Thursday, December 08, 2016

Risk and Human Behavior

We had a little water in our basement (very normal for this area), so we had an inspector/fixer guy come over today and take a look.

He told me a great story, and it's a cautionary tale.

Around 2006, he started flipping houses. Perfect fit for him, because he can fix quite a few different things. So he'd buy a house, fix it up, and flip it.

He flipped 18 houses.

He was red hot, and he was ready to retire. He had four houses left that he was flipping, then he was getting out of the game with about 900k or so.

That was in 2008.

You know what happened next. The real estate market absolutely collapsed, he couldn't sell any of the houses, couldn't afford to keep them (because he'd borrowed money to buy them), and he blew up.

So he's in his 60s and he's still working, and he said he'd be working for a long time.

What was remarkable about this fellow is that what he he was doing wasn't particularly risky, given the standards of the time. When everyone around you is taking absolutely huge amounts of risk, taking risk feels normal. Even taking excessive amounts of risk (like he did) seems conservative, because so many other people are taking absolutely insane amounts of risk.

The least crazy person in a group of crazy people is still crazy. It is incredibly tough to remember that.

"That guy is taking too much risk, and I'm taking much less risk, so that must mean I'm safe." That's the kind of thing people say to themselves in a boom, but they're comparing their behavior to the wrong end of the stick.

It's hard to understand that in a financial bubble, though, because risk is highly and almost unerringly rewarded until the market crashes. So not taking huge amounts of risk seems stupid, because that huge risk is making you huge amounts of money, and if you keep making money from high risk, it doesn't feel like high risk anymore.

It feels normal. It feels smart.

It's also very hard for people to understand that markets are predatory. Unregulated or lightly-regulated markets are incredibly predatory, and that creates fisherman and fish. While the inspector/fixer guy might have thought he was the fisherman, he wasn't--he was the fish. The banks loaning people obscene amounts of money with very little collateral?

The banks were the fishermen.

He didn't understand that, and he's working an extra twenty years because he didn't.

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