The rate of total homicide and the rate of homicide due to mental disorder rose steadily until the mid-1970s. From then there was a reversal in the rate of homicides attributed to mental disorder, which declined to historically low levels, while other homicides continued to rise.

Paper and press release.

Remember this the next time you read a newspaper article about how scared everyone is because some patients escaped from a mental institution:

We are convinced by the media that people with serious mental illnesses make a significant contribution to murders, and we formulate our approach as a society to tens of thousands of people on the basis of the actions of about 20. Once again, the decisions we make, the attitudes we have, and the prejudices we express are all entirely rational, when analysed in terms of the flawed information we are fed, only half chewed, from the mouths of morons.

Granting the presence of perverse incentives, what are the operating mechanics that cause widespread bad loans (where the higher interest rates do not adequately cover increased risk of loss) under our present system? After all, the bad lending, while it has a surface plausibility to bankers under cost pressure, is, by definition, not rational, at least for the lending banks and the wider civilization. How then does bad lending occur so often? 

It occurs (partly) because there are predictable irrationalities among people as social animals. It is now pretty clear (in experimental social psychology) that people on the horns of a dilemma, which is where our system has placed our bankers, are extra likely to react unwisely to the example of other peoples' conduct, now widely called "social proof". So, once some banker has apparently (but not really) solved his cost-pressure problem by unwise lending, a considerable amount of imitative "crowd folly", relying on the "social proof", is the natural consequence. Additional massive irrational lending is caused by "reinforcement" of foolish behavior, caused by unwise accounting convention in a manner discussed later in this letter. It is hard to be wise when the messages which drive you are wrong messages provided by a mal-designed system. 

In chemistry, if you mix items that explode in combination, you always get in trouble until you learn not to allow the mixture. So also, in the American banking system.

So Munger identified this volatile combination about 17 years ago at least. In the same letter Warren Buffett added:

A few small sections of Mr. Munger's letter have been excluded: When Berkshire's report exceeds 72 pages, we have problems in binding it. Because of this limitation, either Charlie's letter or mine had to be cut and I decided a coin flip was appropriate. In fact - as things turned out - I finally decided nine flips were appropriate. -- W.E.B.

Only thing I would (and did) add to iang's post is that historically speaking when things are looking bad is when deals are found. Jason Zweig (channeling Ben Graham)

"Could things possibly get worse? I don't know, but I am an optimist -- so I certainly hope things do get worse. Nothing else should satisfy an intelligent investor."

The reason is psychological. And it's the same dynamic when it's a security vendor trying to sell its products or services, a CIO trying to convince senior management to invest in security or a security officer trying to implement a security policy with her company's employees.

It's also true that the better you understand your buyer, the better you can sell.

First, a bit about Prospect Theory, the underlying theory behind the newly popular field of behavioral economics. Prospect Theory was developed by Daniel Kahneman and Amos Tversky in 1979 (Kahneman went on to win a Nobel Prize for this and other similar work) to explain how people make trade-offs that involve risk. Before this work, economists had a model of "economic man," a rational being who makes trade-offs based on some logical calculation. Kahneman and Tversky showed that real people are far more subtle and ornery.

Here's an experiment that illustrates Prospect Theory. Take a roomful of subjects and divide them into two groups. Ask one group to choose between these two alternatives: a sure gain of $500 and 50 percent chance of gaining $1,000. Ask the other group to choose between these two alternatives: a sure loss of $500 and a 50 percent chance of losing $1,000.

These two trade-offs are very similar, and traditional economics predicts that the whether you're contemplating a gain or a loss doesn't make a difference: People make trade-offs based on a straightforward calculation of the relative outcome. Some people prefer sure things and others prefer to take chances. Whether the outcome is a gain or a loss doesn't affect the mathematics and therefore shouldn't affect the results. This is traditional economics, and it's called Utility Theory.

But Kahneman's and Tversky's experiments contradicted Utility Theory. When faced with a gain, about 85 percent of people chose the sure smaller gain over the risky larger gain. But when faced with a loss, about 70 percent chose the risky larger loss over the sure smaller loss.

This experiment, repeated again and again by many researchers, across ages, genders, cultures and even species, rocked economics, yielded the same result. Directly contradicting the traditional idea of "economic man," Prospect Theory recognizes that people have subjective values for gains and losses. We have evolved a cognitive bias: a pair of heuristics. One, a sure gain is better than a chance at a greater gain, or "A bird in the hand is worth two in the bush." And two, a sure loss is worse than a chance at a greater loss, or "Run away and live to fight another day." Of course, these are not rigid rules. Only a fool would take a sure $100 over a 50 percent chance at $1,000,000. But all things being equal, we tend to be risk-adverse when it comes to gains and risk-seeking when it comes to losses.

This cognitive bias is so powerful that it can lead to logically inconsistent results. Google the "Asian Disease Experiment" for an almost surreal example. Describing the same policy choice in different ways--either as "200 lives saved out of 600" or "400 lives lost out of 600"-- yields wildly different risk reactions.

Evolutionarily, the bias makes sense. It's a better survival strategy to accept small gains rather than risk them for larger ones, and to risk larger losses rather than accept smaller losses. Lions, for example, chase young or wounded wildebeests because the investment needed to kill them is lower. Mature and healthy prey would probably be more nutritious, but there's a risk of missing lunch entirely if it gets away. And a small meal will tide the lion over until another day. Getting through today is more important than the possibility of having food tomorrow. Similarly, it is better to risk a larger loss than to accept a smaller loss. Because animals tend to live on the razor's edge between starvation and reproduction, any loss of food -- whether small or large -- can be equally bad. Because both can result in death, and the best option is to risk everything for the chance at no loss at all.

How does Prospect Theory explain the difficulty of selling the prevention of a security breach? It's a choice between a small sure loss -- the cost of the security product -- and a large risky loss: for example, the results of an attack on one's network. Of course there's a lot more to the sale. The buyer has to be convinced that the product works, and he has to understand the threats against him and the risk that something bad will happen. But all things being equal, buyers would rather take the chance that the attack won't happen than suffer the sure loss that comes from purchasing the security product.

Security sellers know this, even if they don't understand why, and are continually trying to frame their products in positive results. That's why you see slogans with the basic message, "We take care of security so you can focus on your business," or carefully crafted ROI models that demonstrate how profitable a security purchase can be. But these never seem to work. Security is fundamentally a negative sell.

One solution is to stoke fear. Fear is a primal emotion, far older than our ability to calculate trade-offs. And when people are truly scared, they're willing to do almost anything to make that feeling go away; lots of other psychological research supports that. Any burglar alarm salesman will tell you that people buy only after they've been robbed, or after one of their neighbors has been robbed. And the fears stoked by 9/11, and the politics surrounding 9/11, have fueled an entire industry devoted to counterterrorism. When emotion takes over like that, people are much less likely to think rationally.

Though effective, fear mongering is not very ethical. The better solution is not to sell security directly, but to include it as part of a more general product or service. Your car comes with safety and security features built in; they're not sold separately. Same with your house. And it should be the same with computers and networks. Vendors need to build security into the products and services that customers actually want. CIOs should include security as an integral part of everything they budget for. Security shouldn't be a separate policy for employees to follow but part of overall IT policy.

Security is inherently about avoiding a negative, so you can never ignore the cognitive bias embedded so deeply in the human brain. But if you understand it, you have a better chance of overcoming it.

This essay originally appeared in CIO.