Lessons in financial economics from Seinfeld

Seinfeld (1989-1998) described itself as “a show about nothing.” But actually, it’s a show about financial economics. Seinfeld illuminates many important ideas about behavioral economics and market structure.

1) Storage is not free

In “The Soup,” Kramer gets rid of his fridge in an effort to eat only fresh foods. Predictably, he ends up constantly stealing food from Jerry’s fridge. Kramer has discovered storage costs.

This episode, which aired in 1994, anticipated an astounding development twenty years later: the appearance of negative nominal interest rates in Europe and Japan. Many finance professors, including me, had previously taught that negative rates were impossible because savers could always simply own physical currency, which has a zero interest rate, rather than buy a bond with a negative yield.

Like Kramer, we forgot that storage has costs. If you try to physically store euros, the notes may be stolen or lost or eaten by rats as happened in Greece in 2011.[1] Storage costs for paper currency are a major problem for drug dealers, such as Pablo Escobar:[2]

Despite his best efforts, however, even Escobar couldn’t spend all that money, and much of it was stored in warehouses and fields. According to his brother, about 10%, or $2.1 billion, was written off annually—eaten by rats or destroyed by the elements.

The 10% estimated loss rate provides an empirical basis for what I call the rodent-based theory of monetary policy. Instead of a ZLB (zero lower bound) for interest rates, we have a RLB (rodent lower bound) of -10%. Rates set by rats.

2) Anti-skill is valuable

In “The Opposite,” George has an epiphany:

every decision I've ever made in my entire life has been wrong. My life is the complete opposite of everything I want it to be. Every instinct I have in every aspect of life, be it something to wear, something to eat…it’s all been wrong.

Jerry makes an excellent observation:

If every instinct you have is wrong, then the opposite would have to be right.

George has anti-skill: the ability to make not just random decisions but to make bad decisions. In this respect, George is a typical retail investor. Frazzini and Lamont (2008) make an observation similar to Jerry’s:

Our main result is that on average, retail investors direct their money to funds which invest in stocks that have low future returns. To achieve high returns, it is best to do the opposite of these investors.

More broadly, Barber and Odean (2013) review a large body of evidence suggesting that retail investors have anti-skill (they call it “perverse stock selection ability”) as in the previously mentioned evidence from Taiwan.

My advice to you is: find the George Costanza in your life, and listen carefully to his advice. Ask him which stocks to buy, which job to take, and where to live. Then do the opposite. If you are university faculty, identify the Professor Costanza among your colleagues. However he votes at a faculty meeting, you should vote the opposite way.

3) Risk management is misunderstood

In “The Fatigues,” George is forced to give a lecture on risk management to a group of executives. But instead of lecture notes, George has accidentally brought Jerry’s monologue about Ovaltine. George reads the jokes aloud in a flat tone. Amazingly, his performance is a hit with his boss, Mr. Wilhelm, who is unable to distinguish between risk management and Ovaltine.

4) Agency costs are real

In “The Chicken Roaster,” Elaine is temporarily in charge of the J. Peterman company. She abuses her expense account and buys George a sable fur hat. This behavior would be no surprise to Adam Smith, who wrote in The Wealth of Nations that:

… being the managers rather of other people's money than of their own, it cannot well be expected, that they should watch over it with the same anxious vigilance with which the partners in a private copartnery frequently watch over their own. Like the stewards of a rich man, they are apt to consider attention to small matters as not for their master's honour, and very easily give themselves a dispensation from having it. Negligence and profusion, therefore, must always prevail, more or less, in the management of the affairs of such a company.

George quickly loses the expensive hat. Negligence and profusion, indeed.

5) Investing is a social activity

In “The Stock Tip,” George learns from a friend about Centrax, a company with an exciting new technology to televise opera.[3] George convinces Jerry to buy Centrax shares. Here we see another way in which George is a typical retail investor: influenced by friends and transmitting investment narratives to others. At the end of the episode, George expresses interest in another stock which is some sort of “robot butcher,” perhaps foreshadowing today’s AI-driven market.

The social aspect of stock market investing has been a major theme in academic finance for the past forty years, starting with Shiller (1984):

Investing in speculative assets is a social activity. Investors spend a substantial part of their leisure time discussing investments, reading about investments, or gossiping about others' successes or failures in investing.

