[lbo-talk] definitive evidence on the housing bubble

Wojtek Sokolowski sokol at jhu.edu
Thu Feb 3 07:05:05 PST 2005


Michael:
> True enough, but it seems like such person would also be a member of a
very
> numerous tribe. According to a recent Frontline episode ("The Secret
History
> of the Credit Card," which is being rebroadcast on Sunday in the New York
> area at least), the majority of people who have credit cards do exactly
this
> -- they have substantial money in a savings account along with a revolving
> credit card balance. (This is even stupider than with a HELC, since not
> only is the interest differential higher in the first place, but it can at
> any time be doubled on top of that for seemingly tiny infringements
*after*
> you've run up a large debt, which most people are shocked to find out).
> But if you ask people in a focus group why they don't pay off their loans,
> they'll tell you it makes them feel prudent to have money in the bank for
> emergencies. For some reason, having 2 grand in the bank and 2 grand on
> their card makes them feel prudent, but having zero on each makes them
feel
> vulnerable. The Frontline report gave the impression that this kind of
> fuzzy thinking about credit is very widespread.

Absolutely, except that instead the word "fuzzy thinking" I would use "cognitive framing." People use different cognitive frames - i.e. mental "filters" that focus on some bits of information while ignoring other, and group that information in a particular way - to different aspects of their lives, including financial decision making, cost/benefit analysis etc. The so called 'endowment effect' is one example of it - and this is probably what explains the phenomenon that you are describing.

Endowment effect is a tendency of assigning a higher value to goods being in one's possession than to the same goods being in other people's possession. Experimental studies show that this is not just bargaining tactic to win a better price, but it occurs even when people have nothing to gain or lose from the exchange.


>From a cognitive point of view, endowment effect is the application of
different frames to the same object - one that cognitively expands the object's value and one that shrinks it. Thus the funds that one is "endowed with" i.e. has them in his bank account seem to be more valuable than the same amount borrowed from a credit card company. Or better yet, the "endowed with" funds seem more cognitively valuable than borrowed funds despite the greater time-value of the latter.

Wojtek



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