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Using a ‘foreign language shield’ to improve investment decision making

Introducing a “foreign language shield” into a decision-making process is a proven way of making better decisions, according to Cass Sunstein, the Robert Walmsey University Professor at Harvard Law School.

Sunstein, a former administrator of the White House Office of Information and Regulatory Affairs (OIRA), told the Fiduciary Investors Symposium (FIS) at Harvard University that the Obama administration had introduced a rigorous cost/benefit analysis of any and all proposed regulatory changes, and this had acted as an effective “foreign-language shield” that improved the impact of new regulations.

“If you’re an adviser, get the cost/benefit figures, the risk/return figures, the algorithms, up and running. It’s a great safeguard,” he said.

The term “foreign language shield” comes from the behavioural finance finding that speaking a foreign language has been shown to turn off the part of the brain that makes quick, intuitive and generally error-prone decisions.

Sunstein said that behavioural economics holds that two systems operate within the brain: system one, and system two. System one governs rapid, intuitive and relatively error-prone decisions; while system two is more analytical, cooler and more rational.

Sunstein said system one leads people to think that “if there’s Ebola in New York we’re in big, big trouble”, while system two is the part of the brain that says “more people have married Kardashians than have died from Ebola”.

Evaporate

“A number of the biases that people show – including, by the way, loss-aversion, and there’s new data suggesting present bias – evaporate when people are answering questions in a foreign language,” Sunstein said.

“Now, it shouldn’t be that when you’re in a foreign language you lose your capacity for error. It should be that would be increased. But the reason is when you’re in a foreign language, your intuitions, your quick intuitive reactions, are disabled. You’re working really hard.

“So if you hear a speech in a foreign language, when the speaker makes a joke, it’s never funny. To find something funny, your intuition needs to be working.”

The demand for rigorous cost/benefit analysis is “in President Obama’s 2011 Executive Order, which says you have to quantify everything and make sure the benefits justify the cost”.

“I found this was a fantastic safeguard – sometimes resisted, and not always in the regulatory areas I imagine that you work with, honoured – but extremely helpful,” he said.

“So if you have a regulation that’s designed to promote – let’s take it outside the financial area – environmental quality or safety on the highways, and it costs hundreds of millions, which on the regulatory side is not trivial, or billions, which on the regulatory side is a big number…then the fact that an interest group wants it, or there’s a professional within government who thinks it’s an important safeguard, or the fact that there’s some theory that regulators hold that suggest it’s a good idea, or if there’s some noise in Congress suggesting [it] should be done, we have a built-in foreign-language-type shield, which I try to use all the time, and say, that’s not going to increase benefits for people, so even $100 million expenditure isn’t justified.”

Sunstein said OIRA had veto power, subject to the President’s override.

“So if it says no…that’s the end of it, really, unless the President comes in,” Sunstein said.

“And he’s a pretty busy guy.”

Sunstein said a delegate at FIS had outlined to him “new ways of building risk-management strategies that are more forward-looking and capacious than existing ones”.

Steroids

“And that’s system 2 on steroids,” Sunstein said. Such techniques should be used “not to figure out how to justify what ether the adviser or the client wants to do, but to figure out what they should want to do”, he said.

“The goal of the technique or the technology is to say [for example], this is what you want to do if you want to maximise returns,” he said.

“One way to see cost/benefit analysis is like a rhetorical tool that gets people to frame in a maximally persuasive way an argument to which they are antecedently committed. I don’t see it that way.

“I see it as away of figuring out what you should do. Just like a risk management technology that informs investors, so cost/benefit machinery helps government figure out what it should do.

“If you’re trying to figure out what the right rule is for mercury as it’s emitted from powerplants, how could you possibly know what you wanted to do with that rule without having a concrete sense of the costs of the mercury regulation and the – monetised to the extent that you can – benefits of the mercury regulation.

“So for mercury if it costs $4 billion, what are you going to get for that? Maybe you’ll get 200 lives saved. The government’s standard number for the value of a…life is $9 million, so that’s not a clear winner. But if you’re getting 5000 lives saved, it’s looking great.”

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