GUEST AUTHOR BLOG by Michael Farr, CNBC Contributor and author of "The Arrogance Cycle."
This week I’d like to offer a shameless plug for my second book, which just out. In "The Arrogance Cycle,"I provide what every investor needs to know to protect his or her assets from the next big financial bubble.
What’s the arrogance cycle?
We’ve just lived through it. As market bubbles build, our confidence level rises (dis)proportionately. Everyone wants in on the action. We want to believe Wall Street, and once we do, the inevitable happens. Like Dr. Frankenstein breathing life into an inanimate flesh, investment professionals sought ever more novel ways to create wealth. The only problem was that it was all artificial.
In the years leading up to the financial crisis, the US enjoyed the benefits of a massive credit bubble. And these benefits were many: soaring home and stock prices, easy credit, rampant consumerism, instant gratification…you know, the good life. The credit bubble was a side effect of the efforts to avoid an economic contraction, which, in turn, was caused by the dot-com stock market bust. In an effort to cushion the blow of the stock market crash, Greenspan dramatically reduced interest rates and, in the process, prevented a normal economic contraction from clearing. He also unleashed a tidal wave of spending, speculating, and arrogance. Houses, boats, cars, flat-screen TV’s, huge investment returns – all this could be yours, and for no money down.
Arrogance was upon us.
"Quivering insecurity and fear, or the bulletproof, superhuman sense of infallible certainty – both can overwhelm judgment and reason."
At the same time this was happening, US banks were able to take advantage of low interest rates, soaring home prices, and the ongoing wave of deregulation. Underwriting standards were thrown out the window, and many banks leveraged their balance sheets as much as 40:1 in an effort to goose profits, bonuses and stock prices. The combination of easy mortgages, low rates, and a loose regulatory environment was the perfect prescription for systemic financial disaster. In "The Arrogance Cycle," I show that every bubble in history has been fueled by ample credit, imprudent leverage and a feeling you can’t lose (arrogance).
I focus on individual factors – such as rampant consumerism, a sense of entitlement, narcissism, and resentment toward the upper class – that combined to create the perfect economic storm. By consulting with leading psychologists and relaying first-hand experience with investment clients, I provide a case study of the arrogant investor. In reviewing failed enterprises like Enron, AIG, Lehman Brothers, and Bear Stearns, as well as the illegal activities of Bernie Madoff and others through the lens of arrogance, the book sheds light on those disasters and offers a means to detect the insidious presence of arrogance so that in the future we can contain the damage before it spreads.
"The Arrogance Cycle" is always at hand. We are always at some point on our arrogance continuum. Quivering insecurity and fear, or the bulletproof, superhuman sense of infallible certainty – both can overwhelm judgment and reason. Healthy, deliberate decisions naturally drive better results.
Many thanks to so many of you who have helped with our quarterly Arrogance Survey. We will have another one at the end of this quarter, and the results will be announced on CNBC.
Michael K. Farr is President and majority owner of investment management firm Farr, Miller & Washington, LLC in Washington, D.C. Mr. Farr is a Contributor for CNBC television, and he is quoted regularly in the Wall Street Journal, Businessweek, USA Today, and many other publications. He has been in the investment business for over twenty years and now author of "The Arrogance Cycle."