Wednesday, August 25, 2010
Written by Bo Billeaud
For some people, money has that seawater effect — the more you drink, the thirstier you get. And in their quest for more, they often end up with less.
Here’s a true story. The late Joseph Heller was once at a party with his very good friend, Kurt Vonnegut, given by a billionaire financier. After noting the opulence of their surroundings, Vonnegut turned to Heller and asked, “Joe, how does it make you feel to know that our host, only yesterday, may have made more money than your novel Catch-22 has earned in its entire history?” Heller is reported to have replied: “Well, that may be, but I’ve got something he can never have.” Vonnegut asked, “What on earth could that be?” And Heller said, “Enough.”
There is a lot of wisdom in that retort. While everyone has an “enough” point, not everyone knows where it is. And for some people, that can lead to real trouble. For them, money has that seawater effect — the more you drink, the thirstier you get. And in their quest for more, they often end up with less.
Nelson Bunker Hunt is a former billionaire — the son of oil tycoon H.L. Hunt. In the 1970s, Nelson, along with his brother William, attempted to corner the global market in silver. And for a while, he did, acquiring an estimated 100 million ounces of silver throughout the decade. Toward the end of the Hunt brothers’ silver adventure, things got quite exciting. In fact, in the final months of 1979 the price of silver quintupled, rocketing from $11 an ounce in September to $50 an ounce in early January of 1980.
Nelson kept buying all the way up — easy money is a powerful narcotic. He made (an additional) fortune. However, as all good things are wont to do, the party ended.
Abruptly. Once the silver hysteria subsided, the price of silver collapsed to below $11 an ounce just two short months later. Nelson Bunker Hunt was wiped out and ultimately ended up in bankruptcy court.
John Merriwether was a successful bond trader for Solomon Brothers. He spent much of the 1980s putting together the best — and smartest — bond trading group in the world. Leaving Solomon Brothers in 1992, Merriwether and his group of traders (which included Myron Scholes and Robert Merton, Nobel laureates who shared the 1997 Nobel Prize in economics) set up a hedge fund called Long Term Capital Management. LTCM was initially wildly successful. Annualized returns exceeded 40 percent per year. A million dollars originally invested in 1994 grew to more than $4 million in four short years. The principals became very, very rich. And they knew that they were the smartest guys in the room, which led to an attitude of arrogance that sowed the seeds of their doom.
Knowing that “if a lot is good, then more must be better,” the very smart principals of LTCM began cashing out early investment partners, taking their place in the fund with their own money — just in time for the absolute implosion and collapse of the global credit markets brought on by the 1998 Russian rubble financial crisis. After quadrupling in value over a four-year period, the Long Term Capital Management fund lost more than 90 percent of its value over a three week period in September 1998. The fund went into receivership. The principals — who once had $1.9 billion dollars of their own money invested in LTCM — lost everything. Oh, and along the way, they almost took down the entire global financial system.
What senseless, stupid, and self-inflicted tragedies. And the amazing thing about all of these cases was this: The individuals involved were already rich, real rich. The risk they took (losing something that was very important to them — the money that they already had) to incrementally gain something completely unimportant (more money) made no sense whatsoever. The additional money had no practical utility to them whatsoever (once you’ve reached the level of a billionaire, how much can you spend, really?). However, the money they risked, and lost, had enormous utility. They just didn’t understand the concept of enough.
You do not have to be a Nobel Laureate in economics to make smart investment decisions. You don’t really have to be smart at all. What you do have to be though, is this: not stupid. For all of us, financial decisions should absolutely be viewed entirely through the lens of incremental reward and unforeseen risk.
It seems to me that we are rapidly approaching a potentially interesting point for both the economy and the financial markets. Last December, I wrote a column about the potential downside ramifications of our economy’s debt situation (“There’s a Slow Train Coming”), which was followed by a more recent column regarding a possible market reaction should this economic recovery slow or stall (“Revaluing Wall Street”). Corroborating the not-so-subtle conclusions suggested by connecting the above dots, an in-house body of research that I maintain is also suggesting that a cautious investment allocation right now is not a bad idea at all.Bo Billeaud has been president and chief investment officer of a Lafayette-based money management firm for the past 18 years. Contact him at