The Psychology of Market Crashes: Should We Have Seen the Crash of 2008?

Dr. Daniel Kahneman, winner of the 2002 Nobel Prize in economics, joins us to discuss his book Thinking, Fast and Slow.

Many analysts claim that they knew we were headed for the crisis of 2008, but was it truly knowable? In this brief video segment, Kahneman explains hindsight bias and our need to explain past events. The full version of the interview can be watched here. A full transcript follows the video.

Morgan Housel: You've written about hindsight bias with the financial crisis in 2008.

Daniel Kahneman: Yeah.

Housel: What can you tell me about that?

Kahneman: There's something I actually find shocking. There are now quite a few people who say, "I knew there was going to be a crisis."

I think that's perverse. It's a perverse use of the word "know." That's because we use the word "know" for something ... when I believed in something, and my belief was true, those are the two conditions under which we're allowed to say the word "know." I believed it with very high confidence.

But in fact, they didn't know that there was to be a crisis. They thought there was going to be a crisis. Then there was a crisis, and then all of a sudden they "knew" it was going to be a crisis, but there were people who were just as smart, and as motivated and so on, who didn't think there was going to be a crisis.

What is very important about this is whether you conclude that the crisis was really knowable. Given the number and the quality of the people who failed to see it, the fact that there are many people now who are sure that they knew it doesn't convince me. I think it wasn't knowable.

It was much less knowable than we tend to think because of the ease with which we can explain it. Everybody who didn't predict it looks blind, in retrospect. That's hindsight.

The article The Psychology of Market Crashes: Should We Have Seen the Crash of 2008? originally appeared on Fool.com.

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