The Pendulum Continues to Swing

Monday, September 15, 2008 marked the beginning of what has been termed “the week that shook the world”—or at least the financial world in which I made my living. Shortly after midnight, Lehman Brothers declared bankruptcy. As a venerated household name, the news of Lehman’s collapse resonated with people in a way events of the previous months had not. The crisis on Wall Street suddenly had a massive, unexpected casualty which made it clear the trouble was far from isolated and other giants were on the brink of failure.

I vividly recall the quizzical looks of people, whom I encountered in all manner of settings, which conveyed an aura of, “How in the world did that happen?” Everyone was desperately trying to make sense of this unprecedented situation. A colleague of mine at the time had a client who was a clinical psychologist. Unsurprisingly, the psychologist’s practice was receiving a huge number of calls from patients sick with worry and seeking reassurance. I’ll never forget the psychologist calling my colleague and asking, “We are telling our patients that everything is going to be OK. That’s right, isn’t it?”

Given the incredible pace at which news was breaking, people became hyper-focused on day-to-day market movements. There was a collective sigh of relief when markets closed on Friday afternoons because it allowed for a slight reprieve from the onslaught. A common refrain at the time was “Sunday is the new Monday” because people were waking in the middle of the night to see what Asian markets were doing, which inevitably affected their pre-market behavior in the morning. They would watch calamities unfold in U.S. markets throughout the day and, at closing bell, begin to turn their attention back to Asian markets. It became an endless loop, and the reactionary behavior ran counter to their best long-term interests.

One of the most startling aspects of the Great Financial Crisis is that it unfolded mere months after the good times (or, at least, the perception of good times). A year prior to Lehman’s collapse, I met with someone who told me he put all his money in Outer Banks real estate because it was a “can’t lose investment.” I have a file containing some of the more memorable pitches and research pieces from the time (my wife and colleagues will attest I am a bit of a pack rat), and I am still struck by the absurdity of their optimism in 2007 and pessimism in 2009. Extremism in any form, be it political, social, or economic (i.e., financial engineering) rarely, if ever, wins the day relative to sound, prudent thinking.

Bottom Line

The pendulum swings constantly between fear and greed, and sometimes the pendulum overreaches. The challenge, as Warren Buffett put it, is to be “fearful when others are greedy and greedy when others are fearful.” This is admittedly easier said than done in the face of our individual insecurities and group-think behavior. Behavioral psychology provides meaningful opportunities to seize upon irrational actions. As such, prudent investors contemplate all sorts of scenarios—good and bad—so that, when market dislocation inevitably becomes extreme, they know whether to take action.

During business school, I spent a term studying abroad at the London School of Economics. One Saturday, while walking through Notting Hill’s famed Portobello Road Market, an old scrap of paper in one of the stalls caught my eye. It was a defaulted debenture of a Belgian railroad company from the 1930s. I bought and framed the bond and have it on display in my house as a reminder that debt sometimes defaults, cutting-edge technologies eventually become obsolete, and all bets are off when the Nazis rise up as your next-door neighbor. America’s most esteemed financial institutions are no less immune. After all, it is the deer you don’t see that is most likely to total your car.