Financial Meltdown: Good Luck, Bad Luck, Who Knows?

Here’s a Chinese parable that I try to keep in mind.

Good Luck Bad Luck!

A farmer used an old horse to till his fields. One day, the horse escaped into the hills and when the farmer’s neighbors sympathized with the old man over his bad luck, the farmer replied, “Bad luck? Good luck? Who knows?” A week later, the horse returned with a herd of horses from the hills and this time the neighbors congratulated the farmer on his good luck. His reply was, “Good luck? Bad luck? Who knows?” Then, when the farmer’s son was attempting to tame one of the wild horses, he fell off its back and broke his leg. Everyone thought this very bad luck. Not the farmer, whose only reaction was, “Bad luck? Good luck? Who knows? ”Some weeks later, the army marched into the village and conscripted every able-bodied youth they found there. When they saw the farmer’s son with his broken leg, they let him off. Now was that good luck or bad luck? Who knows?

The fact that a bad event can turn out to be good, and vice versa, is a useful perspective with which to view important moments in our lives, I think. Most of us have experienced this truth. For me, for example, there was a depressing time when I lost my job; soon afterwards an opportunity came my way resulted in my starting a company that led to far greater rewards than I would have had in the job that I lost.

There are good reasons why people simply accept what seems to be bad luck or good luck at face value. For one, very often what seems like bad luck or good luck really is what it seems. For another, it is hard to be philosophic in the face of a loss, especially a great loss. And for a third, who wants to try to find a gloomy side to what appears to be good luck? But I like to take the broader view of events when I can remember to do so because it can help get past the sadness of misfortune or avoid some foolishness that can result from experiencing some “good” luck.

What About Now?

It’s not immediately clear that the farmer’s story gives us a relevant perspective on this current financial meltdown as many of us contemplate substantial declines in our asset values. Most people have very strong feelings that the gaining of wealth is a good thing and the loss of it is bad. No Chinese parable is likely to convince us that it could be bad luck to gain a lot of wealth or good luck to lose it.

But consider this: I had a very good friend who came from modest circumstances, as we say, and who made a great deal of money in his 30’s. Well, my friend let his wealth get the better of him somehow. Unknown to anyone, perhaps even to himself, he apparently had an addictive personality. His new wealth led him to several addictions and ultimately to his untimely death. You’ve probably heard similar stories; it’s not all that uncommon. I guess if my friend could have known what his future would hold before he embarked on his quest for wealth he might have decided that making so much money so quickly truly would be bad luck for him.

Or consider Thierry Magon de La Villehuchet, the co-founder of an investment management firm that funneled money to Bernard Madoff. Unable to face his losses and/or those of his clients in Madoff’s scheme, he apparently killed himself. I’d be surprised if he were the only person to do that before this is all over. Might Mr. Villehuchet have chosen a different, perhaps less lucrative career if he had known the full implications of what his financial success would bring to him? I suspect he might well have said that the farmer’s story had relevance to his life.

Losing wealth is not a reason to rejoice but I do think there are some good reasons to welcome this bear market if we consider the larger picture of our society.

The End of Cheap Money: Good Luck or Bad?

In 1982, The New York Times Sunday Magazine ran a cover story on Paul Volcker, Chairman of the Federal Reserve Bank. The point of the story was that Volcker was declaring victory over the inflation epidemic of the 1970’s. Having raised short term interest rates to about 20%, Volcker was saying he was through with high rates, that rates should come down now because there would be no more out-of-control inflation.

What followed almost from the moment of that article was 26 years of nearly steady reduction of interest rates all the way down to 1% under Mr. Greenspan and now to zero in the face of our current problem, a potential deflation. Lower interest rates are almost always good for equity investments. Thus, the period 1982 - 2008 will mark one of the longest periods of abnormally high investment returns in the history of investing because for nearly the entire time the wind of lower interest rates was at the back of equity investors.

But the wealth-creating machine of lower interest rates was corrupted during the most recent part of this trend, 2002 - 2008, by the addition of unregulated and misunderstood leverage - - from LBO’s to CDO’s to MBS’s and so on. I would argue that the end of this period in our history should not be seen necessarily as bad luck.

In some ways it seems to me that our society has become like my addictive friend. Social values have been distorted by great wealth that has accentuated a variety of societal addictions. Though not unique to this time in history, money has increasingly influenced politicians who have granted legal opportunities to their supporters to make more money in ways that have turned out to be toxic to the system and have now led to its partial collapse.

So, for example, Mr. Schumer stops the Congress from reforming the clearly unfair favorable tax treatment given to private equity compensation (which is taxed at only 15% as a capital gain); the private equity folks heap debt on the balance sheets of companies, most of which were previously healthy; that debt eventually becomes untenable loans on the books of greedy bankers; the banks then must be bailed out by taxpayers in order to save the economy from the ruin that a failed banking system would cause. All a function of excessive greed - a value system gone awry.

And then we have the personal costs, beyond wealth. The promise of much fast money has led many of the most talented young people to forego life paths like medicine or science or teaching or research or public service in favor of investment banking or “quantitative” investing. One reason some do it is that the costs of education and houses rose so high that many new college graduates could hardly hope to pay off their college loans or own a home unless they chose a highly lucrative field of work. Thus both greed and the inflated costs of high-end living have pushed talented youths to pursue fields in which they learn nothing beyond how to make money out of money, producing very little if anything useful in the process.

