Should optimists avoid credit cards?

By Peter Andrew

I like optimists. Who doesn't? Optimism is one of America's defining national characteristics, and was an essential part of this country's rise to greatness. But some academic studies suggest that people with too rosy an outlook can get themselves into trouble, especially financially, and can-do can quickly turn into couldn't-do.

The trouble with optimism

Of course, it's not just Americans who can find their optimism tipping over into overconfidence or even self-delusion. Last year, Australian researchers uncovered similar traits in their compatriots. Unusually optimistic subjects in their trials tended to work fewer hours, have shorter planning horizons and fail to clear their credit card balances in full each month.

But there's plenty of that here too. A 2005 Duke University study, Optimism and Economic Choice, found a similar correlation in the U.S. And another, published in the Journal of Economic Psychology in 2007, indicated that the overoptimistic often make poor choices when choosing a new credit card.

For example, those who usually roll forward significant balances might seek out the best credit card reward programs when their rational, optimal choice would have been finding the lowest APRs. Presumably, they kidded themselves that their lives would change: Their income would grow, they'd win the lottery, or they'd magically alter their patterns of behavior and start zeroing their balances each month.

Credit card executives also susceptible

All this is worrying enough. On a personal level, unmanageable credit card debt can lead to stress and misery -- and that's written by someone who's experienced it firsthand. But what's much more scary is the idea that the people who run credit card companies -- along with banks and our other corporations -- might be equally subject to that overconfidence and self-delusion that comes from excessive optimism. Another Duke University study, this one published last year, found:

Chief executive officers in the U.S. have a more optimistic outlook on their businesses and, more broadly, on life than the general population. In addition, CEOs are more willing to take risks, a trait that influences companies' financial policies and decisions.

This second study adds weight to a view contained in Barbara Ehrenreich's 2009 book, "Bright-Sided", which suggests that in modern America positive thinking has become "a dominant, almost mandatory, cultural attitude." And she worries that it can lead in all too many people to hopelessly unrealistic expectations. In one chapter, "How Positive Thinking Destroyed the Economy," Ehrenreich spreads the blame for the credit crunch between overoptimistic consumers and lending executives, both of whom, she says, lost their ability to properly assess risk.

Grounds for, er, optimism?

Writing in The Boston Globe on Feb. 5, Farah Stockman reported on the views of a friend of hers, who'd had significant success in hedge fund management. He didn't buy the view that the 2008 economic collapse was a result of Barney Frank's community loans, and subprime lending. Instead he thought it was down to "universal, unwarranted, unwavering optimism."

And at least some of that came from the 23 years prior to 2005, which he described as a golden age of stability. Many of those responsible for risk management in banks, credit card companies and other organizations had zero professional experience with things going wrong. Just as bad, the computer models upon which they relied to assess risk had received most of their data in the preceding two decades, so the numbers that were crunched were based on a freak period of calm. No wonder they failed to foresee the approaching financial crisis.

Have things got better?

Even the dimmest risk managers today know that disasters can happen, and, if they forget, their computer models, now populated with recession-time data, should remind them. Meanwhile, consumers have received a similarly salutary lesson: On April 2, the American Bankers Association published figures that showed that credit card delinquencies (accounts 30 days or more past due) had continued to tumble during the last quarter of 2012. And they hadn't just fallen to pre-recession levels. The rate was at an 18-year low.

So some of us may have reined in any excessive optimism we once allowed ourselves. But that may not last for long, and you might suspect that there are still plenty of people out there who struggle to be realistic about their finances. Heck, you might even know one. If the one you know is you, here are two rules that could help:

1. If you're about to take on debt based on the belief that "something will come along" to make it affordable, walk away.
2. If you're about to treat yourself to something you know you can't afford on the grounds that "you deserve it," see rule No. 1 above.

I used to do both of those, and, believe me, I'm much happier since I stopped. And, if anything, I'm more optimistic about life.