Posts filed under “Really, really bad calls”

Vocabulary Problem: Cognitive Dissonance

Paul Krugman asks:

Unusually, I’m having a vocabulary problem. There has to be some word for the kind of person who considers his mild discomfort the equivalent of torture, crippling injury, or death for other people. But I can’t think of it. What brings this to mind is this from Alberto Gonzales: I consider myself a casualty, one of the many casualties of the war on terror.

The answer to this query is one of my favorite phrases, pulled from psychiatry and often applied to investing. But its just as valid in the legal and political realm.

I typically use it to describe absurd and perplexing statements made sincerely.

The phrase is Cognitive Dissonance.

You can find technical definitions at Changing Minds, Wikipedia, and The Skeptics Dictionary. The way I use it somewhat modifies the classic definition, when applied to an economic or investing context (but it works just as well for politics).

Cognitive Dissonance occurs in the mind of an individual when a theoretical belief system is confronted by factual evidence demonstrating outcomes contrary to what theories dictate should occur.

Examples are many and varied: Deep value investors buying beaten up stocks with no regard to other risk factors, only too see them fall another 50%. Buy & Hold investors getting utterly demolished this year; Radical deregulation resulting in market mayhem being denied by its advocates as a root cause, especially with derivatives. Rather than question the theory — be they Investing or Economic — the person suffering from Cognitive Dissonance ignores the facts in front of their eyes or devises rationales for why the undesired outcome occurred, blaming other factors (but not their thesis).

A few recent classic examples:

• Blaming the housing boom and bust on the Community Reinvestment Act of 1977 rather than an abdication of lending standards (See various posts);

• Phil Gramm denying deregulation had anything to do with the current crisis; (See A DeRegulator Unswayed)

• Blaming the population for being too gloomy (June 08), rather than questioning whether the low unemployment and inflation data where problematic (Are We Too Gloomy?)

• Amity Schlaes false definition of recession to maker the claim there was no economic contraction; (See Amity Shlaes Does Not Know What a Recession Is)

There’s more but you get the idea.

Cognitive Dissonance can lead to a politician appearing out of touch; recall John McCain’s The Fundamental’s of the Economy are Strong quote, which certainly did not help his campaign.

In investing, it can be downright deadly. Those who bought the Home Builders in 2005 had to ignore rising rates AND prices, inventory build and stagnant income. The purchasers of Banks in 2007 or Brokers in 2008 engaged in a similar risk denying approach.

There are many other forms of Cognitive Dissonance in investing and economics, it is one of those psychological factors that astute investors and traders must constantly be on the look out for. Those who are brutally honest with themselves and engage in a degree of introspection should be able to avoid its most pernicious effects.

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Related:
The Psychology Behind Common Investor Mistakes (July 2005)

http://www.ritholtz.com/blog/2005/07/the-psychology-behind-common-investor-mistakes/

Recessions Often Begin With Positive GDP Data (May 2008)

http://www.ritholtz.com/blog/2008/05/recessions-often-begin-with-positive-gdp-data/

Who is Right: Professionals or the Populace ? (June 2008)

http://www.ritholtz.com/blog/2008/06/who-is-right-professionals-or-the-populace/

Pervasive Pollyannas of Prosperity (June 2008)

http://www.ritholtz.com/blog/2008/07/pervasive-pollyannas-of-prosperity/

Category: Investing, Psychology, Really, really bad calls

UPDATED: Worst Predictions for 2008

Special Schadenfreude edition: In case you missed it, here is our updated collections of the worst predictions for how 2008 would turn out: • The 10 Worst Predictions for 2008 (Foreign Policy) • The Worst Predictions About 2008 (Businessweek) • 2008 Investment Guides Are HILARIOUS (New York Magazine) • Famous Last Words (CNBC) • The…Read More

Category: Financial Press, Markets, Psychology, Really, really bad calls

2008 Investment Guides Are HILARIOUS

Via New York Magazine, comes this amusing collection of bad forecasts for the 2008 year: • Jon Birger, senior writer, Fortune Investors Guide 2008 Smart investors should buy [Merrill Lynch] stock before everyone else comes to their senses.” Merrill’s shares plummeted 77 percent. • Elaine Garzarelli, president of Garzarelli Capital, Business Week’s Investment Outlook 2008…Read More