Perhaps a serious economic downturn is exactly what America needs to regain a healthy work ethic that includes the idea that the rewards of work are in large part the work itself. It would have been better for us if the financial crash had come sooner because the damage would have been less.

Looking Forward

And here is something else to consider. Eventually the economy and the markets will recover. We don’t know if that will come in 2009 or in 2015 or some other time. Personally, I think it will come whenever it becomes clear that deflation is not dominating the economy, just as the last bull market started when it became clear that inflation was not dominating the economy. The personal finances of those who are able to manage their funds to coincide with the next bull market - and not the dangerous false rallies that draw more money into a bear trend - will do quite well.

So: Is the financial crisis we have entered into a good thing or a bad thing? I would argue that we might not want to try to answer that question quite yet.

Comments

[Daniel Eskin:]

Well said.

Good things can come disguised as bad things in all areas of life. And truthfully, we've all seen that tons of entities in the US (and in the world as well) are not sustainable during situations like this. Letting them go bankrupt can definitely help the economy keep its strong players. It's just like capitalism and free markets -- survival of the fittest.

Food for thought: a forest fire decomposes dead trees into nutrients that allow new plants to grow.

2008 Dec 29 11:54 AM

[Marc Michel:]

I couldn't agree more. While the loss of wealth is painful to experience and i am among the many who have lost significant wealth this year, I am hopeful that we as a country come out of this with a much healthier set of values than our worship of the almight dollar. I too hope that more of our college students study something else beyond business and accounting and that they pursue careers that actually add value to our country. The Wall Street incentive system has gotten so lucrative that it has warped our economy and drained our brightest. I hope balance is restored. I also hope that we learn to value our relationships and experiences more than we value material things. It will be very interesting to see what emerges, but I am hopeful.

2008 Dec 29 12:00 PM

[Carl Spackler:]

So if I am Thierry Magon de La Villehuchet, is it good luck or bad luck that he "off'ed himself? There is no good side to some bad things like death. Just like death, there can be no silver lining in some economic occurences too. I agree that this economic storm will clear some dead branches in the trees, but it will also kill some trees too. Those destroyed by it will be hard pressed to find a silver lining.

2008 Dec 29 12:10 PM

[prudentinve...:]

Excellent article!

2008 Dec 29 12:22 PM

[jrs87sch:]

This is very true; opportunity is among us.

It is strange how fast investors forget about the last big screw-up. It hasn't even been 20 years since the Savings and Loans Crisis, and once again these banking entities are in trouble.

2008 Dec 29 12:29 PM

[gooter:]

Capitalism, by itself, bears out the true nature of a man. It can corrupt, motivate, teach, reward, and punish. When you learn to practice it beyond charts, cash flow, fundamentals etc., from a people perspective, you can enrich your life and the lives of others. Working for enrichment vs. money leads to a more fulfilling life.

2008 Dec 29 01:19 PM

[Nidhi Kadalbal:]

Paradigm shift is what you are suggesting that Americans should accept, from excessive corporate greed to a more sustained growth. Agree with that, but adapting to that change is the hardest.

"you cannot solve the problem unless you change your mindset" - Einstein. Hope we can ease into that change .. :)

2008 Dec 29 03:55 PM

[Illusional ...:]

Could not agree more. Change is hard sometimes, especially the first step. The problem so far is that the government has not shown any signs of making that change, and while the government is only part of the people, they need to step up and be a good example of what they are elected for. Regulation or deregulation, it is the people on board that dictates success or failure rather than the method used.

2008 Dec 29 07:13 PM

[DaveW:]

Jim,
Nice, thinking outside of the box article! Well done.

In a way, you are talking about something analogous to the 'Black Swan' - events which are unforseen and unexpected that can change the course of future events for better or for worse. Hard to price these in!

2008 Dec 29 07:39 PM

[Nikola:]

Since we are getting all philosophical here, let me just say:

Black Swans are in the eyes of the beholder. There are no swans....

2008 Dec 29 08:05 PM

[investor88:]

Good to take events and market cycles in our stride, which is easier said than done especially when it hits our purse deeply or worse. Agree with Jim views.

2008 Dec 29 10:17 PM

[Steven Hansen:]

"In some ways it seems to me that our society has become like my addictive friend. Social values have been distorted by great wealth that has accentuated a variety of societal addictions. Though not unique to this time in history, money has increasingly influenced politicians who have granted legal opportunities to their supporters to make more money in ways that have turned out to be toxic to the system and have now led to its partial collapse."

well said. this was an excellent article.

2008 Dec 30 03:12 AM

[ferguson:]

Jim Kingsdale wrote,

For another, it is hard to be philosophic in the face of a loss, especially a great loss.

2008 Dec 30 11:00 AM

[ferguson:]

Jim Kingsdale wrote

For another, it is hard to be philosophic in the face of a loss, especially a great loss.

The mention of philosophy in this context suggests that it might be time to cite the Greek philosopher, Epictetus, i.e.,

"It's not what happens to you, but how you react, that matters."

2008 Dec 30 11:05 AM