Why Good People Do Bad Things

And how you can prepare yourself for it.

The Great Recession of 2008 destroyed $10 trillion in household wealth, millions of people’s retirements, created paralyzing unemployment, and left families on the street. And practically no one went to jail. Not because the system was unable to find bad actors, but because there was a failure of incentives. If all the bad outcomes in the world were created from individuals with bad intentions, then fixing the world would be an easy problem to solve. Just remove the bad people. However, the world is far more complicated than that, and to understand that is to understand the universe of incentives.

Incentives run human behavior and more importantly, human systems.

It was not a failure of any single individual, but a failure of the system and the incentive mechanism that was operating naturally in the background of the world economy and life more broadly.

The homebuyer. The mortgage broker. The bank. The ratings agency. The investment bank. The regulator. The Politician.

Each group had an incentive that overrode integrity because they believed it would provide relief. Once banks could sell loans off their books, they could care less about who was on the loan. Once the homebuyer realized they didn’t need credit to buy a home, what would stop them from living with a nice roof over their head? Securities issuers paid for ratings, and the ratings agencies would get more business if they gave good ratings. Also, ratings agencies are public companies, and they need to please their biggest shareholders.

Even the Federal Reserve director admitted that he had a “flaw” in his worldview. Showcasing that the people running the most important organizations and institutions in the universe are no different than you and I. We’re all motivated by incentives.

When competitive and self-interest pressures cause individuals to act in a worse collective outcome, good intentions make no difference in the end.

The same situation occurs time and time again in history. In Rome’s late republic, just before the fall, the senators were more interested in their personal honor, as opposed to protecting the longevity of peace. Resulting in the collective destruction of the institutions and cultures that they swore to protect.

The System is Already Shaping Your Life. You Just Haven’t Realized It.

You may be thinking that the Great Recession is someone else’s problem. This couldn’t be further from the truth. The same mechanics are running right now in systems that you interact with every day. There are multiple examples of systems not working for the benefit of the individual, while all actors are acting rationally. These are dangerous systems that need to be scrutinized. But that will be for a different article.

Your Debt is Someone Else’s Profit:

You must treat debt as a systematic trap. Not just a personal choice. The way loans are sold off in 2008 is still operational today. Even more so actually, with buy now pay later products. When lenders do this, they don’t care if you can repay it, they just care that the deal gets done. The more deals that get done, the more they get paid. The system is engineered to make borrowing feel rational. Understand the incentive on the other side of every financial product you sign.

Your Retirement is a coordination Problem. And could hurt you painfully if you’re not careful.

In recent decades, there has been a shift from funding pensions through your employer to contributing to 401(k) retirement accounts that are managed by individuals, significantly transferring the investment risk from the companies to the workers. From the firms’ perspective, it makes sense to transfer the risk to the individuals. Anytime you can transfer risk away from yourself, you will take that option. But what did that create? Most people are ill-equipped to manage their own retirements and be portfolio managers. The financial industry benefits from this, as you outsource the work to financial advisors who charge extractive fees.

Instead, you can gain basic financial literacy, keep it simple, utilize low cost index funds, and truly learn how to manage your own money. That’s what the system has forced.

How to Stop Being the Product

Build Antifragility.

Many people believe their large 401ks or home equity will protect them from the moloch problems we face. (Moloch is the ancient idea of a system that demands sacrifice from everyone within it, producing outcomes nobody individually wanted). This couldn’t be further from the truth. No longer than 20 years ago did we face a potential existential crisis in the financial systems that destroyed worker’s retirements. Destroyed the equity they had in their home. Destroyed the relationships they had with loved ones.

So how do you protect yourself against such an event that could come at the untimeliest moment? Build antifragility. Own a diverse set of assets that don’t correlate with each other. Have more than one income stream to rely on in case you lose your job with the single employer that could end your dreams. Build strong relationships. Dollar cost average into your relationships with people while resisting being consumed by work or exterior forces outside of your direct control. This will protect them in times of need so that you have someone to rely on if you get crushed- financially, emotionally, or physically.

Understand incentives before you trust institutions.

Opt out where you can, engage strategically where you can’t

As an American, there are just some things you can’t say no to. You must pay taxes. You need to live somewhere; you need transportation in some fashion. However, there are places where you can strategically engage that will improve your human capital and make your time more efficiently spent. Use the incentives of the systems in place where it is possible to take advantage of your knowledge. Invest in tax advantaged accounts, which can be a range of products, not just retirement. Acquire skills that have pricing power in the future economy. Own assets that will forever be in demand, and those are not just stocks.

Using the existing tools and understanding the incentives of what is in place will allow you to be a step ahead of everyone else in the game of life. Think carefully about the systems you currently utilize. Systems that you don’t have to opt in to but can tactically tilt in your favor. Think about where your professional skills are at, and if they will be valuable in 5 or 10 years. Also, don’t forget to think about the systems you have to opt in to. We must pay taxes, but is there a way to pay less taxes over your lifetime? We must have a home, but what is the best method in your situation for owning that home? Are there easy improvements to make that will increase its value? Or should you rent?

