Thursday, October 1, 2009

Ignorance and Arrogance

People are generally ignorant of their own country’s history of financial crises and debt default. In the course of their research, Professor Reinhart and Professor Rogoff found that even government officials were blissfully unaware of such basic information as their country’s domestic debt records or recent housing market prices. In many cases, the authors (two veterans of the International Monetary Fund) said, national records simply do not exist.
Despite (or perhaps because of?) these huge memory lapses, both private investors and public officials, again and again, insist that the fundamentals of whatever financial bubble they happen to riding at any given time are sound, even indestructible.
When such hubris is eventually proven wrong, and whole economies are brought to their knees, investors finally realize how big their blind spots really were. In response they demand all sorts of new transparency rules, official investigations and investor protections — responses that eventually coax investors into a renewed feeling of omnipotence over the market, which again leads to a new underestimation of risk and, eventually, a new crisis.
In fact, until the current crisis, economists for years had been bragging about “ The Great Moderation,” the idea that technocrats had finally tamed the business cycle. New ways of pooling risk in the form of snazzy financial products had virtually eliminated all risk — or so everyone thought before Lehman sought bankruptcy protection.
This pattern of events has a long history. Even back in 1929 there was a false sense of security over new-found mass financial “sophistication.”
In their book, Professors Reinhart and Rogoff reprinted a gem of an archived advertisement. It tells, condescendingly, of the irrational exuberance that had plagued an earlier, more benighted species of investor:

when all Europe guessed wrong

The date — Oct. 3, 1719. The scene — Hotel de Nevers, Paris. A wild mob — fighting to be heard.

“Fifty shares!” “I’ll take two hundred!” “Five hundred!” “A thousand here!” “Ten thousand!”

Shrill cries of women. Hoarse shoats of men. Speculators all — exchanging their gold and jewels or a lifetime’s meager savings for magic shares in John Law’s Mississippi Company. Shares that were to make them rich overnight.
Then the bubble burst. Down went the shares. Facing utter ruin, the frenzied populace tried to “sell”. Panic-stricken mobs stormed the Banque Royale. No use! The bank’s coffers were empty. John Law had fled. The great Mississippi Company and its promise of wealth had become but a wretched memory.

Then, the advertisement proudly promises:

Today, you need not guess.

History sometimes repeats itself — but not invariably. In 1719 there was practically no way of finding out the facts about the Mississippi venture. How different the position of the investor in 1929!

Today, it is inexcusable to buy a “bubble” — inexcusable because unnecessary. For now every investor — whether his capital consists of a few thousand or mounts into the millions — has at his disposal facilities for obtaining the facts. Facts which — as far as is humanly possible — eliminate the hazards of speculation and substitute in their place sound principles of investment.

The ad — for a company called Standard Statistics, whose address has since been turned into a Chipotle Mexican Grill — ran on Sept. 19, 1929, about a month before the market crashed.

Any of this sound familiar?

New York Times

No comments: