Thursday, July 7, 2016

Everyone Else is Doing It

A thought that is semi-deep, and a bit dark:

Normally, in finance, when “everybody is doing it,” it’s a bad idea.  For example, if everyone is piling into internet stocks, it’s a bad idea to buy them (because they will be overpriced).  If everyone is selling, it’s a bad idea to sell (the shares will likely be underpriced).

But there’s a big exception to the wisdom of contrarianism, in the case of credit risk. If everyone is taking a certain credit risk, you might want to go ahead and take it. Why? Because if it goes bad, the government will bail you out in order to prevent societal collapse.

If only a few people will be hurt by the collapse of money market funds, they are not safe. If everyone will be hurt, then they are safe not in the first instance, but in a second order way: because of the implied federal guarantee that their widespread use has brought into being. So because something is unsound enough (and big enough) to be a threat to the system, it is safe!

This is the sort of insight that almost physically repulses me. I do not recommend factoring it into an investment approach. Yet the world does work this way, sadly. At least in some areas, at some times.