver Thursday.

Some banking executives have vigorously defended their actions, asserting that they have broken no laws. Indeed, regulations from the Affordable Care Act to the Dodd Frank Act to the Transfer Pricing Laws of the Internal Revenue Service have long been criticized for their bloated lengths and incomprehensible language.

Nevertheless, the longstanding practices of Wall Street traders appear to reveal an underlying belief that any manipulative strategy is acceptable as long as it is legal. Under such circumstances, what method is available to protect the public interest, other than government laws and regulations?