Category: Financial Press, Humor, Markets, Really, really bad calls, Trading

The Fall of AIG

Part III of the Washington Post series on AIG. Today’s version: Downgrades And Downfall. Here’s an excerpt: Once a small part of the firm’s business, the increasingly popular [credit-default swaps] contracts had helped boost the company’s profits to record levels. The company’s computer models continued to show only a minute chance that the firm would…Read More

Category: Bailouts, Corporate Management, Credit, Derivatives, Really, really bad calls

Revenge of the Black Swan

“The models suggested that the risk was so remote that the fees were almost free money. Just put it on your books and enjoy the money.” –Tom Savage, President, AIG’s Financial Products > The second part of the 3 part series is now posted, A Crack in The System. This section gets into the details…Read More

Category: Bailouts, Credit, Derivatives, Really, really bad calls

72% of Conservatives Still Support Bush

I am still very surprised at this: “George W. Bush remains popular among conservative Republicans (72% approve of him) despite his low overall approval rating. Meanwhile, moderate and liberal Republicans are as likely to disapprove as to approve of the job he is doing, and Democrats of all political orientations hold Bush in low regard.”…Read More

Category: Politics, Psychology, Really, really bad calls

Bank of England Allowed ‘Crazy Borrowing’

“We need to develop some new instruments, which sit somewhere between interest rates, which affect the whole economy… and individual supervision and regulation of individual banks. We need to develop something which bridges that gap and directly addresses the financial cycle and prevents the financial cycle and the credit cycle getting out of hand.” -Sir…Read More

Category: Credit, Derivatives, Markets, Real Estate, Really, really bad calls

Was There Really a Financial Crisis ?

Hale “Bonddad” Stewart is a former bond broker with several regional firms. He currently writes for Bonddad Blog, the Huffington Post and practices domestic and international tax law

Website: http://www.bonddad.blogspot.com/

Law office: http://halestewartlaw.com/

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A recent paper by the Minneapolis Federal Reserve has gotten a lot of attention. The paper is titled Facts and Myths About the Financial Crisis of 2008 and it argues there was in fact no credit crisis. Several people have used this paper to argue that Wall Street overstated the severity of the credit crisis in order to get a bail-out they didn’t need. What these commentators have failed to heed is this paper was widely criticized within the financial community, even drawing a rare rebuke from a sister Federal Reserve Bank. In short, to argue there was no credit crisis — to say we were “punked by Wall Street” — flies in the face of every available fact on the crisis.

First, let’s provide some background for this debate. As of this writing 311 lenders have “imploded.” The XLFs — the ETF that tracks the financial sector – is down almost 70% from a high in the summer of 2007. Total credit losses at the world’s financial institutions have totaled 1 trillion dollars:

The gauge is down 46 percent in 2008 as credit losses and writedowns at the world’s largest banks surpassed $1 trillion and the U.S., Europe and Japan entered the first simultaneous recessions since World War II.

In other words, the financial sector’s economic position is terrible at best.

But the evidence runs deeper. About every six weeks the Federal Reserve issues a paper titled “The Beige Book.” This is a book complied from anecdotal evidence from the Federal Reserve Districts on the general economic environment. Every Beige book issued in 2008 has indicated credit conditions were tightening and loan demand was decreasing.

Read More

Category: BP Cafe, Credit, Derivatives, Finance, Really, really bad calls, UnScience

Quote of the Day: Phil Gramm

“You’ve heard of mental depression; this is a mental recession,” he said, noting that growth has held up at about 1 percent despite all the publicity over losing jobs to India, China, illegal immigration, housing and credit problems and record oil prices. “We may have a recession; we haven’t had one yet.” “We have sort…Read More

Category: Markets, Really, really bad calls

Harvard: Not So Smart After All

We interrupt the GM hearings for this brief moment of schadenfreude: Harvard’s endowment has now blown through over $8 Billion, or 22% in the last four months. Correct me if I am wrong, but wasn’t Harvard’s endowment outperforming the broad indices for a long time? And didn’t their Board of Trustees fire/replace/chase awayt hese outperforming…Read More

Category: Hedge Funds, Markets, Really, really bad calls