What’s on your mind these days? Many of you might have thoughts along the following lines: “I am worried about the financial and economic crisis. About my money. About my work. About my wealth.” Today, let’s focus on the current economic crisis and the lessons we can learn from it to better our business thinking.
Your money is not your wealth
First of all, here is a new perspective for all those of you who worry about your money. “Wealth is not how much money you have. Wealth is what you’re left with when you lose all your money,” is an interesting definition of wealth by Roger Hamilton. What are you left with if all your money goes? Your network. Your knowledge and skills. And your character.
Lesson: Don’t worry about your money — instead focus on building and expanding a quality business network and your knowledge and skills base. Also stop caring about your reputation — instead refocus on refining your character. Notice that you have zero influence on your reputation and what people think of you, and that you have 100% influence on your character and your mindset.
Bad thinking and herd thinking
Every financial management course teaches students early on about the positive correlation between risk and return. The higher the risk of an investment, the higher the return, and vice versa. Institutional and private investors who uncritically acquired high-yielding sub-prime structured instruments that were branded as low-risk investments disregarded this fundamental financial principle. At the end of the day, all the repackaging and reselling of the sub-prime mortgage risks cannot eliminate the ultimate credit default risk that is based on the credit standing of the end-borrower and not the issuing bank. But as all other institutional and private investors bought the high-yielding sub-prime paper, why should we not also blindly follow the herd?
Lesson: Simple reality checks would have helped many investors to become more critical by asking questions like “Why does this instrument offer such a high yield although it is sold as a low-risk investment? How do we really know that the risks are low? How sure are you from 0–100% that this is really a low-risk investment?”
Why were investors so uncritical? Overconfidence
One of the most common thinking traps that people fall into is the so-called overconfidence bias. In a nutshell, overconfidence describes the common state when people believe they know more about a situation than reality sustains. Overconfident people are unaware of their knowledge gaps and perceptual blind spots. These make up our dangerous unconscious un-knowledge: we don’t know what we don’t know. Most of the financial institutions did not really know what risks they were taking into their books. The same holds true for high-yield-craving private investors and the risks in their portfolio.
Lesson: Always pay attention to what you do not yet know about a business situation. After all, Aldous Huxley is right: “Facts do not cease to exist just because they are ignored.”
Groupthink and vuja dé
To make bad things worse, another dangerous thinking trap amplified the effects of risk ignorance: Groupthink. By late 2006, a few economists and policy-makers warned that the US real estate market would get into deep trouble as soon as the US interest rates started to rise again. These critics were often ridiculed, silenced and forced to adhere to the prevailing mindset of the dominant uncritical majority. Although clear warning signs of an imminent US real-estate crisis were voiced for more than two years, most businesspeople and investors chose to ignore them or failed to take notice (vuja dé).
Lesson: To prevent groupthink, encourage your employees to do their own thinking and be critical.
Conclusion: What caused the financial crisis? First, bad thinking and herd thinking coupled with overconfidence and ignorance. Second, short-term focus on exciting growth and profit figures and neglect of sustainable long-term growth and profitability. Third, ego and greed by focusing mainly on one’s own short-term personal gains and remunerations.
The credo of many managers and investors can be nailed down in one sentence: “I want to have more now!” Such egotistical thinking is value-exploitation at its worst. It is the antithesis of value creation, the credo of a responsible creative thinker. As of November 2008, 6.8 billion people live on Earth; this number is estimated to increase to 9 billion by 2050. Imagine what this means for the sustainability of life on this planet and to future generations if all fellow humans followed the maxim “I want to have more now!” Clearly, Albert Einstein was right: “We cannot solve our problems with the same thinking we used when we created them.” It’s time for a new creative renaissance.
In two weeks’ time, we will discuss ways to turn the economic crisis into a business opportunity.
© Dr. Detlef Reis 2008. This article was published in parallel in the Bangkok Post under the same title on 20 November 2008.