Tuesday, February 24, 2009

The Cognitive Distortions Of Chicken Little

I was listening to CNBC, and they just reported that the sky is falling. Oh my God!! Look out below.

The Financial Media is deepening and prolonging the recession by engaging in a series of what a professional would call cognitive distortions. The first of these is called Catastrophizing. This is defined as believing that a situation is much worse than it really is. Here's an example of Catastrophizing. A large bank reports a huge loss due to a unrealized loss in its securities portfolio, and deteriorating loan asset quality leading to higher charge offs and loan loss reserves. Then a talking head, or one of the anchors on CNBC says something like this:

"The entire Banking System is insolvent."

Well actually, no it's not. There are thousands of Banks in this country and just because Citigroup thought they could "ride the worm," if I may be allowed to quote from Dune, doesn't mean that every other banker did.

This Catastrophizing is closely related to Magnification, or the tendency to put a stronger emphasis on negative events and ignoring the the positive events.

So what are the causes of these cognitive distortions? There are many possibilities:

1) The media is so immersed in the flow of information and the negative effect of the markets that all they can see are the problems. This "wall of bad news" leads to the distortions listed above. The media was guilty of this in reverse when the markets were heading up. Can anyone remember an anchor actually challenging the Energy Bulls with tough questions two years ago, or were you as annoyed as I was that they were treated as God like investors incapable of error?

2) They are easily manipulated by large institutional investors who have their own agendas to advocate. Have you considered that the commentators who are pushing Nationalization are short the Banks, and their souls are not as pure as they seem?

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