Psychological Aspects of the Financial Crisis: In Warren Buffett We Trust?

The news regarding the ongoing problems in our financial systems, analysis and second-guessing of those news, and prescriptions for or against proposed ways to right the ship (AKA the Bailout/Rescue package) have reached a fevered pitch.

Rather than add to this imbroglio, I’ve decided to "take a time out" (though I’ll admit I have been an avid participant in debates on various related blogs over the last few weeks to keep on top of this), and focus solely on the psychological aspects of all this. Things that should largely be beyond the realm of political and economical opinion (I am not an economics expert, nor do I believe that infusing politics into this is helpful at this point).

To borrow a well-worn metaphor, if you cannot see the forest for the trees, maybe you can at least create some clarity for yourself as to what types of trees you are dealing with:

1) The fractional reserve banking system that most of the world has used for many decades is fundamentally based on confidence and trust between the parties involved. That is what we mean when we use phrases such as "the full faith and credit of the U.S. goverment".

Since the Bear Stearns "forced sale" in March, trust has been evaporating at ever faster rates. So much so that at this point, nobody trusts their counter-parties anymore, and hoards cash positions wherever they can.

2) In the absence of confidence and trust, there is only fear and uncertainty. Fear tends to attract more fear, such that there is a tendency to become a self-fulfilling prophesy. Hence the words we use and think do matter.

You see, terms such as "melt-down, toxic assets, fire sale, depression, collapse," asf. all have a tendency to incite further fear, because they draw on metaphors of real and direct physical harm rather than the hardly comprehensible yet comparatively boring transfer of blips of numbers on computer screens and piles of paper between various complex corporate entities (themselves largely purely abstract and based on further piles of paper).

After initially due to form going overboard with such language, the mainstream media has now largely pulled back from its usage, after apparently scaring ITSELF with the precipitous stock market "dives" last week.

Lesson: I would advise you to do the same. Stop using misleading and inflammatory language for the sake of your own sanity during a time of challenge.

3) Back to the issue of trust, since it is a purely psychological state, all elements of long term forming of associations in our mental real estate – in other words "branding" – come into play. The best example of this I could find is the fact that last week, the brand of "Warren Buffett" – shrewd yet kindly investor and economic wise man, the "Oracle of Omaha" – commanded a tidy premium when lending money to Goldman Sachs and General Electric well beyond that which the U.S. government would charge.

In other words, Warren Buffett has built up a brand that made him more trustworthy in the minds of many than even the "full faith and credit" of the U.S. government. Now while this is of course illogical on its face, it is nevertheless true at a deeper psychological level:

The inherent endorsement those two companies got from having Buffett invest a total of about $8 Billion was worth the premium to them, given his well-known penchant for strict value investing and abhorrence of leverage (investing with borrowed money). It was somewhat like say Michael Jordan endorsing Wheaties.

Lesson: Continue to build your own brand as a haven of sober analysis, rational balance, and calm, in ANY interaction with customers, clients, and even just your friends and family. You simply can’t go wrong.

4) Being reminded of prior warnings by Buffett against an impending housing bubble, let’s quickly look as to how this sort of thing can develop (and repeatedly so). Why would otherwise supposedly largely rational people act in ways that would turn out to be so problematic, even ruinous longer-term?

The answer is twofold: First, there is denial.

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