Everything you want to know about the bank crisis New Statesman This is the worst financial crisis in 60 years, and it has shaken the banking system to its foundations.
Subprime In Sheep's Clothing Forbes Relatively affluent borrowers might not stick around once their equity turns negative, potentially beginning a vicious circle of home abandonments that push down prices and encourage new defaults.
Subprime loans taking homeowners down (Munster, Ind.) Times This year, about 1.5 million subprime adjustable rate mortgages like Stacey and Joy Clemons' are scheduled to reset to higher rates in the United States. That is fueling fears the foreclosure crisis that kicked into high gear last year will go on and on.
June 23, 2008
As the U.S. continues to sift through the debris of the subprime mortgage crisis, we find ourselves replaying the same question in our head: When did it start seeming like a good business idea to make big loans to people who had no demonstrable means of repaying them?
The answer is complicated and may best be found in history, particularly an illuminating tome called Extraordinary Popular Delusions and the Madness of Crowds. First published in 1841 by Scottish journalist Charles Mackay (and sadly as relevant as ever today), the book recounts several stunning examples of ordinarily rational people abandoning all sense in the pursuit of phantom riches.
The cumulative effect of the book is to demonstrate the dire depths of crowd psychology and, in particular, how they relate to financial markets. Financier Bernard Baruch, who credited Mackay's work with convincing him to sell most of his stocks shortly before the great 1929 crash, summarized it thusly in his introduction to the 1932 edition: "Anyone taken as an individual is tolerably sensible...as a member of a crowd, he at once becomes a blockhead."
Mackay looks at three great financial bubbles from the past before delving into more generalized deviations from reason, such as witch scares and silly catchphrases. The Dutch tulip craze of the early 1600s may be familiar because of the numerous comparisons with the Internet bubble of the late-1990s. The Dutch upper class, flush with merchant wealth, strangely became more enamored than usual with tulips. Prices rose and then went through the roof. In one case, a 12-acre estate was exchanged for a single bulb. One bulb could command a price of more than 5,000 florins, equivalent in value to 21 tons of cheese. The Amsterdam Stock Excahnge set up separate markets for the auctioning of tulips.
Less familiar are the Mississippi Scheme of the early 1700s, in which a few savvy French marketers formed The Mississippi Company. Armed with a couple of trade documents of debatable value, the founders floated fantastical plans to develop the nascent Louisiana Territory. The public ate it up and clamored in long lines to buy shares, which increased in value 50-fold over the course of a few months."Many persons in the humbler walks of life, who had risen poor in the morning, went to bed in affluence," notes Mackay.
Of the same ilk and the same period is the South Sea Bubble. The prospering South Seas Company, formed in 1711 to exploit Britain's growing maritime trade, inspired a legion of half-baked imitations. As long as they claimed some link to New World mercantilism, the companies/schemes attracted investors, even with a business plan as detail-poor as the following: "A company for carrying on an undertaking of great advantage, but nobody to know what it is."
Each of the schemes follows a similar pattern. A few adventurous souls come up with an idea of feasible but entirely specualtive money-making value. A handful of greedy followers glom on, either investing with the original innovator or forming similar entertpises of their own. At a certain critical mass, greed gives way to another great motivating emotion of markets: fear. Otherwise sensible investors panic at the prospect of being left out of the money-making spectacle and throw money at anything that comes along promising a connection to it. Rationality exits and prices soar -- until somebody realizes 2 + 2 still equals 4 and everything comes crashing back to earth. Tulips are mere flowers again, a speculative overseas business scheme is once again seen as just that, and a risky loan is once more a risky loan.
Mackay explained it better than most: "Men, it has been well said, think in herds; it will be seen that they go mad in herds, while they only recover their senses slowly, and one by one!"
The Neurobiology of Mass Delusion Energy Bulletin History is replete with examples of social organizations, whether a business or a nation, that failed to perceive the realities of a changing environment and didn't adapt in time to prevent calamity.
The Madness and Wisdom of Crowds Framed Sheep The point though is to see if we can draw a parallel between the wisdom and madness of crowd behaviour.
The subprime house of cards Cleveland.com One of the biggest crime waves in the last decade had nothing to do with guns or drugs or gangs. The criminal tools were houses and lousy loans
The Giant Pool of Money: Anatomy of the Subprime Mortgage Mess Get Rich Slowly The American housing crisis isn’t over yet. The fallout from the subprime mortgage mess will continue to settle for months (or years).
Which was the dumbest financial mess?
33% 8% 42% 17%
neocountry1 said...
where are the posts?
The madness of crowds versus the savvy of the few.
If you're smart enough to get in on a trend - whether it's tulips, dot.coms, housing, - that's o.k. The key is to know when to get out. That's a key most people seem to misplace.
When everyone else is doing it, when it's hot, that's a good time to leave the market no matter what the returns.
There's an interesting show on tv called "Deal or No Deal". This show has specific amounts of money randomly placed in numbered suitcases. It's so random as to make any attempt at discovering the case with the milliion dollars completely impossioble. What I like about the show is how one individual can convince themselves how they have the suitcase with million. They pick the case numbers based on some bizzare concept of the significance of the numbers to their own life.
They believe God has ordained them for the million because they are good people, or because they have a need to pay off the mortgage, or because Mom needs an expensive surgery to stay alive.
They all violate the first rule of a good deal: "never leave money on the table."
The "banker" offers money supposedly based on the odds after a certain number of cases have been opened. The smart person would calculate the odds (which are not in your favor) and take the offered money.
But they usually don't. Often by the time they take the offer it's less than previous offers. You could basically take the first offer, because it's money you didn't have when you came to the game.
Now, you take that mentality and combine it with the madness of crowds and you have the makings of disaster.
My rules are simply: Don't speculate on what you don't understand. Always have a stop-loss system in place to get your initial investment out if the profits drop. Always sell when the profits appear to be going so high that the crowd wants in. And don't try to get a bargain out of a bargain.
And remember that madness turns to panic.
The only thing I would add to the above is that if it appears to be way "too good to be true", it usually is", and if your in a market where even "turkeys can fly", then be very careful 'cos they fly like rocks.
I know very little about finances and the market. Otherwise, I'd be wealthier than I am. But I have one comment on the subject of "risky loans" and the question, "When did it start seeming like a good business idea to make big loans to people who had no demonstrable means of repaying them?"
You may remember a wonderful scene from "The Best Years of Our Lives" when Fredric March makes a speech discussing how disastrous the effects would have been if the concept of collateral had been applied to military tactics during the war. He said that sometimes, you have no choice but to gamble on the future of the country. It was the kind of speech that only works in the movies but, on some level, I suspect he may well have been right.
The problem, of course, is that March's purpose was to obtain loans without collateral for WWII vets. They had already displayed their reliability in far more dire straits than poverty. Once we start applying such generosity to anyone, the mob moves in and sanity moves out.
By the way, where is everyone? I just came back from celebrating my 7th wedding anniversary on the Jersey Shore. Did everyone else on this board also go out of town at the same time?
DPR,
First and foremost, a very Happy Anniversary to you both!!
As far as where is everybody? Perhaps they are fighting their "Herd Instinct" today.
Hi, SSJ!
Thank you for the good wishes.
That's a bright, sniny new name you have. Is it just for a change or is there a story behind it?
Of course, if everyone fights their "Herd Instinct" at the same time, they've really succumbed to it after all, haven't they.