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Phil's Rambling Rants
February 26th, 2009
03:19 pm


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The financial mess

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Date:February 27th, 2009 03:14 pm (UTC)
I think you are right about the problem being short-term thinking.

It isn't quite as simple as executives deciding that they themselves needed to profit, though.

It has to do with the change that occurred as stock trading became more open to the individual investor.

What changed was that equity investing used to be a long term proposition - dividends were important but the stability of the stock and the long term potential was the real purpose for investing in it.

Once individuals (whom I call "gamblers") had access to immediate updates and the ability to trade for themselves rather than go through a broker (and spend significant money) for transactions, the focus changed.

"Day trading" led to the need for a stock to actually grow in value in the short term, rather than show a profit or provide dividends over the long term.

Since most of the major stockholders are large entities that can't move quickly (large blocks of buying or selling directly affect the stock price), they had to adapt to these changed expectations or find themselves unable to provide an appropriate or proper return to their underlying pension funds. Many of them added high-growth options because that is what their investors wanted.

Fast forward a couple of decades and this is now the way things are expected to be. Executives are compensated not for the value of the stock but the growth of the stock, so that is how decisions are made.

It is a vicious cycle that didn't come about suddenly because a group of greedy executives decided to make it so. It happened because investors fooled themselves that growth was equal to value, both in real estate and in equities, and this proved to be a false assumption.

After all, IF the real estate market doesn't collapse, THEN you could get a new fixed-rate mortgage by the end of the term of your ARM. Most people I know who got into ARMs believed this is what would happen - after all, real estate had not gone down in the short memories of current mortgage shoppers.

In other words, very few people were trying to screw anyone - especially since most of them were investing in real estate themselves. Rather, it was short-sightedness that is all too human that led folks to believe that what had not happened in a long time simply could not happen.

There have been people predicting a real estate collapse annually for about 20 years. That it finally happened doesn't invalidate most of the years real estate increased in value. Neither did the fact it took so long to actually occur mean it was never going to occur.

The answer, as we have been told over and over and over, is to invest for the long term, look at the value and be reasonable about the risks no matter what "everyone" is saying.

Edited at 2009-02-27 03:16 pm (UTC)
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