Everything Is a Meme
In the years preceding the financial crisis of 2008, certain key phrases appeared over and again in the public discourse on investing.
One that stands out in my mind is that home prices in the United States haven’t declined nationally since the Great Depression. The phrase appeared in television commentary by pundits, statements by Federal Reserve officials, in analyst reports, and in private conversations with Wall Street analysts.
I discovered the phrase yet again when studying securities ranging from housing stocks like KB Home (KBH), to large international banks like Citigroup (C), to government-sponsored entities like Fannie Mae, to mortgage companies like Countrywide Financial, to insurer and major credit default swap underwriter AIG.
This wasn’t just any old phrase. It was an important phrase. It was important because the phrase itself suggested that investors in mortgage-backed securities (MBS) could recover losses since the value of the mortgage collateral (i.e., home prices) would still exceed the value of the debt against that collateral. It also meant that a housing downturn would be a recession, not a bubble-bursting depression. Which in turn meant that bank balance sheets would be fine, that homebuilders would be cheap, contrarian investments, and that AIG’s credit default swap portfolio obligations would ultimately be covered. It also implied that the Great Depression was a sort of relic of history that wouldn’t or couldn’t happen again. So, yes, this little phrase was powerful and packed with fallacies.
Such phrases are memes — ideas that get passed around from person to person as kernels of truth — and memes are passed around the investment business like the common cold. Don’t get me wrong — I’m not suggesting that memes are always false. Naturally, they can be either true or false. In this case, the statement itself was, of course, true. In the preceding 70 years or so, home prices in the United States, in fact, hadn’t declined nationally. However, the statement’s implication that home prices wouldn’t fall in the future was pure fallacy. And this meme gave everyone the comfort to accept that premise.
But why were people so willing to believe that home prices wouldn’t fall? Why are any memes believed? Why do we attach ourselves to some memes and not others?
On the one hand, the analytical task of deciphering the truth is difficult and uncertain. But isn’t that what analysts and fund managers are paid for? So, why do even professional investors check out when they should be checking in? According to Nobel Laureate Daniel Kahneman, we humans have a bias toward finding the easy way to solve a problem. We put forth minimal mental effort. Or, we choose to accept ideas that are comforting to our beliefs or self-image. And of course, this has profound implications for investing. What could be more comforting to a housing or banking analyst who has already performed the Herculean task of researching the accounting, cash flows, and managerial choices of all the companies in a chosen industry? Or perhaps the meme is comforting to a value investor who finds a homebuilder trading at historically low multiples? Or maybe a growth investor is comforted by a company reporting a sharp growth rate? To understand why we do this, we must step way back from the investment decision-making landscape and understand belief formation at a very rudimentary level.
Beliefs are stored in our brains as memories. They are the emotional and psychological guardrails that help guide us through life. According to social psychologist Milton Rokeach, there are five types of beliefs — here’s how I would characterize them (This framework reflects the author’s interpretation):
- Objective Reality: Basic indisputable truths (e.g., the sky is blue, the earth is round, etc.).
- Subjective Experiential Beliefs: These beliefs arise from deep personal convictions, independent of others’ convictions (e.g., I’m a good person, I’m afraid of the dark, etc.).
- Authority Beliefs: Many facts are not verifiable by an individual, so we must rely on trusted leaders (e.g., parents, teachers, religious leaders, doctors, etc.).
- Derived Beliefs: These beliefs are gleaned from the authorities with which we identify. Such beliefs can be easily changed if differing ones are expressed by the trusted authority (e.g., my doctor is against the Affordable Care Act, my professor is a fan of President Obama, etc.).
- Inconsequential Beliefs: Tastes and preferences (e.g., I like strawberries, I dislike rude people, etc.).
This belief structure helps explain a great deal of why we attach ourselves to certain ideas and memes when applied to the field of investing. We derive beliefs from others whom we trust and are in positions of power and authority, particularly in areas where we ourselves are uncertain or lack conviction. And when we encounter a statement on a particular topic, it can access our belief systems involuntarily. In general, automatic accessing of our belief systems is a good thing. These are our guardrails in life. Don’t touch the hot stove, teach your children right from wrong, etc. However, when certain memes appeal to our belief system, we expose ourselves to a wide range of behavioral psychology problems ranging from confirmation bias, to framing, to social proof, to authority influence, to meme validation, to cognitive dissonance. The list goes on and on. In short, a well-constructed meme can make us gullible.
For instance, when in 2005 Alan Greenspan said that home prices haven’t declined nationally since the Great Depression, it was powerful. It was powerful because he framed the issue for the public which provides the power of suggestion. He was a revered authority figure as the chairman of the Federal Reserve, so it tapped into Authority Influence. The phrase was repeated over and over by others throughout the Fed and the banking and investment business, creating powerful meme validation through repetition. And as we saw well-known investors and wirehouses participating in these markets, it gave us just enough social proof to let ourselves believe that sub-prime mortgages must be fine.
But this wasn’t just a once in a lifetime phenomenon. Memes are all around us and ever-present. Consider another meme that is currently out there: peak oil. Renowned geologist M. King Hubbert wrote a paper in the 1950s that predicted US oil production would peak in the 1970s and then decline thereafter. Because US oil production did in fact peak in the early 1970s and declined thereafter, industry observers declared victory for peak oil and then anointed the phenomenon “Hubbert’s Peak.” The only problem with all this is that Hubbert was wrong. He had made his prediction as a geologist on the basis of scarcity of oil reserves and the relentless extraction and decline rates in the energy industry. In contrast, US energy policy is what created the overall decline in US production.
First, as the environmental movement gained strength in the 1960s and 1970s, large swaths of federally controlled land and sea was prohibited from oil exploration let alone extraction due to environmental considerations. As of today, including both onshore and offshore resources, the US federal government owns about 2.5 billion acres of mineral rich land, approximately 97% of which is prohibited from exploration and development.
Second, in August 1971, President Nixon enacted price controls on a wide range of products — including oil and gas — as part of his effort to distract the country from his move to fiat money. Subsequent to his departure, both Gerald Ford and Jimmy Carter similarly enforced price controls on oil and gas. Just as economic theory predicts, price controls led to a decline in investment and shortages of energy. The energy business is truly global and the large multinational energy companies like Exxon simply allocated their capital to more attractive climates. Because of the dense and difficult regulatory situation in the United States, investment failed to return even after the price controls were removed because the United States remains both high-cost and difficult.
So, in the end Hubbert was right, but for the wrong reasons. Investment capital will flow to those places on the globe with the most attractive ROI and lowest risk. And if there is any doubt about this, consider the escalation of US production recently with the shale oil boom, which uses newer techniques to access existing and well-known deposits that were previously too costly to extract, demonstrating unequivocally that a geologic definition of peak oil has yet to be reached in the United States. Hubbert was flat out wrong, yet the meme lives on. Such is the power of memes.
Be strong. Resist. In the world of investing, treat everything as a meme. They can be true, false, or maybe. Just make sure your mental model of the world won’t fracture when you recognize a meme is no longer true.
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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.
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