One of the more fascinating social experiments that I have observed is a game credited to Martin Shubik, called The Dollar Auction.   My context for this auction has been in groups of senior leaders (classrooms of 30 or more) during Executive Development events.  In these settings filled with lofty titles carried by people driving nice cars and wearing expensive suits, the auction is actually for a $20 dollar bill…not just a lowly $1.

The game works like this:

-Everyone in the room is eligible to bid on the $20 bill.  The bidding starts at $1.00.

-The second place bidder must pay the amount of his/her losing bid.

Things start out as expected.  Someone opens the bidding, it quickly escalates to the risk-free level of par value and then pauses for just a second as the players ponder their strategy.  Often, the  $19 bidder recognizes their risky situation and decides to stick it to the fool willing to pay $20 to get $20.  After a momentary pause, this group of executives is off to the races. 

I’ve personally witnessed corporate executives of all types escalate the bidding into the hundreds of dollars.  I’ve also watched as groups came back to their senses and stopped short of $100.  I’ve not yet witnessed any group stop at $20 or below.  (Full disclosure: you should know that the executives were told in these settings that the winning bid above par will be donated to charity and the losing bid payment used for drinks that evening.)

Shubik commented on observing the same behaviors above that, “game theory alone will probably never be adequate to explain such a process.” 

While I am unqualified to offer clinical commentary on this pathological behavior, we don’t have to look far to see it at work in the current financial crisis.

  • AIG is admitting on the day following the $85 billion (billion with a “B”) federal government bailout of this global giant that they had no idea how bad things really were.  I thought that firms that dabbled in insurance had a good handle on risk. 
  • The overnight dissolution of Lehman, Bear and billions of dollars in partner equity was created on the back of exotic mortgage-oriented financial instruments that are so complicated that few understand them.  Hmm, how many over-educated people willing to bid more than a dollar for a dollar does it take to destroy a financial system?
  • The housing industry and mortgage financiers built the real-estate bubble and catalyzed the credit crisis by effectively enticing unwitting individuals into paying more than a dollar for a dollar.  Hey, I’m all for caveat emptor, but why did the builders and mortgage bankers/brokers/underwriters think that they could extend this auction indefinitely without someone or something calling a sudden, rude halt to these people printing their own money?

The Bottom-Line for Now:

The common outcome of The Dollar Auction offers an interesting perspective on human behavior.  We are seeing similar manifestations of this behavior at work in what we are slowly learning about the events leading up to this historic (not in a good sense) financial crisis.  For some reason, common sense, prudence and good, old-fashioned principles of  risk management fly out the window when it appears that the magical money-making machine has been turned on.  Whatever happened to making money by developing goods and delivering services that meet and exceed customer needs?

I’ve long spoken openly about my perspective that the destruction of a business and the abuse of stakeholder trust are crimes punishable by imprisonment.  Ditto that for the destruction of a financial system.