Why humans create bubbles

by phil on Sunday Mar 22, 2009 1:21 PM
dlog

It's not just these global movements that caused the financial crisis. It's also human psychology, which, when duplicated in millions of people, becomes a global movement of its own.

In This American Life's, "Giant Pools of Money" episode, Ira Glass comments:

It's easy to ignore your gut fear when you're making a fortune on commisions.

However, I don't think that captures it. He makes it seems like, "oops, some got a little greedy." I think our failings are deeper and more concrete. It's this part of human psychology:
It's very hard to leave money on the table.

Around 1995-1997, I remember hearing stories like this every day, "Oh, you know Jamie from Poway High School. He made $60,000 last week speculating on some cheap Internet stocks." Or, "Did you know Uncle Jimmy went from $100,000 to $500,000 last year trading options" I asked old, wise people, "Well, should we be cautious?" They would say, "Look, you'll never make money if you're negative all the time. If you saw money on a table, wouldn't you grab it?"

You know how parents used to chide their kids, "And if everybody jumped off the bridge, would you follow them too?" The thing is, that's precisely what people do. Nobody wants to be the only idiot who didn't jump off the bridge into the pot of gold.

If all your friends have manisons and you're still sitting in an apartment because you didn't have the guts to ride the wave, you're going to be very very disappointed. Look at the Madoff scam. The people who invested with him were making crazy returns for 17 years. This one couple decided against it, and year-after-year they would hear stories about their relatives going to higher and higher stratospheres of wealth. Fortunately for them, they lived long enough to see Madoff get put behind bars.

It's in situations like this that we need Warren Buffet and his primary device: principles.

Cross-posted on Drunk Log.