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BP and UK house prices are both victims. People who piled into dotcom stocks during the late 1990s were victims too. I am talking about the narrative. There is something deep and primeval about the way a good story tugs at us. It makes us susceptible to ideas, but can make us gullible. This is a danger for investors, but also an opportunity.


In his book ‘Thinking Fast and Slow’, Nobel Laureate Daniel Kahneman wrote: “The exaggerated expectation of consistency is a common error. We are prone to think that the world is more regular and predictable than it really is, because our memory automatically and continuously maintains a story about what is going on, and because the rules of memory tend to make that story as coherent as possible and to suppress alternatives. Fast thinking is not prone to doubt.”

Or take another example. In their book, ‘Animal Spirits’ George Akerloff and Robert Shiller related the story of Mexican President Lopez Portillo. He told his people that Mexico was rich: they had struck oil. So convincing was Portillo’s yarn that the country gave foreign aid to other South and Central American economies. The Pope visited in 1979, seemingly confirming Mexico was a global player of considerable importance. The country borrowed against future oil revenue. Alas, there was a lot less oil than originally thought, but who wanted to contradict the tale? Mexico, its leader, and its populace were seduced by the story; the nation was left with a legacy of debt, inflation and resulting economic disaster.

Now I am going to be a bit naughty and quote from my own book ‘The Blindfolded Masochist’. “Tests using MRI show that when we hear a story the same area of the brain lights up as when we experience those events in reality. The key seems to be what are called ‘mirror neurons’. This applies to chimps too: a chimp watches another chimp having a certain experience, and the same neurons in the two chimps are seen to fire. Writing for ‘New Scientist’ magazine Jessica Marshall says that it is possible that ‘…stories act as social glue binding people together in a common identity that is forged as they share the ideas or emotions prompted by narrative.’”

So our love of a good story may actually have evolved because it yielded an important evolutionary advantage. It helped to reinforce our loyalty to the community to which we belonged, and such group loyalty, or so anthropologists believe, may have given early humans an important evolutionary advantage.

But a story can sometimes so overwhelm us that it can blind us to obvious flaws. At a later date evidence may emerge which might contradict important parts of a tale that influenced our way of thinking, but even when this happens it is very rare that we change our beliefs. New evidence is not enough to change views forged in the furnace of storytelling; we have to be subjected to a new narrative of equal power before many of us change our mind.

So let me venture to give some views that might be controversial. MPs are underpaid;  the current system of remuneration of MPs means that the only people who can afford to take up such a position must in some way be independently wealthy – or have a supplementary income. The system of pay for MPs has the effect of skewing the balance of power in parliament to those who were brought up in a life of privilege. The narrative many of us have been sold, however, is that MPs are greedy so and sos who shamelessly fiddled their expenses. A lot of people, including people who believe that parliament should be made up of a more diverse range of people, think that MPs shouldn’t be paid at all.

Now let me turn to BP. The narrative in the US is that BP is a ruthless cost cutter, once fronted by a smart arse Brit who was more concerned about his own welfare (“I want my life back”) than human lives; a company which shamelessly put its profit and losses above the welfare of the American people. This narrative is so strong that when BP attempts to promote what it sees as fairer compensation claims, it is slammed by the court of US public opinion, not to mention the court of US Justice.

But I would say a similar narrative applies to banks. Yes they behaved shamelessly, yes bonuses were way too high, yes they were run by people who became greedy, but the anti-bank narrative is so strong that I believe banks find it hard to get fair treatment in anything. I am sorry, but PPI claims have become ridiculous, yet so strong is the anti-bank narrative that any attempt by a bank to enforce PPI claims that are in any way fair is met with the utmost derision.

The narrative that banks caused the financial crisis is so strong, that we overlook the part each and every one of us played in the build-up to the crisis of 2008. We bought into the view that because we could leverage off the spare equity in our homes, thus debt was considered to be okay and the seeds of the financial crisis were sown.

On the topic of house prices, I think the UK public have been sold a narrative. The narrative of the 1960s and 1970s – a time which commenced with cheap house prices relative to income; a time when real income rose as productivity advances fed wage increases that were much greater than inflation; a time when real interest rates were much lower than they are now (yes, that is right relative to inflation interest rates were often deeply into negative territory during this period) – was that investing in your own home was just about the smartest thing you could do. It is indeed the case that an average household that bought a property in, say, 1967, found that the real cost of their mortgage plummeted over the following decade or so. But so strong was this narrative that the attitude to property in Britain was changed. The metaphor the ‘housing ladder’ was born, and so terrified had Brits become of not buying their home that house prices rose in 2009, even while the UK was still in recession.

Then there is the narrative of the dotcom boom. So strong was this narrative that many investors missed Google, with its ‘absurd valuation on IPO’, even though today the company’s annual profits exceed its market cap when it was floated.

The narrative can bind society and make it function, it is also the stuff that wars and economic bubbles are made from. The markets can fall for the tyranny of the narrative too, which is why investors who can see beyond the story, can do very well indeed.

 

These views and comments are those of the author alone and do not necessarily reflect the view of The Share Centre, its officers and employees


Showing 1 comment

  1. Fascinating topic, and I’m sure being aware of the narrative will allow the savvy investor to be more objective.

    I suspect your selection of banks was perhaps a poor example; millions of people suffer real pay cuts, while bankers still get bonuses and more skeletons fall out of the wardrobe every week – the narrative may be wrong on detail (PPI), but it’s probably right on balance.

    Mind you, I’ve not heard of one single person, ever, who got a PPI pay out, so I’m not even sure if those claims are unreasonable!

    But BP is a good illustration of one company, two narratives – and the informed investor can decide what’s closer to the truth.

    The dot com boom was such a strong narrative, that several colleagues were happy to take a bet when I offered money that Amazon would survive and thrive. I cleaned up on that.

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