As a professional investor, I have been repeatedly asked my opinion of the credit crisis and what will come of it all. My first answer is that we’ll get through it, so just sit tight. My second point is that it’s vital that people understand what led to the crisis so that we can learn from our mistakes. And yes, they are our mistakes, as in all of us as people with money invested in the market, not their mistakes.
Countless people have said that the credit crisis is beyond the ordinary person’s ability to comrehend, and maybe even beyond our financial leaders’ ability to understand.
Nonsense.
The credit crisis is the direct result of people willing to go very far out on the risk curve for fatter and fatter returns. While in and of itself that’s not necessarily a bad thing, doing it on a grand scale such as we’ve seen over the past several years is a horrible thing. Risky investments have their role to play in many portfolios, but it’s virually always a small roll.
So what happened? In a nutshell, investment products were created that were leveraged 30:1 and even 40:1 in some cases. That means for every dollar of true value, these investments had 30 to 40 dollars of fake (sometimes called ‘paper’) value. It’s really not all that different from the heady dot-com days when business plans written on napkins received millions of dollars of investments. And guess what, those investments returned zip, too. In fact, this is something we’ve seen again and again over the course of history going back to the Dutch tulip mania of the 1600s, but every time we seems to lose sight of the lesson.
In this decade’s chapter of the ongoing saga, those who created and promoted these ‘new style’ investments were supposedly far above the rest of us in terms of sheer intelligence. They could hand you reams of paper ‘proving’ that their approach actually took risk out of the equation through a variety of hedging techniques and other high falutin’ schemes. It couldn’t possiby fail.
Got it. Sorta reminds me of the ‘new economy’ that some of us just ‘didn’t get’ because we had the audacity to question what was going on 10 years ago.
Again, I’m not a proponent of keeping risky investments out of portfolios altogether. They have their place, in a limited role. What happened here is the lure of fat returns, coupled with products so fantastically complex created and promoted by super-humans, led to far, far too much money getting poured into these things. In short, it turned into a ponzi scheme. And we let it happen.
How? Well, in my humble opinion, it wasn’t greed. It was envy, combined with a fear that if you don’t keep up, your goose will be cooked. Portfolio and pension managers envied the other managers who were already in, and in order to look like stars themselves they drank the coolaid. Otherwise they were at risk of losing business because their investors would switch to their competitors. Institutions with endowments such as universities and hospitals saw their competitors get fantastic returns and envied those returns. They felt they needed to duplicate them in order to keep up and stay competitive. Rich families feel constant pressure to aggressively grow the family’s wealth or the family will surely be knocked off the top. Pretty soon you’ve got a very crowded elevator that’s at risk of plunging.
So don’t blame those who created these products. This is a shark-infested world, and they come in all shapes and sizes. Some of them beg change on the corner; some practice law; others sell insurance; and still others are religious leaders. Oh, and some create and promote investment products. Their schemes and products will always be there for the greedy to buy and the envious to pile in on.
And keep in mind, too, that the ones who originally created the products aren’t necessarily ‘bad people who should be punished’. The first mortgage-backed securities were not necessarily intended for mass consumption. It’s the consumers who delegated investment decisions to others and then put pressure on those managers to keep up. Just show us the money. That’s all we need to know.
Did the consumers understand the underlying business represented by the paper they purchased? Did the consumers make an effort to understand the how these products worked? Did they all even realize that they owned these products? The answers are no, no, and no. They left it in the hands of the pros, who were scrambling to keep their returns as high as their competitors’ returns. What’s missing from all of this? Personal responsibility, that’s what. Enter the sharks…
Of course, many consumers are not in a position to take personal responsibility for their investments. It’s just not possible. And this crisis has had far more collateral damage than recent past crisises, with much more to come, so many have been hurt who had no exposure to the financial sector. So for many reasons, the outrage directed at wall street is well justified.
At the same time, I think it’s important to say that we should point that finger of blame at least partially back at ourselves. We were taken. Again. They got us. Doh! So shame on us, and please, let’s try to remember the envy trap the next time the investment community goes chasing rainbows.
