Stephen Greenspan, a psychiatrist who lost money in the Bernard Madoff scam, writes,

Gullibility is a sub-type of foolish action, which might be termed “induced-social.” It is induced because it always occurs in the presence of pressure or deception by one or more other people. Social foolishness can also take a non-induced form, as when someone tells a very inappropriate joke that causes a job interview or sales meeting to end unsuccessfully. Foolishness can also take a “practical” (physical) form, as when someone lights up a cigarette in a closed car with a gas can in the back seat and ends up incinerating himself. As noted, the same four factors can be used to explain all foolish acts, but in the remainder of this paper I shall use them to explain Ponzi schemes, particularly the Madoff debacle.

The four factors are situation, cognition, personality and emotion.

Just to be puckish, suppose that we think of financial bailouts and fiscal stimulus as a Madoff scheme, and we use these four factors to explain why we fall for it.

First, there is situation. Stock markets are tanking. Reports on employment, output, and inflation are disturbing. So we are ripe for a proposed solution. There is strong social pressure to go along with bailouts/stimulus, just as Greenspan felt strong social pressure to invest in a hedge fund that placed money with Madoff.

Cognition means using one’s best judgment (or failing to do so). Here, Greenspan takes the view that he trusted others with greater financial expertise, and those experts let him down. Similarly, we are trusting expert macroeconomists to tell us that bailouts/stimulus are good.

Next, there is personality. Some people are perhaps are disposed to feel safer when government is doing more.

Finally, there is emotion. We certainly want to believe that the government parent can kiss all our boo-boos and make them better.

Overall, I’ll admit that I did not find Greenspan’s explanatory model for foolish decisions very helpful–I think it explains non-foolish decisions also. As to bailouts/stimulus, I actually think that the government’s Madoff scheme may work over the next few years. However, in my view, the long-term risks, in terms of the liabilities being passed to our children and grandchildren, far exceed the benefits.