Wednesday, July 20, 2011

Thursday, July 7, 2011

Why Are Bubbles So Hard to Spot?

I have been reading all of the books about the 2008 crash that have been coming out. I love reading Wall Street books and so far they have all been great. The one I am reading now is particularly interesting because it was not written by a reporter, it was written by someone on Lehman's distressed debt trading desk. The book is A Colossal Failure of Common Sense: The Inside Story of the Collapse of Lehman Brothers by Lawrence G. McDonald. What is so interesting is the story of how the distressed debt desk, which had nothing to do with mortgages or housing, saw the crisis coming years in advance, while the mortgage desk, which was directly involved, didn't see it coming at all. How could this be? Were the mortgage guys dumb? Of course not, these guys had MBAs from the best schools in the country.

My thinking is that the mortgage guys were making money hand over fist from the housing boom. A deep desire to keep making money hand over fist, to keep the lifestyle they had kept them from seeing what was right in front of them. If they could think that they were in a bubble that was going to burst then they couldn't keep doing what they were doing and they couldn't keep making the money they were making. They had to block out any negative thoughts they might have.

The distressed guys had no incentive but to make money for their desk and their firm. They looked at the facts and came to the obvious conclusion.

Why is this important? There have been bubbles that have burst during my lifetime and there will be many more. Wall Street by and large hasn't seen them coming and they won't again. They can't. Imagine what would happen if Merrill Lynch or Fidelity Investments saw a big bubble about to crash in the stock market. Could they stop trading, move all of their clients to cash, stop making money for a while? No way.