The envy trap
October 1, 2008 by digitalseer
As a professional investor, I have been repeatedly asked my opinion of the credit crisis and what will come of it all. My first answer is that we’ll get through it, so just sit tight. My second point is that it’s vital that people understand what led to the crisis so that we can learn from our mistakes. And yes, they are our mistakes, as in all of us as people with money invested in the market, not their mistakes.
Countless people have said that the credit crisis is beyond the ordinary person’s ability to comrehend, and maybe even beyond our financial leaders’ ability to understand.
Nonsense.
The credit crisis is the direct result of people willing to go very far out on the risk curve for fatter and fatter returns. While in and of itself that’s not necessarily a bad thing, doing it on a grand scale such as we’ve seen over the past several years is a horrible thing. Risky investments have their role to play in many portfolios, but it’s virually always a small roll.
So what happened? In a nutshell, investment products were created that were leveraged 30:1 and even 40:1 in some cases. That means for every dollar of true value, these investments had 30 to 40 dollars of fake (sometimes called ‘paper’) value. It’s really not all that different from the heady dot-com days when business plans written on napkins received millions of dollars of investments. And guess what, those investments returned zip, too. In fact, this is something we’ve seen again and again over the course of history going back to the Dutch tulip mania of the 1600s, but every time we seems to lose sight of the lesson.
In this decade’s chapter of the ongoing saga, those who created and promoted these ‘new style’ investments were supposedly far above the rest of us in terms of sheer intelligence. They could hand you reams of paper ‘proving’ that their approach actually took risk out of the equation through a variety of hedging techniques and other high falutin’ schemes. It couldn’t possiby fail.
Got it. Sorta reminds me of the ‘new economy’ that some of us just ‘didn’t get’ because we had the audacity to question what was going on 10 years ago.
Again, I’m not a proponent of keeping risky investments out of portfolios altogether. They have their place, in a limited role. What happened here is the lure of fat returns, coupled with products so fantastically complex created and promoted by super-humans, led to far, far too much money getting poured into these things. In short, it turned into a ponzi scheme. And we let it happen.
How? Well, in my humble opinion, it wasn’t greed. It was envy, combined with a fear that if you don’t keep up, your goose will be cooked. Portfolio and pension managers envied the other managers who were already in, and in order to look like stars themselves they drank the coolaid. Otherwise they were at risk of losing business because their investors would switch to their competitors. Institutions with endowments such as universities and hospitals saw their competitors get fantastic returns and envied those returns. They felt they needed to duplicate them in order to keep up and stay competitive. Rich families feel constant pressure to aggressively grow the family’s wealth or the family will surely be knocked off the top. Pretty soon you’ve got a very crowded elevator that’s at risk of plunging.
So don’t blame those who created these products. This is a shark-infested world, and they come in all shapes and sizes. Some of them beg change on the corner; some practice law; others sell insurance; and still others are religious leaders. Oh, and some create and promote investment products. Their schemes and products will always be there for the greedy to buy and the envious to pile in on.
And keep in mind, too, that the ones who originally created the products aren’t necessarily ‘bad people who should be punished’. The first mortgage-backed securities were not necessarily intended for mass consumption. It’s the consumers who delegated investment decisions to others and then put pressure on those managers to keep up. Just show us the money. That’s all we need to know.
Did the consumers understand the underlying business represented by the paper they purchased? Did the consumers make an effort to understand the how these products worked? Did they all even realize that they owned these products? The answers are no, no, and no. They left it in the hands of the pros, who were scrambling to keep their returns as high as their competitors’ returns. What’s missing from all of this? Personal responsibility, that’s what. Enter the sharks…
Of course, many consumers are not in a position to take personal responsibility for their investments. It’s just not possible. And this crisis has had far more collateral damage than recent past crisises, with much more to come, so many have been hurt who had no exposure to the financial sector. So for many reasons, the outrage directed at wall street is well justified.
At the same time, I think it’s important to say that we should point that finger of blame at least partially back at ourselves. We were taken. Again. They got us. Doh! So shame on us, and please, let’s try to remember the envy trap the next time the investment community goes chasing rainbows.
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Posted in General, Market commentaries, Market predictions | Tagged bad loans, blame, cds, credit default, general market commentary, greed, greedy, investments, mortgage backed securities, stocks, Technology | Leave a Comment
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