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The Elements Of A Financial Disaster

Almost always, there are 5 parts of a monetary disaster. With no exceptions, these elements existed in each financial catastrophe from the Tulip Bulb Mania to the current real estate meltdown.

The 1st generality deals with predicitability. Great investors are a lot likely to recognize an arbitrage opportunity in the market than the government. This answers why a fiscal bubble can get beyond control with nobody trying to end it. If the cost of an asset is going up, most investors are happy regardless of whether a trend isn't sustainable. Congressmen also like this trend as they take credit for phony success.

The second main truth is perceptual bias. We tend to disregard extremely rare events. These are events that are very unlikely but have a giant impact. Homes built in a flood prone area which averages a flood every fifty years has about a two percent probability that it will flood that year. Our human tendency is to disregard this issue. When the inevitable flood comes, we are then shocked over the damage to our home.

The opposite is also correct. If 2 big floods happen within a short period, folks that live in the flood zone will likely move somewhere else although the chances have not statistically changed. After experiencing 2 floods, there could perhaps be a 100-year time period in which there is no flood. The perceptual bias will likely revert to what it was initially.

How are you able to take advantage of this? By purchasing after a tragedy in which the perceptual bias is negative. Purchasing a house after a flood, earthquake, hurricane, or other natural catastrophe is usually a major bargain. Earthquakes, as an example, happen infrequently but when they do occur, they're going to remain fresh in everyone's memories for a considerable time.

Shifting the danger to someone else results in very risky behavior. This often includes having subsidies against a disaster, therefore the building of fancy holiday houses right on the shore of the sea. This removes the risk for the homeowner as the government will pay for a replacement. Another example of this a mortgage lender originating a subprime mortgage and selling it to an investment firm. Financial bubbles almost always exist, in part, from lax lending standards.

Negative cognition happens once the disaster has happened. Greediness turns into fear and markets collapse. The 'bust' cycle is typically equal and opposite to the bubble that predated it. On a more encouraging note, the shakeout from this brings about massive possibilities for clever investors.

In a natural disaster, it is clear who the victims are. In a fiscal catastrophe, figuring out the victims is more complex. Deciding how to help folks and the way to forestall the subsequent disaster has proved difficult. In the current crisis, politicians and big banks both have their own interests at stake. Getting leaders to make responsible and hard decisions is not easy because they prefer to delay issues for somebody else to deal with. Most politicians never look past the subsequent election which is why very little long term planning gets accomplished.

Eileen E. Jacobs is a mortgage consultant from Las Vegas, NV. Mortgage Las Vegas

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