We mortals pride ourselves as rational beings, but we act emotionally. We get attached to previous positions, and will discount or filter evidence rather than change our minds. We read the news for confirmation rather than information.  We are so inundated with information that we rely on emotional instincts to make quick decisions.

Our first instincts are emotional and we tend to then, and only then, rationalize our first decisions. I call this emotional rationalism. Marketers understand this very well.

When you add risk into our thought process we can become even more irrational. Risk is probability plus outrage or fear. Thus the chance of a 911 attack may be small but the outrage of that act may lead us to take extreme measures to prevent such an occurrence from happening again. We spend far more political capital to prevent gun deaths than deaths from swimming pools, which are far more common.

The Age of Reason did not stop wars and hatred; it just changed the institutions that expressed them. Anti-Semitism of the church simply became anti-Semitism in the halls of education and government. Hatred towards those who opposed established faith became even more bitter when it was applied to those who opposed established norms of reason.

Academic credentialism, as distinct from intellectual depth, is not immune to emotional rationalism. Academics will become attached to their theories even when they conflict with the realities of the world they attempt to explain. The world of experience will translate to the world of theory much better than the reverse. Once someone gets a theory in their head it is hard to get them to see the world objectively again.

Thus academics descended on Wall Street with sophisticated models to explain investment behavior. Long Term Capital, a hedge fund from the 1990’s was held in awe because of two PhD Nobel Prize winning economists on its board. Its first few years showed impressive results and helped it attract billions of dollars of capital. But Long Term Capital made bets on Russian bonds and went from a net worth of billions to bankrupt in a matter of a few months. In typical academic fashion the quants explained that the move on Russian bonds was a ‘25 standard deviation event’, so far outside the realm of a rational model that it could not be predicted.

A 25 standard deviation event is a way of saying the odds of this were as remote as getting hit by a meteor while playing the back nine at Augusta National. It is another way of saying that no rational person could be expected to have foreseen this. This is what happens when theory trumps experience. Our world is filled with the outcomes of ‘25 standard deviation events’.

But these same theories brought down a bigger house of cards only ten years later. Debt pools were assembled that were so complicated that when the underlying assets such as a mass of very crappy mortgages collapsed, the credit markets froze because nobody could figure out what any of these pools were worth. The reason these toxic assets are so hard to clean up is because our brightest accounting and financial minds cannot figure out what they are worth.

We still fail to understand the principles of probability and how our emotions filter and distort our reality. As Nassim Taleb notes in his book by the same name we are “fooled by randomness.”

We can discern the various probabilities of a specific outcome of a roll of a pair of dice, because the universe of outcomes is clearly limited and knowable. The same is true of guessing the chance of any combination of cards from one or multiple decks. Cards and dice are a world on known unknowns.

But making bets on the outcomes in the world of global finance is something wholly different. There is no limit to the combinations and outcome of hundreds of national policies, billions of investors, with millions of financial products, subject to the fears and exuberance brought by wars, inflation, and old fashion human greed. This is the world of infinite possibilities, the world of unknown unknowns. This is a world better served by a philosophical understanding of risk embedded in a world of experience than a delusional faith in theoretical models proposed by credentialed academics.

Yet we have still failed to understand this fundamental reason for our recent credit collapse and we are making the very same mistakes, only this time in the government sector. We still swoon for the sound of intelligence over experience.

A car ‘czar’ brags that he has no experience in the automobile business, but “business is business”. Steve Jobs at Apple was replaced by an executive from the soft drink business; Jobs was brought back- you can now Google the story on your iPhone.

In a subject as massive and as filled with unknown unknowns as global climates we are making bets with familiar delusional certainty and even declaring that the “debate is over”. I may not know which end of the test tube the cork goes into, but I would feel a bit better about reordering our entire economy and social structure based on a fifty year climate prediction if we could predict the weather next week.

Many blame the financial collapse on greed and capitalism, but these flaws have been with us forever.  As Thomas Sowell noted, blaming the financial collapse on greed is like blaming a plane crash on gravity; it is true but not a very useful description.

With some months to now reflect and study the causes of the credit collapse, we cannot hide the central role the government played in the disaster. Had Fannie Mae not guaranteed the crappy mortgages they could not have been assembled into vehicles earning AAA ratings and become acceptable to global investors on such a grand scale. We have been fleeced at the gaming table but the casino owners , the dealers, and the pit boss were all government bureaucrats. They just reserved the high roller tables for Wall Street.

As we watch and hope the government will reform the excess of Wall Street, we should be more concerned who will reform the excesses of government. We should ask how they plan to solve a problem by repeating the very same mistakes that caused it.

In the wake of the elections  of November 3, 2008 we noted the dramatic swing of the independent voter.  Who are these voters and why do they refuse to ally themselves with one of the two major parties?  I confess up front that this is my sense and perception and I do not propose to support this with any legitimate research.

The independent is fiscally conservative and socially tolerant. This would make them libertarian but they are not dogmatically so.  They do realize that there is a place in foreign affairs for the military whereas the more dogmatic of the libertarian would categorically condemn foreign military adventures.

The social tolerance explains their willingness to support a black man with a distinctly ethnic name.  They are tolerant of ethnic diversity and I guess they are probably about evenly split on the subjects of gay marriage and abortion rights.

