In his book Thinking, Fast and Slow,
Daniel Kahneman offers, "Subjective confidence in a judgment is not a reasoned evaluation of the probability that this judgment is correct. Confidence is a feeling, which reflects the coherence of the information and the cognitive ease of processing it. It is wise to take admissions of uncertainty seriously, but declarations of high confidence mainly tell you that an individual has constructed a coherent story in his mind, not necessarily that the story is true."
As an observer of social mood and how changes in confidence alter our preferences, decisions, and actions, I come back to this quote from Kahneman frequently. Whether true or not, the stories in our head matter. They are the initial transmission mechanism from our specific level of confidence to our actions. What is a coherent and easily understood story becomes an actionable truth.
The past seventy-two hours have offered a wonderful opportunity to see how both as individually and as groups we quickly develop our own stories when events occur. Over the weekend, following news reports from Cyprus that depositors there would be taxed as part of a bailout, pundits, investors, and policymakers all took to Twitter and began offering their stories: "Cyprus will lead to contagion," "Cyprus crossed the Rubicon," "Cyprus sets a terrible precedent." For those reading all of the feeds, the message was both coherent and clear: Cyprus equals bad. It was no surprise then that the markets sold off sharply on Sunday night as worried investors’ stories turned into action. Given our natural aversion to uncertainty, when news is perceived to be bad, the crowd moves quickly.
Beginning yesterday, though, other stories began to surface suggesting that maybe the situation in Cyprus was not as dire as we first thought. One of those stories was offered by Andrew Ross Sorkin, who in his Dealbook column last night noted:
Cyprus is unique. Besides being tiny, its banking system looks different from those in most other countries. Much of the big money deposited in its banks is from foreign investors, including Russians who have long been suspected of money laundering. Those investors had fair warning that Cypriot banks were troubled. The issue has been simmering for six months. But those investors left their money in the bank, in part because they were gambling that the banks would be bailed out at no cost to them. If the current plan is approved, depositors will have lost that bet.
Worse, the strategy employed in the bailout of Greece — in which bondholders of its sovereign debt were paid less than face value — will not work in Cyprus. Cyprus’s banks own much of the country’s debt, so any effort to reduce that debt by forcing debt holders to accept less would only make the banks more troubled.
Given the brutal history between Russia and so much of Europe — and speculation that so much of the money is ill gotten — it is clear why it would be so politically unpalatable to countries in the eurozone, Germany in particular, to bail out Russian depositors. And even if the move were to create a run on the banks in Cyprus, the contagion would be limited.
There is very little chance that politicians would ever choose to use the model they developed in Cyprus in a country like Italy or Spain, where a run on the banks would have such profound implications. By the way, if you’re wondering why investors left so much money in troubled Cypriot banks, here’s a trivia question: Would you have been better off leaving your money in a bank in the United States or in Cyprus over the last five years?
The answer: You would have been better off in Cyprus, even after the bailout, when your money was “confiscated.” If you had 100,000 euros in a Cypriot bank account over the last five years, where the interest rate has averaged about 5%, you would have about 127,600 euros today. Even after the bailout, which would require you to give up 10% of your deposit — 12,760 euros — you would be left with 114,840 euros.
For investors then, the choice is which story to now believe: the "Cyprus is the beginning of the end of the world" story, or the "Cyprus is not worth worrying about" one offer by Mr. Ross Sorkin. Will it be the lady or the tiger?
While this choice may seem obvious, I would note two aspects of it. First, it took almost forty-eight hours for a thoughtful and balanced mainstream discussion on Cyprus to surface. As Kahneman points out in his book, our brains operate at two speeds, fast and slow. When it comes to issues related to our safety and security, we shoot first and ask questions later. When our story is bad, bad equals immediate action, or more accurately, immediate re
Even more, I would note that because of how our brains operate during periods of weak confidence, thoughtful and balanced views have a very hard time competing with easily understood fear-laced messages. Cyprus equals unique may be true, but it will take far more effort to convince low confidence investors of that than the message Cyprus equals bad. For those lacking confidence, anything that draws into question one of Mr. Ross Sorkin’s "Cyprus is unique" arguments could quickly bring doubt to his entire story. Remember "subprime is contained"?
Time will tell where all of these stories go, but I would pay very close attention to market levels from here. As a socionomist, I believe that markets measure mood like a thermometer measures temperature. Falling markets will be indicative of falling confidence, and with lower confidence levels, investors are much more likely to act first and read thoughtful and balanced articles later.
Over the past seventy-two hours, we saw a snapshot of this phenomenon in real time. I suspect that the next seventy-two days will offer even more.
Peter Atwater's groundbreaking book "Moods and Markets" is now available on Amazon and Barnes & Noble.
“Peter Atwater brilliantly provides a framework for understanding both the socioeconomic hubris that led to the great credit bubble of the past decade and the dark social-psychological hangover that has resulted from its collapse. In so doing, he offers an invaluable guide to what promises to be a very difficult and turbulent period ahead as we experience what he calls the ‘me, here, and now’ behavioral tendencies of the post-crash world.” —Sherle R. Schwenninger, Director, Economic Growth Program, New America Foundation
Position in SH, GLD, and JPM.
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