Friday, December 21, 2007

Institutional imperatives

One of the tenets the book "The Warren Buffett Way" illustrates is resisting the institutional imperatives. Institutional imperatives are about looking over your shoulder to see what you competitors are doing, and do exactly what your competitors do. You think that if your competitors are doing it, then it will be OK for you to do it.

This kind of behaviour lacks independent and critical thinking, yet it is amuzing that the Wall Street and many CEOs act exactly in that way.

The recent subprime mortgage crisis in the US is an excellent example. A couple of investment banks thought it a good idea to package risky mortages into investment-grade collaterised debt obligations (CDO's)and sell these instruments to institutional investors. Soon other investment banks got wind of it and also wanted to be part of the action, while not really questioning the soundness of the product. Goldman Sachs, Deustche Bank, Merrill Lynch, Bear Sterns, Citigroup and others then offered it. All the major rating agencies, S&P, Moody's and Fitch joined the party and gave these CDO's their blessings as investment-grade instruments.

Alas, this party tumbled like a pack of cards. With rising interest rates and adjusted higher interest rates, many homeowners defaulted on payments. These investment-grade instruments became junk, and a lot of investors lost a lot of money. Major investment banks have to date written down more than USD100 billion as losses, and the heads of CEOs of a couple of these investment banks have rolled as a result. And we are not seeing the end of this crisis yet.

So, think for yourself. Don't follow the herd. And don't just listen to those investment analysts, thinking that they are professional and konwing what they talk about. Distinguish between investment salesmen and true investment professionals. Do your own homework.

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