These social dynamics imply that investment ideas are like infections that spread throughout the population by person-to-person contact. Here’s Shiller (2017) discussing this process as an explanation for bubbles:

In a bubble, the contagion is altered by the public attention to price increases: rapid price increases boost the contagion rate of popular stories justifying that increase, heightening demand and more price increases. In a stock market bubble, these might be stories of the companies with glamorous new technology and of the people who created the technology.

Shiller was writing in April 2017. Demonstrating his uncanny gift for prediction, he also discusses contagion, the economic impact of the 1920 influenza epidemic, and the SIR model of disease. These were all subjects that I didn’t consider until March 2020 when COVID swept over the world. If Shiller ever mentions Noah’s flood, I suggest that you buy a life raft immediately.

6) Social dynamics are unpredictable

In “The Pledge Drive,” Elaine witnesses her boss eating a Snickers bar with a fork and knife. She tells George about this odd behavior. George thinks it’s classy and repeats this behavior in the presence of work colleagues. Soon everyone in New York City is eating candy with silverware.

Economists would call this process “herding,” an “informational cascade,” a “bandwagon effect,” or “social learning.” As described by “Turkey Dave” in Hirshleifer (2020), the field of social economics is concerned with these dynamics, involving bubbles, crashes, and waves of seemingly arbitrary behavior. These dynamics may reflect rational individuals who are seemingly irrational at the aggregate level, as described in Hirshleifer and Teoh (2003):

(1) frequent convergence by individuals or firms upon mistaken actions based up on little investigation and little justifying information; (2) the tendency for social outcomes to be fragile with respect to seemingly small shocks; and (3) the tendency for individuals or firms to delay decision for extended periods of time and then, without obvious external trigger, suddenly rush to act simultaneously.

Not all incipient bubbles actually bubble. Sometimes, they fizzle out. In “The Puffy Shirt,” Jerry tries to start a trend for puffy shirts, but it backfires.

7) Yada yada yada

In “Yada yada yada,” George’s girlfriend uses the term “yada yada yada” as a way of succinctly telling stories while eliding over embarrassing details. For example, “my ex-boyfriend came over last night, yada yada yada, today I’m really tired.”

Yada yada yada is the ultimate answer to the most basic question about crypto: what is the use case for cryptocurrency? The answer: yada yada yada. As in “crypto is a revolutionary new financial technology, yada yada yada, therefore you should buy bitcoin.”

8) Narratives matter

In “The Van Buren Boys,” Elaine is ghost-writing J. Peterman’s memoirs. Kramer sells them his entire corpus of anecdotes, but Elaine feels the stories are not good enough. Jerry suggests that she can re-write them:

Well, just shape them, change them. You're a writer…Make them interesting.

This gives Elaine an insight:

Interesting! Of course! People love interesting!

Elaine is correct. People do love interesting. And it doesn’t take a professional writer to implement Jerry’s suggestion that the story can be “shaped,” because that process happens naturally through anonymous social sharing and repetition. Here’s Hirshleifer (2020):

 … information is systematically distorted in a process of leveling and sharpening. Subjects emphasize the perceived essence of a story by selectively retaining details consistent with it, intensifying details, increasing magnitudes, and adding compatible new details and explanations. As a result, rumors can become inaccurate and extreme.

Shiller (2017) explores the ideas of narratives:

I use the term narrative to mean a simple story or easily expressed explanation of events that many people want to bring up in conversation or on news or social media because it can be used to stimulate the concerns or emotions of others, and/or because it appears to advance self-interest. To be stimulating, it usually has some human interest either direct or implied. As I (and many others) use the term, a narrative is a gem for conversation, and may take the form of an extraordinary or heroic tale or even a joke. It is not generally a researched story, and may have glaring holes, as in “urban legends.” The form of the narrative varies through time and across tellings, but maintains a core contagious element, in the forms that are successful in spreading. Why an element is contagious, when it may even “go viral,” may be hard to understand, unless we reflect carefully on the reason people like to spread the narrative.

Kramer’s best anecdote is about attempting to take the subway in order to return pants to the store. Somehow, the story is compelling, and has a core contagious element. Similarly, the story that “AI will transform the economy, and you should therefore invest in technology stocks” has a contagious appeal.

Kramer’s pants come to a tragic end. Kramer slips and falls in the mud, thus ruining the very pants he was planning to return. Let us hope the AI narrative has a happier ending.