The independent is a realist.  He realizes that there is a continuum of socialistic government policy and individual liberty and is only likely to become mobilized when he sees a move to an extreme, which he probably now sees. When 48% of the population received more in benefits that they pay in taxes it is extreme in any reasonable view. The independent recognizes that there is evil in the world and that there is a time when violence must be employed.

The independent is civil.  The demonization of one party by the other, the name calling, and the negative campaigning alienates the independent. In a display of uncivil discourse they hear only the emotion and not the message.

The independent is rational.  He does not blindly follow a party line if it does not make sense. He is skeptical of radical change, but willing to question policies that no longer work. He understands that taking money from one person and giving it to another does not create wealth. In fact it is more likely to destroy it. He understands that the economic laws that govern his household are not dramatically different than the economic laws that govern our nation. Wealth must be earned, and debt must be repaid- one way or another.

The independent understands the role of government and its limits. He understands that life is imperfect, often unfair, and frequently uncertain.   He understands that government policies that seek to solve all our problems and counter the laws of nature often end in tyranny.

The independent is not necessarily the same as a populist.  The independent is more likely to compromise than the populist, less likely to have a single issue litmus test, and less likely to campaign actively, put a bumper sticker on their car or attend a ‘Tea Party.’

The independent is less tied to a principled philosophy and thus is more likely to be swayed by appearances and charisma. By not being attached to a party he is more likely to change if his candidate disappoints.  This explains the voter swing in VA and NJ.

The independent is more likely to change priorities in crisis.  After 9/11 they became hawks. After the financial meltdown they became economics Keynesians. After the bailouts and nationalizations they became fiscal conservatives.

The independents are honest and expect the representatives to be honest as well.  Transparency and bipartisan efforts were promised by this administration and they are not keeping their promise. They are intolerant of the corruption that is plaguing the party in power. They are even more intolerant that the party leaders tolerate the blatant corruption of a Charles Rangel or Chris Dodd.

The Republican populists that challenged the party leaders in NY district 23 are probably correct that the Republicans cannot win by being a lighter version of Democrats. But they also cannot win by ignoring the wishes and motivation of the independents. The alliance between the independents and populists in matters of sound economics and limited government will not necessarily include a mandate on social issues the independents oppose.

The radical policies of the current administration have energized the Republican base more than the attractiveness of any specific candidate to represent them.  Centrist Democrats in the White House or in Congress may have rendered a figure like Sarah Palin irrelevant.  Combined with the flexibility (or fickleness) of the independents the Right has quickly regained a footing many recently thought was unrecoverable.

What does it say that this memorial was unveiled in Jerusalem while we still have a hole int he ground?  Remember which side of the ‘fence’ this was built on.

Tips to Letty Kaplan

In the three months after 9/11 there were 1,000 extra traffic deaths in the U.S.

We would surmise that the threat of flying caused more people to drive and that driving is much more dangerous than flying.  But the additional deaths occurred on local roads in the Northeast close to the terrorist attack, and these fatalities were far more likely to involve drunken and reckless driving.  9/11 led to alcohol abuse and post-traumatic stress that led to extra driving deaths among other problems.

140 U.S corporations abused the stock market decline after the attacks to back date stock options.  Police resources were shifted from anti-Mafia units and other crime prevention including chasing financial scoundrels. 9/11 could have contributed to the financial meltdown.

Due to less air travel, influenza – which travels well on planes- spread less.  In DC the extra police on the street during terror alerts decreased crime.  Marijuana became one of California’s most valuable crops as imports from Canada and Mexico was squeezed by tighter border restriction .

From Superfreakonomics by Steve Levitt and Stephen Dubner.

Economic externalities are  a fascinating subject. Recall how unexpected and unpredictable many of these externalities seem and imagine how many externalities will result from the government’s widespread legislation.

While mindless mantras kept advocating that we are LESS safe as a result of Bush’s anti terror policies, some of us could not ignore the absence of terror attacks on our soil after 9/11.

One reason was a very deliberate and careful decision to engage the enemy is his own backyard.  Al Qaeda did not have unlimited resources, and our military engaged and eliminated thousands of them in Afghanistan and Iraq. In spite of strategic mis-steps that are always clearer in retrospect, even a bad strategy in Iraq kept Al Qaeda more focused on surviving in the streets of Iraq and the mountains of Pakistan that formatting further terror in the malls of America.

But another reason was the increased efforts of the CIA now coming under scrutiny.  While our mortal enemies were broadcasting decapitations on the internet we used enhanced interrogation techniques (EITs) such as water boarding to prevent further attacks.

As reported in the Wall Street journal editorial on 8/27/09, this was not done by rogue sadists, but was done with the advice and consent from the Pentagon, the Justice Department , and with knowledge and consent of the Congressional Intelligence Oversight Committee. Read this very important editorial, The Real CIA News here.

Some contend that these EITs were ineffective, but this belies the moral question as to whether effectiveness is even the issue.  The report identified clear results such as Binyam Muhammed, who planned to detonate a dirty bomb and previously unknown Al Qaeda members planning a second in the U.S. in California.

One of the reasons we failed to prevent the attack ON 9/11 was the crippling of our intelligence forces in the previous decades.  We struggle to find a way to defeat a murderous immoral enemy using the high moral standards we demand.  But Holder’s effort to criminalize those who had to make very difficult decisions in the wake of 9/11, in the very arduous moral gray zone few of us have to consider, will serve only to make us more vulnerable.

You cannot win a war in a court room; you can only lose it.  Denying we are at war will not change our enemies committed to defeating us.