Robert Shiller writes in the New York Times about the role of group-think during the upward phase of our blown-up housing bubble. He recounts the polite discounting of his warnings in Irrational Exuberance (see all of Shiller’s books) and says “speculative bubbles are caused by contagious excitement.”

He segues to the remaining gap between economics and psychology in a discussion about his experiences as a predictor of catastrophe. In doing so, he coincidentally supports the neuroeconomics research in a new paper by Drs. Camelia Kuhnen and Brian Knutson – The Influence of Affect on Beliefs, Preferences and Financial Decisions – “beliefs are updated in a way that is consistent with the self-preservation motive of maintaining positive affect and avoiding negative affect, by not fully taking into account new information that is at odds with the individuals’ prior choices.”

Translated into trader’s English their point is that we tend not to pay much attention to information that would suggest we are wrong about something. In other words, we are less than open-minded (politics anyone?) because if we find out we are wrong, we might have to feel badly about ourselves and that is simply no fun.

Shiller mentions this exact kind of thing when he says “Economists…pride themselves on being rational. … The notion that people are making huge errors in judgment is not appealing.”

To my way of thinking – “not appealing” = doesn’t feel so good = “avoiding negative affect”.

Let’s make sure we have this straight. We don’t want to feel badly about ourselves so we “overlook” data that could actually lead us to a better decision?

Feeling “bad” for a bit could prevent us from making decisions that are going to make us feel far worse somewhere down the line. Put another way, we prefer to feel better now even if we risk feeling really bad later.

Economists like to believe we are rational. Behavioral economists noticed we are not. Neuroeconomists can show us our brains firing on emotion before logic and Andrew Lo of MIT says logic and emotion are two sides of the same coin.

What this means is that we need to learn how to tolerate feeling bad – usually for just a little bit. At first you have to think of it as the tedious research phase of an important project. (It does get easier with practice.)

“Negative affect” has protective value in it. The feelings we don’t want to have are actually on our side…and learning not only to be able to feel them but to inquire about their message can’t help but produce better decisions from those flip sides of the coin.

And that skill is a significant part of what we call having PSYCHOLOGICAL CAPITAL.