Fit to Bust by Phillips Tim

Author:Phillips, Tim
Language: eng
Format: epub
Publisher: Kogan Page

Chapter Six

Greater fools

“It’s not the despair… It’s the hope I can’t stand. JOHN CLEESE

The greater fool theory of investing means that you don’t have to believe that what you’re buying is worth what you pay for it, as long as there’s someone else who is prepared to buy it from you for more than you paid.

That’s the nature of an economic bubble. Plenty of research demonstrates that we’re rarely aware of when we’re in a bubble, and unable to predict when we’ve encountered the greatest fool, and the bubble is about to burst. All sudden failures in this book have a bit of the bubble about them – a sense afterwards that we were gripped by a collective madness, a financial hangover.

While the Tulip Mania (p 122) shows us that bubbles don’t need technology, electronic markets, complex financial instruments, or shareholder economies to exist, the examples of bubbles in this section show how a collective madness can grow from a perfectly normal reaction: that people who have little to lose and much to gain from speculation, when handed an opportunity that they don’t fully grasp, will naturally go for it. When we look back and laugh at them, we’re ignoring the fact that we do the same. We like to buy houses when the prices are going up, even though economic theories say that there should be less demand when prices rise. We tell ourselves that you never lose money on a house, when even the experience of the past 20 years shows us that, often, we do lose money.

The news media celebrates risk-takers who succeed as modern gods. It admires winners and ignores losers. The speculator’s game of choice for 100 years was contract bridge, in which you cooperate with your partner to make a contract based on the value of the assets – cards – you have, then carefully marshal your resources to achieve your goal. Today’s CEOs prefer poker. It’s a game of considerable skill but based on aggression, maximizing your personal resources at the expense of others. In poker you can win with poor cards, as long as there’s a bigger fool than you at the table.

Fund manager Howard Marks, the founder of Oaktree Capital, talks about ‘The seven worst words in the world: too much money chasing too few deals. When that happens, run for the hills.’ This is what happened to the people who didn’t follow that advice.

Feeding risk Lehman Brothers

In 2005, Raghuram G Rajan, then chief economist of the International Monetary Fund (IMF) and now a professor at the University of Chicago Booth School of Business, presented a controversial paper at the annual Jackson Hole monetary conference. The title: ‘Has Financial Development Made the World Riskier?’93 The question wasn’t controversial. The answer, though, was: yes.

At the time, the financial instruments that banks such as Lehman Brothers had created were widely credited with removing risk from banking, while boosting returns. It seemed ridiculous that in the middle of a long boom, with few predictions that it would end, Rajan should issue a warning that it all might suddenly end.

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