Tuesday, December 16, 2008

Madoff & Mind

The world has been gripped by the demise of Wall Street broker and former Nasdaq Stock Market chairman Bernard Madoff's exclusive multi-billion dollar investment funds. Mr. Madoff apparently ran his business, the Bernard L. Madoff Investment Securities LLC, as possibly the greatest Ponzi scheme in history. Last week the scheme collapsed in face of the current economic crisis. Mr. Madoff was arrested. According to Robert Frank, Peter Lattman, Dionne Searcey, and Aaron Lucchetti's article with the title "Fund Fraud Hits Big Names" posted Dec. 13, 2008, in The Wall Street Journal, large investments of wealthy private as well as institutional investors are in jeopardy. A Reuters article posted Dec. 16, 2008, with the title "Madoff case fuels attacks on SEC", informs us that the U.S. Securities and Exchange Commission stands accused of lax oversight. Yesterday, Ian Urbina's article in The New York Times with the title "A Palm Beach Enclave, Stunned by an Inside Job" grippingly described the impact of Madoff's fraud on the duped investors.

This morning, Chris Arnold tells us about the psychology of investment in his segment on National Public Radio's Morning Edition entitled "Madoff's Alleged Ponzi Scheme Scams Smart Money". In this report, Professor Camelia Kuhnen of the Kellogg School of Management at Northwestern University cites her functional magnetic imaging studies implicating members of our brain's limbic system that may play a crucial role in our investment decisions and risk taking. The limbic system is a phylogenetically old structure of the brain. Its members control our startle and fear reactions and also mediate our responses to reward, pleasure and addiction.

Functional magnetic resonance imaging, or fMRI for short, is a tomographic scanning technique that permits us to visualize small changes in local blood flow in the brain. Since blood flow is tightly linked to brain cell metabolism in the healthy brain, the method can be used to identify brain regions involved in behavior. However, the method cannot provide insights into the nerve cell mechanisms engaged in the process. Even if fMRI studies conclusively demonstrated that limbic structures were activated commensurate with people's willingness to trust in an investment opportunity, the result would not disambiguate whether the observed activation was the cause or the effect of the willingness to risk one's fortune. Why some people entrusted all their assets to Bernard Madoff, why some gave only a fraction, and why some shied away entirely, therefore, remains an open question. Free will may exist!

I list more National Public Radio stories on the Madoff scandal below:

  • Yesterday, Maggie Fox reported in her article entitled "No stomach for market turmoil? Thank your genes" on Reuters the findings of a new study by Professor Kuhnen and a colleague that appeared today in the online journal PLoS One ( Kuhnen and Chiao, 2009 ). The researchers asked college students to invest amounts of money of their choosing in an investment game and matched the risk that the virtual investors took against their genetic backgrounds. Notably, the researchers sought out genes regulating the levels of neurotransmitters. Nerve cells of the central nervous system use neurotransmitters to communicate information between each other. The researchers specifically looked for a variant of the serotonin transporter gene 5-HTTLPR known to be prevalent in people who exhibit explicitly anxious behavior compared to people with other variants of the gene. The variant of the other gene tested, dopamine D4 receptor gene DRD4, was shown prevalent in people with a high tolerance for risk. The researchers found that the group with this variant took more risk with their investments. The findings suggest that a genetic predisposition may play a role in risk taking in the financial market place (02/11/2009).
  • According to Michael Rothfeld's report with the title "Madoff Investors Brace for Lawsuits" for The Wall Street Journal today, the investors who profited from Madoff's funds may be asked to help compensate those who lost (10/26/10).
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