The psychology behind the recession

Economists have given many reasons why the United States is in the midst of the worst economic downturn since the Great Depression: under-regulation, massive corporate debt, and subprime mortgages are among the explanations. Less discussed is the underlying attitude that accompanied these structural problems - an attitude best captured by the psychological trait of narcissism. An inflated sense of self often known as self-centeredness or arrogance, narcissism is the unrecognized psychological component of the bubble economy.

Narcissists are not just confident, but overconfident. They are so convinced they will do well that they take unnecessary risks and believe the fantasy that they will never lose ("Housing prices never go down!"). They are also willing to take big risks. Consequently, narcissistic people often do fairly well when markets are on an upswing and risks can pay off. But what happens when the market turns south? A study by psychologist Joshua Foster and his colleagues had participants invest $10,000 in simulated funds in the 30 Dow Jones companies during September and October 2008, when the average fell 27%. Narcissistic participants lost considerably more money than less self-centered people - primarily because they picked riskier stocks.

Business professors Arijit Chaterjee and Donald Hambrick found a similar result in real life: Companies led by narcissistic CEOs experienced greater volatility than those headed by the less self-aggrandizing. When the overconfident risks paid off, things boomed; when they didn't, it was a bust. In Good to Great, Jim Collins reported that the CEOs of the most successful companies were humble, hardworking, and gave their teams credit. Companies headed by more self-centered leaders never made the leap to being truly great. Kevin Hassett of the American Enterprise Institute was blunt in his assessment of the personalities involved in the current financial crisis: "Harvard narcissists with MBAs killed Wall Street," he wrote.

Narcissism fed the consumption side of the bubble economy as well. Narcissism predicts materialism, compulsive spending, risk-taking, and even gambling. If even a small number of consumers are willing to go into risky amounts of debt to impress their neighbors and satisfy their inflated self-images, the prices of real estate are driven upward. Before long ordinary homebuyers were considering unconventional loans just to get into the market before everything became unaffordable. We are now all victims of the disastrous result. This is the common pattern with narcissism: The narcissist's short-term gain causes wide-ranging suffering for others.

Unfortunately, narcissism has become much more common. In The Narcissism Epidemic, we review three datasets, all showing shocking increases in narcissism. In one, narcissistic personality traits among college students rose just as fast as obesity between 1982 and 2006. In two others, the rate of increase doubled during the last five years. In the last, by the National Institutes of Health, only 3% of Americans over 65 had ever experienced Narcissistic Personality Disorder (NPD), the more severe, clinical form of the trait, compared to nearly 10% of people in their twenties.

Narcissists' power is often exaggerated through their charm, guile and exploitativeness. Narcissists don't make the best leaders in the long run, but they often end up at the head of the table anyway. In a study led by psychologist Amy Brunell, the more narcissistic participants stepped up to take charge in group settings. Before long, however, the group realized the narcissist wasn't a very good leader - how can you be when you're centered on yourself and don't really care about anyone else? But by then the narcissist was the boss.

For now, the severe recession has put a damper on narcissistic overconfidence. Homebuyers can no longer get no-document loans, and lenders are now more cautious about writing mortgages with a higher risk of default. The residue of narcissism is seen most clearly in the lack of responsibility taken by many participants of the credit bubble. The desire for a bailout has taken the place of the desire for a Hummer. But with narcissism still on the rise, there may be other bubbles to inflate. Overconfident people have particularly short memories, and when housing bounces back, it will be tempting for lenders and homebuyers to once again fall in love with interest-onlys and zero down payments, and for banks to take too many risks. Credit cards are still easy to come by and Americans are still racking up enough debt for the system to eventually collapse. Before that happens, we should bring back values that counter narcissism, like personal responsibility, integrity, and community mindedness. Of course, more regulation couldn't hurt either.