EFFECTIVE PERSPECTIVE | SUMMER 2010 EFFECTGreater Fools
by Matt FugateWhen I consider the rise and fall of the housing market over the last decade, it's hard not to be judgmental. What in the world made people think this kind of meteoric rise in prices was in any way sustainable? By the time we closed on our first house, we were informed it had already realized a thousand dollars in equity. I still don’t understand how that happened. Was there a spontaneous generation of new kitchen appliances in the time between the offer and the closing?
Escalating home values isn’t a huge problem if it involves wild profits realized through sales to real people. That makes sense to me. Trouble started when we began refinancing our homes at or near the new market value, basically selling our own homes to ourselves. This brings to mind the old legal adage that says a person who chooses to represent himself in court has a fool for a client. Nevertheless, many were counting on there being a bigger fool out there.
In fact, in economics the greater fool theory states that humans make risky or unwise investments on the assumption there is a greater fool than themselves who will pay even more than they did. This strategy works just fine until you run short of fools. In the case of refinancing your home, when you sell your house to yourself at the price you think a greater fool would pay, doesn’t that mean you’ve made yourself that greater fool?
This is a wild, irresponsible generalization, of course, simultaneously naïve and mean-spirited. I understand why people did what they did during the housing boom. Middle-class folks were really ready for a win. Regardless of actual market history, I can’t think of very many times in my working life when we haven’t been heading into, in the depths of, or just getting out of some sort of recession. No wonder we jumped at a chance to get in on what looked like a sure thing.
The last big bust I remember was the tech bubble at the turn of the century. There were a lot of problems with that boom we should have seen coming, but everybody was having such a good time. Information technology departments were bursting at the seams, crying out for more help. People were buying up domain names, hoping to re-sell (dare I say, “flip”?) them to somebody else for thousands, nay, millions of dollars. Venture capitalists were pumping money into anything that ended in “dot com.” It was great until it wasn’t. Everyone realized that “greatbreadsoftheworld.com” wasn't significantly better than “breadsoftheworld.com.” Investors discovered just how difficult it was to make money by providing free content. And funny how demand for technology resources seemed to drop suddenly around the year 2000, just when you’d suppose we might need them. Remember Y2K? It was in all the papers. Remember papers?
So, what’s the next bubble going to be? Let’s face it, there will be another. There will be another commodity or financial opportunity that will be too good to be true, and too good to pass up. Maybe we’ll get lucky and it will involve health care. I hear those costs have been going up at a crazy rate. Eventually, the health care market will have to “reset” itself, right? We’ll be talking about the great deals you can get on health care right now, and better oversight and consumer protections and more responsible choices, and ethics and accountability and all the good things that come as the result of feeling remorseful and foolish about being taken.
However, I remain optimistic. The best thing about mistakes is that they’re a great way to discover what not to do. I figure that if these lessons are so clear I can see them, then surely people who have far more business acumen than myself can too. We will learn from our mistakes as a people. And yes, being the innovators we are, we’ll make new mistakes. And we will learn from them as well.
We’d be fools not to.