Like many of you I have been watching the financial news with great interest. But I have also found that my knowledge of Cognitive Therapy has been immensely helpful. It may be that our anxieties right now are being fed by selective biases in our thinking---biases shared by millions of us who are watching the news. How can we be more rational? How can we cure our financial panic attack?
Here are some cognitive distortions that I believe are driving financial anxieties:
1. Catastrophic Thinking
It's almost as if five minutes can't go by watching the news without hearing catastrophic statements- such as "catastrophe", "meltdown", etc. But is there a catastrophe and will there be one?
Some of these issues have been covered in my recent blogs on Psychologytoday.com.
Let me describe a few in particular.
What is a financial catastrophe? As of now the market (DJIA) has fallen about 20 % from its high in the past year. This is in contrast to the market dropping 89 % in the 1930s from its high and losing about 14.5 % per year for about six years during the 1930s until it mildly recovered (by about 2 % in 1941--primarily because of defense buildups). The unemployment rate today is about 6.3 % as opposed to 25 % during the 1930s. Furthermore, until the depression had taken quite a toll on people, there was no FDIC, no medicare or medicaid, no unemployment insurance, no social security, no net to catch people in. In addition, the per capita income was a small fraction of what it is today and very few people actually owned their own homes. People were falling from a low level of real wealth to begin with. So many people were destitute. This is very different from the 21 st century USA.
Some people believe it's a catastrophe to lose 20% in an overvalued stock portfolio, not recognizing that they still have 80% of what they had before.
Now some will claim, "we are heading toward a catastrophe". I have two thoughts about these predictions. One is that it is possibly true ---only if nothing is ever done.
Second, it is not true, because it is inconceivable that even Congress can't get it's act together. I find "nothing happens" in Congress to approach 0 as an asymptote. Close to impossible. Is there anyone willing to make that bet with me? Once liquidity is opened up in the market by the laws that are established and new actions are taken (mark to market, increased insurance, FDIC extensions), then people will be able to borrow and the economy will continue to function more effectively. This is a difficult time, but solvable problem.
2. Fortune Telling
Perhaps I am doing fortune telling, but I wonder what the evidence and rationale is that some people have for saying that we are headed toward a catastrophe. Especially if monetary policy and liquidity is restored, it is not likely that even a 700 billion dollar "investment" will lead to a catastrophe. In addition, even though many people predict a recession (as I do), what is remarkable about the American economy is how few recessions we have had in the last 25 years. And people survive recessions. A recession is two consecutive quarters of negative growth. That might mean that a business netting one million dollars might net $950,000. This is hardly hunger in the streets.
3. Discounting the Positive
This is rampant in how individuals and newspeople respond to the crisis we are facing (and which I feel confident will be resolved). One factor that is being discounted is that even mortgage backed securities are eventually worth something. These are being labeled by some pundits as "junk" and "garbage"---but they are backed by HOUSES! Imagine this. Imagine that you lose your house to a bank due to foreclosure. How much will the bank be able to sell the house for--- eventually? Is it greater than zero? It may not be 100 % but it is hardly garbage or junk. It may be marked down by 25%, but it still is worth 75%. So whoever owns the securities that are backed by the house can recover significant amounts. Once these houses clear the market, the market returns to fair values. (This also means that your house and mine loses value for now. But if you are not selling your house this year, take a nap)
Another way in which pundits are discounting the positive is that there is about 11.5 trillion dollars in investment accounts in the USA---not counting the value of real estate (where the average American has 45 % equity in his or her house) for a total net worth of 58 trillion dollars. This is significant. We are a very, very rich country. This should not be discounted in this time of financial panic attacks.
4. Labeling
Along with mislabeling mortgage backed securities as "junk", there is continual labeling by politicians on both sides of the other side. How this helps solve the problem is beyond me. It's like entering negotiations by screaming at the other side. It seldom helps. In contrast, viewing opponents in the process of negotiation as having different interests, tradeoffs, theories and voter constituents is far more helpful. This helps the process of giving in to get more for both.
5. Selective Filter
There is currently excessive focus on the investment banks that were highly leveraged (30 to 1) and the poor balance sheets of those trafficking in mortgage backed securities. But there is an enormous national and international economy that still can create and consume products--and, once liquidity is returned, will be able to move forward. Perhaps they will move forward with more caution, but this is not a nuclear holocaust. It is perhaps for this reason that larger banks like Citigroup, Barclays, and Bank of America--along with wise investors like Warren Buffet--- view this as a BUYING OPPORTUNITY.
6. Shortened Time Perspective
It's almost as if the last two weeks have become the future of mankind. What congress does in the next day becomes a predictor of the future of America. Someone who has a difficult time getting a home equity loan may believe that this will mean that they will never be able to get financing (even though they have excellent credit and good equity). There is the sense of urgency that if I don't know right now, then it is awful. In contrast, a more rational perspective is that if you don't know right now, you will probably know later. Banks don't make money unless they lend it. And they will lend it to people with good credit. If you don't get the loan for a few weeks, exactly what will happen? You will wait.
As many of you know, there is a field of economics called "behavioral finance". It is cognitive therapy applied to investors. These are the times that we can really help people (including ourselves) get a handle on reality. Examine the way that you (and pundits) are looking at the recent news. It's like a financial panic attack!
