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The perils of unmitigated positive thinking

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Private citizen, Alan Greenspan, could afford to be blunt. “Our choices right now,” he said in early August 2010, “are not between good and better; they’re between bad and worse. The problem we now face is the most extraordinary financial crisis that I have ever seen or read about.”

These comments echo a growing sentiment that Americans are up against something far different from the average downturn. Thus far, according to the Pew Economic Policy Group, the financial crisis has cost the American people $3.4 trillion in lost real estate wealth; $7.4 trillion in lost stock wealth; and 5.5 million jobs. Pimco’s Bill Gross calls this change in the national psyche the “new normal” -- an economic environment marked by reduced expectations, slow growth. falling incomes and low returns on investment.

The New York Times’ Nelson Schwartz recently lamented: “The new normal challenges the optimism that’s been at the root of American success for decades, if not centuries.” In turn the new normal has spawned a quantum change in the way Americans view the economy, their future prospects, and how they should employ their capital. The real question facing Americans -- public policy makers and citizens/investors alike -- is not what constitutes a positive attitude, but what constitutes a healthy attitude, one capable of guiding investors through the next, and perhaps even more dangerous, chapter of the financial crisis.

When the financial crisis began to take its toll on the United Kingdom in 2008, Queen Elizabeth at a meeting with financial analysts asked the logical question: “Why didn’t anyone see this coming?” Though directed at the London financial community, it could have just as easily been put to the mainstream media, academia, the politicians or the regulatory apparatus of the government. The answer she received would soon become standard fare: “No one saw this coming.” The implication, of course, was that if no one saw it coming, then no one reasonably could be held accountable.

For countless private investors on both sides of the Atlantic Ocean, Queen Elizabeth’s question prompted a more personalized assessment: “Why,” they asked their financial advisors, “wasn’t I advised that this might be coming?” For those completely honest with themselves, the question reduced to “Why didn’t I see this coming?” After all is said and done, each of us is responsible for the stewardship of our own portfolios, and to blame anyone else is pretty much an exercise in both futility and passing the buck.

At the height of the stock bull market in the late 1990s and early 2000s, too many investors forgot that a healthy skepticism was part and parcel of a successful approach to the market. Unfortunately, that loss of focus contributed to millions believing the utopian mantra that markets and the economy no longer cycled (the Goldilocks economy), that we were on a one-way street to perpetual prosperity (the end of history argument), and that the stock market would never falter again. Such unmitigated positive thinking cost investors trillions during the subsequent stock market meltdown and credit crisis.

Even a cursory study and understanding of the financial markets and their history might have prevented, or at least diluted, those losses. After all, the history of financial cycles in reality is just as rich in mania, panics, bubbles and crashes as it is in bull market triumphs, although only a handful on Wall Street would have subscribed to such anecdotal evidence during the first decade of the 21st century. In the end, the most damaging result of unmitigated positive thinking is that it set up its practitioners for failure and allowed others to exploit it to their own advantage.

In the wake of the financial meltdown in 2008, Alain de Boton dispensed the following advice in a Financial Times opinion piece:

Seneca

It is time to recognise how odd and counter-productive is the optimism on which we have grown up. For the last 200 years, despite occasional shocks, the western world has been dominated by a belief in progress, based on its extraordinary scientific and entrepreneurial achievements. On a broader perspective, this optimism is a grave anomaly. Humans have spent most of recorded history drawing a curious comfort from expecting the worst. In the west, lessons in pessimism have derived from two sources: Roman Stoic philosophy and Christianity. It may be time to revisit some of these teachings, not to add to our misery but precisely so as to alleviate our sorrow.

To focus on the first of these sources, the philosopher Seneca should be the author of the hour. Living in a time of financial and political upheaval (Nero was on the Imperial throne), Seneca interpreted philosophy as a discipline to keep us calm against a backdrop of continuous danger. His consolation was of the stiffest, darkest sort:

“You say: ‘I did not think it would happen.’ Do you think there is anything that will not happen, when you know that it is possible to happen, when you see that it has already happened?”

Seneca tried to calm the sense of injustice in his readers by reminding them -- in AD 62 -- that natural and man-made disasters will always be a feature of our lives, however sophisticated and safe we think we have become.”

These are not the thoughts of a pessimist but of a realist. As the first draft of this essay was written, a volcano had erupted in Iceland shutting down air traffic in Europe, an oil well accident in the Gulf Mexico threatened the Louisiana coastline and an economic crisis in Greece had shaken Europe’s economy to its foundations. Seneca was correct. In the end, there is as much justification in preparing for the worst as there is for the best.

Fed chairman, Ben Bernanke, made a similar point to Seneca’s in a speech before the Council on Foreign Relations in March, 2009 in the wake of Wall Street’s near collapse in late 2008:


Financial crises will continue to occur, as they have around the world for literally hundreds of years. Even with the sorts of actions I have outlined here today, it is unrealistic to hope that financial crises can be entirely eliminated, especially while maintaining a dynamic and innovative financial system.

By this, I do not mean to suggest that one should live life with a cloud constantly hanging over his or her head. At the same time, an unwarranted optimism, as both Seneca and de Boton suggest, can lead to unfortunate results. A well-grounded, realistic attitude covers the middle ground -- a synthesis between optimism and pessimism -- and comfortably suits the times in which we live.

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