Bubbles. We’ve just been through two of them in relatively short succession: the Internet bubble of the late 1990s, and the recent housing bubble.
Why do bubbles occur? The list of explanations includes shortsightedness, sheer stupidity, and greed. The history of bubbles is a story of excessive enthuasisms—for anything from tulip bulbs to subprime mortgages.
But is there something more fundamental at work? Something more innate and psychological? It seems to me there is. It arises from who we are as humans, and in how we think and behave, individually and as social animals.
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You’ve heard it before: Stay the course. Don’t sell when your assets are valued at the lowest point.
Is this “do nothing” message always correct? Could it lull you into making a bad decision?
The idea of not making any market moves is based on the assumption that before the bear market started and the recession kicked in, you were rational and had put together a balanced portfolio—diversifying your risks and reflecting your risk tolerance.
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Is it the 1930s all over again? If that were true, it would be one very good reason to panic, sell everything, and put your money in a mattress. But it turns out that the comparisons between today and the Great Depression are (mostly) bunk.
You should know by now (if you’ve been reading the papers or the blogs) that the stock market crash of 1929 did not cause the Great Depression. Instead, the Depression came about because of a flawed economic response in Washington. As the economy cooled in the early 1930s, rising bank failures led to sharp contraction in credit. Congress balanced the budget and imposed trade tariffs. The result was a downward spiral in the economy and massive unemployment. The economic collapse led to the failure of the financial system—notably, a surge in bank failures and collapsing stock prices.
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Every year, I look forward to newspapers’ “what’s in/what’s out” lists.
High up on the financial “what’s out” list in 2009 is “leverage”—borrowing money to make a bigger bet, whether on housing, commodities, currencies, collateralized debt obligations, or corporate buyouts.
And the “what’s in” list has to have a home for thrift. The notion of saving for a rainy day tends to come back in fashion whenever we’ve been through the kind of economic downpour that has hit investors in 2008.
After a drop of 40% in the stock market, even disciplined savers and investors may have to ratchet up savings to restore our portfolios. Among those who had been saving only a bit—and national statistics indicate that’s a very large percentage of households—the need for a return to thrift is even greater.
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Much has been made of the market’s recent volatility. Today, 300-, 400-, and even 500-point swings in the Dow feel almost normal.
Many factors have been cited as contributors to the big moves: hedge funds delevering their portfolios, institutional investors selling liquid assets (i.e., stocks) to raise money to fund commitments to less liquid investments, mutual fund redemptions, and so on. No doubt, they’ve all played a role—and with no apparent end in sight.
I would add another factor at work: The market is trying to reprice the economic system in the United States.
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