Tuesday, July 6, 2010

What does failed intelligence tell us about investing

Problems in decision-making are often universal not just issues for investment professions. It pervades all areas of life where there is uncertainty, limited information, and time constraints. More importantly, the behavioral or psychological problems with making good decision are also everywhere. Behavioral finance and economics is just the application of psychology to a specific social science and is not unique. The biases in economic decisions are found in other areas of decision-making.

The book, Why Intelligence Fails: Lesson from the Iranian Revolution and the Iraq War, by Robert Jervis provides insights on what may be two of the bigger blunder in intelligence and pointedly shows the complexity of making good decisions with limited information. Many would like to believe that these intelligence blunders were simply a matter politics, psychology, and group think. Change the politics and the problem will go away. Jervis an expert in intelligence matters reviews the record and finds that the conventional view of failure are incorrect.

Intelligence problems are more complex because there are a host of decision-making issues. We form plausible explanations given the fact that we have on hand. Those facts are usually inadequate. There usually is an effort to fit a story on what we do know and eliminate the alternatives which do not fit our initial assumptions. The "models" employed can often be flawed because it is not questioned. We are often faced with insufficient imagination, too much certainty, and limitation on the alternative considered. While politics can be associated with the problem, the issue is much deeper and broader within any organization.

In the case of Iran, there were assumptions on mindset of the Shah. He was supposed to be strong-willed and able to make swift decisions. The assumption was wrong. In Iraq, we assumed that it was in its best interest to follow of path of WMD development. Attempts to evade in the past suggest that just because we did not find the evidence did not mean it did not exist. Faulty assumptions.

The same problems of limited imagination exist with investment decisions.

Some interesting quotes from the book:

"If it were a fact, it wouldn't be intelligence" -General Michael Hayden head of the NSA

"We missed the Soviet decision to put missiles into Cuba because we could not believe that Khrushchev could make such a mistake." -Sherman Kent

"Estimating is what you do when you do not know" -Sherman Kent

"There is nothing a government hates more than to be well-informed, for it makes the process of arriving at decisions much more complicated and difficult." - Keynes

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