Think freely of the systems you find yourselves in and learn how to better position yourself to be successful.

Think in systems, not enemies.

It’s tempting to blame individuals for the travesties we face today. And to be quite honest, some of the situations that we find ourselves in are because of individuals. However, we need to take a step back and think more broadly. Understanding the structural forces in life and how they shape the decisions of powerful individuals will reveal a quite alarming fact that when someone gets fired and replaced, or an elected official kicks out an incumbent, they find themselves in the same incentive systems that the previous individual was in and ended up doing bad things.

Why do you think all politicians say they will go to Washington and make a difference, but never do? I genuinely believe that at least some want to do good, but they find themselves in the same position as the last person who we perceive as evil. And even worse, politics comes into play. Single issue bills never pass, deals always need to be made, money always needs to be moved.

How can we correct the systems that have created incentive mechanisms that don’t align with our values? For politicians, there are basic ideas of how to get politicians to act in our interest. Two of them are term limits and campaign finance reform.

There is only one limit at the federal level for elected officials, and that is on the President. Neither the House of Representatives nor the Senate have term limits, allowing them to stay in office indefinitely. This allows individuals to accumulate relationships with the leaders of industries and become more focused on receiving their funds from campaign donations than governing society. The longer members of Congress are in office, the more entrenched these relationships become. The more elected officials become dependent on their donations. I’m not arguing that we make term limits extremely short that constantly puts in new and inexperienced staff, but there comes a time when new blood is needed, with new ideas that will inevitably have a better outcome than we currently experience, regardless of the inexperience.

This leads nicely into the next way to change the incentives for politicians, which is overturning or significantly modifying Citizens United (2010). This was a supreme court decision that allowed corporations to donate an unlimited amount to elections. The problem here is obvious, but the solution to the incentive problem is not. How do we get politicians that get unlimited money from corporations to stop giving themselves unlimited money from corporations? To be honest. I don’t know. The best answer I can think of is a grass roots effort led by local leaders across the country coming together and dropping political hostility toward each other. But there is a better chance of those people being violently attacked before that happens. The difficulty of knowing how get people inside a broken system to fix it is itself the best proof that incentives matter more than intentions.

For executives, we need to take a different approach to their incentives because they are motivated by money instead of power. The ratio of CEO pay in 1965 was about 20:1. Today, it’s closer to 300:1. And I’m not sure if you’ve noticed, but CEOs aren’t 15x more valuable today than they were in the 1960s. Today, the primary way to attract good CEOs to your company is to pay them through bonuses and stock options that are tied to short term stock price movements. Instead, companies should be tying their executive’s compensation to long term metrics or any metric that you want to change their behavior toward. Penalizing can only go so far. People will do what they are rewarded to do.

Antitrust enforcement is another area of our current economic arrangement that needs to be focused on. Capitalism is amazing, but capitalism requires competitive pressures that will make companies more accountable, more efficient, and to have more choice. Our healthcare system, airlines, massive grocery chains, and more are all being consolidated to where consumers no longer have the leverage to push for change. Competition also encourages businesses to offer better wages, better benefits, and better flexibility to attract the best employees. We need to return to this environment, which is now absent from the American economy.

Conclusion: The System is the Villain

We started with the question that should bother everyone who thinks about the world in a serious fashion: How do good people build bad systems? The mortgage broker who gave the bad loan, the pharmaceutical rep that overprescribed a medication, the senator who just voted to deregulate/overregulate. They were inside a system that incentivized the wrong things, causing the wrong decision. It’s tempting to point at individuals to find a villain who is real and powerful. But we must take a step back and reevaluate what is going on with the structure within which these individuals are working within. It’s a trap to think about the individuals, because it distracts us from the system.

However, all of these things start with you. The individual who needs to bring about change in their community, then their city, state, country and world. Don’t forget… all change that happens occurs through individuals and we must remain persistent and consistent in demanding change and creating change for ourselves. All systemic change begins with individuals who understand the system well enough to know exactly where to apply pressure. The goal was never to stop believing in people, but to stop expecting virtue alone to fix what only better rules can change. The American Nightmare isn’t that we’re surrounded by evil people. It’s that we’ve created systems to make people complicit in bad outcomes.

Recognizing this is scary, but it’s not alarmism. It’s the beginning.

You can’t see what you can’t see, and now you can see it.

If this reframe changed how you see things, share it with someone who’s still looking for the villain. And if you want to go deeper on how these systems shape American life, and how we can change it, then that’s exactly what The American Nightmare and my page is about.

https://a.co/d/2S9yall (The American Nightmare. Now on Amazon)

Next time we’re going into the healthcare system specifically ­­- and what you can do to stop optimizing for their revenue and start optimizing for your health.

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