The first book I ever read on investing was a tome entitled “The Intelligent Investor” written by Professor Benjamin Graham. This treatise outlines Graham’s philosophy of “Value Investing“, of which Warren Buffett is the most well-known practitioner. As a young man I struggled a lot with understanding Graham’s idea of investing based on “intrinsic value“, because I couldn’t quite conceptualize what it was in my mind. Was it the value of retained earnings minus debt, the book value of the company, the projected earnings per share in perpetuity discounted by net present value? As I continued to feed my mind a steady diet of finance information, this did not alleviate the confusion, rather it compounded it. However, I still found immense value in Graham’s magnum opus. The one quote that has stuck with me for a long time since reading the book is:
“In the short run, the market is a voting machine but in the long run, it is a weighing machine.”
This is a valuable principle, because we often run into situations where what is popular is what is easy, makes us feel good in the moment and hurts us long term, while what is hard, makes us uncomfortable and brings us growth long-term is unpopular. This is illustrated by a conversation from the Andrew Ross Sorkin movie “Too Big Too Fail” in a conversation between Michele Davis (Cynthia Nixon), Neel Kashkari (Ayad Akhtar) and Hank Paulson (William Hurt)
Neel Kashkari: Poor bastard who bought his dream house? The teaser rate on his mortgage runs out, his payments go up, he defaults.
Henry Paulson: Mortgage-backed securities tank. AIG has to pay off the swaps. All of them. All over the world. At the same time.
Neel Kashkari: AIG can’t pay. AIG goes under. Every bank they insure books massive losses on the same day. And then they all go under. It all comes down.
Michele Davis: [horrified] The *whole* financial system? And what do I say when they ask me why it wasn’t regulated?
Henry Paulson: No one wanted to. We were making too much money.
In the short term, everyone was making too much money, and despite quite a few people being aware that it was going to become a major threat to the financial system, nobody wanted to be the canary in coalmine. They were faced with a choice, where they could side with the voting machine, face no negative consequences and in fact be positively rewarded, which was a much more palatable choice than to side with the weighing machine, face a lot of negative backlash from their colleagues, and potential lose millions. This is not uncommon, as whistle-blowers, “doomsayers”, and the messengers tend to be disliked because they ruin the mood.
A good analogy would be that a high school kid’s parents are out of town, and he decides to have a party. However, as the evening progresses, the party starts to get out of hand, people show up with kegs, before you know it the living room has turned into a mosh pit and people are playing ultimate frisbee with $200 china. If the kid decides to call the cops, or his parents, he is likely to be the person who faces negative consequences, despite the fact that he was not in the moral wrong. Continue reading