Asset appreciation draws in people that really don’t know anything about the asset. And people start being interested in something because it’s going up, not because they understand it or anything else. The guy next door, who they know is dumber than they are, is getting rich and they aren’t. And their spouse is saying can’t you figure it out too…It is so contagious. — Warren Buffett
Warren Buffett said that in an interview published this week. He’s describing the primary driver behind the next crisis, whenever that is…and every crisis that came before it.
This week marks the 10th anniversary of Lehman’s collapse during the downward spiral of the Financial Crisis. There’s been a lot written about it this week. Some anger, understandably, still exists. The blame game is still being played a decade later. Alternative fixes are still being argued over.
Fear still lingers too.
In the same interview, Buffett said this about fear:
People have always panicked…We had all kinds of panics in the country in the 19th century. When people are fearful, it’s instantaneous transmission to everyone else. I went to a party, actually, of a wealthy friend of mine sometime in September. And all of a sudden, 50 people there, who owned their homes outright and everything…every single one of them, that’s all they wanted to talk about. Because when people are afraid, they are afraid.
Confidence comes back one at a time, but fear is instantaneous… Fear just spreads like nothing you ever seen.
And it doesn’t make a difference how sophisticated people are or whether they got PhDs or anything else. When they are afraid, they are afraid… Fear is extraordinary with most people.
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People have long memories just like they did after 1929. It took a long time. People, when they’ve experienced extreme fear, it sears something in them.
Fear moves faster and lasts longer than most ever anticipate. And the side effect of fear tends to be a generational thing. Much like the Great Depression lead to fear and distrust in banks, the same happened with the Financial Crisis. How many people will avoid the stock market for the majority of their lives because of 2008? Too many is my guess.
The best explanation I came across for why the crisis happened also came from Buffett:
Ben Graham used to say you get in more trouble with a good idea than a bad idea because the good idea you originally had — the idea that stocks were cheaper than bonds generally — after a while, the very action of the stocks becomes more important than the fundamental reasons and the fundamental reasons disappear and people buy something because it’s going up. There’s no telling how far it will go but you can be pretty sure there will be a bad ending.
He said something similar during an interview for the FCIC:
The basic cause, you know, embedded in psychology — partly in psychology and partly in reality in a growing and finally pervasive belief that house prices couldn’t go down and everyone succumbed — virtually everybody succumbed to that. But that’s — the only way you get a bubble is when basically a very high percentage of the population buys into the same originally sound premise and…that becomes distorted as time passes and people forget the original sound premise and start focusing solely on the price action.
So every – the media, investor, the mortgage bankers, the American public, me, my neighbor, rating agencies, Congress, you name it, people overwhelmingly came to believe that house prices could not fall significantly. And since it was the biggest asset class in the country and it was the easiest class to borrow against, it created probably the biggest bubble in our history.
Chasing instant riches on the way up and panicking as prices fall seems so obvious in hindsight. So two useful lessons: Emotion and investing don’t mix. I would add, refusing to let go of things outside of our control compounds the issue.
But if anything stands out, the last 10 years shows that many people learned the wrong lessons. I highlighted Seth Klarman’s lessons from 2008 several weeks ago. In the same letter, he pointed out 10 false lessons from 2008:
- There are no long-term lessons — ever.
- Bad things happen, but really bad things do not. Do buy the dips, especially the lowest quality securities when they come under pressure, because declines will quickly be reversed.
- There is no amount of bad news that the markets cannot see past.
- If you’ve just stared into the abyss, quickly forget it: the lessons of history can only hold you back.
- Excess capacity in people, machines, or property will be quickly absorbed.
- Markets need not be in sync with one another. Simultaneously, the bond market can be priced for sustained tough times, the equity market for a strong recovery, and gold for high inflation. Such an apparent disconnect is indefinitely sustainable.
- In a crisis, stocks of financial companies are great investments, because the tide is bound to turn. Massive losses on bad loans and soured investments are irrelevant to value; improving trends and future prospects are what matter, regardless of whether profits will have to be used to cover loan losses and equity shortfalls for years to come.
- The government can reasonably rely on debt ratings when it forms programs to lend money to buyers of otherwise unattractive debt instruments.
- The government can indefinitely control both short-term and long-term interest rates.
- The government can always rescue the markets or interfere with contract law whenever it deems convenient with little or no apparent cost.
It’s hardly a complete list of wrong lessons, and more wrong lessons have been learned since it was written. Overall, I think it’s clear that beliefs and biases get in the way sometimes.
Last Call
- Why Facts Don’t Change Our Minds – J. Clear
- Valuable Lessons from Peter Lynch – Fortune Financial
- Long-Term News – M. Housel
- You Can Time the Market, Just Not All the Time – J. Zweig
- Making Public Private – Irrelevant Investor
- Trillion Dollar Toppers: Market Triggers, Value Drivers and Pricing Catalysts – Musings on Markets
- What Does an EV/EBITDA Multiple Mean? (pdf) – M. Mauboussin
- Risk, Uncertainty, and Ignorance in Investing: Lessons from Richard Zeckhauser – 25IQ
- Bottom-Up, Fundamental Speculators – Medium
- Free Book: The Template for Understanding Big Debt Crises – R. Dalio
- The Map to Think About How Global Living Conditions are Changing – Our World in Data
