Tuesday, August 28, 2007

"Delusional Borrowers" and Reality Checks

by Tanta on 8/28/2007 07:32:00 PM

One of the things we've noticed--not to say beaten like a dead horse from time to time--is that in the last several years a lot of people who aren't very good money managers got much bigger loans that they could reasonably be expected to carry. A lot of people are out for the blood of these borrowers, demanding that they be "punished" for having done something powerfully dumb.

I am often reminded of this little gem, "Unskilled and Unaware of It: How Difficulties in Recognizing One's Own Incompetence Lead to Inflated Self-Assessments," by Justin Kruger and David Dunning. They argue:

People tend to hold overly favorable views of their abilities in many social and intellectual domains. The authors suggest that this overestimation occurs, in part, because people who are unskilled in these domains suffer a dual burden: Not only do these people reach erroneous conclusions and make unfortunate choices, but their incompetence robs them of the metacognitive ability to realize it. Across 4 studies, the authors found that participants scoring in the bottom quartile on tests of humor, grammar, and logic grossly overestimated their test performance and ability. Although their test scores put them in the 12th percentile, they estimated themselves to be in the 62nd. Several analyses linked this miscalibration to deficits in metacognitive skill, or the capacity to distinguish accuracy from error. Paradoxically, improving the skills of participants, and thus increasing their metacognitive competence, helped them recognize the limitations of their abilities.
I remain convinced that there's something wrong with blaming the financially inept for not realizing that they are financially inept, when those who are supposed to be financially ept--loan officers, brokers, financial counselors, advice columnists in business publications--spent the last several years refusing to tell them that they were financially inept.

Of course people who are in over their heads are surprised. They lacked the skills necessary to understand what "over their heads" might mean.