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There’s a simple reason why things that appear safe are the most dangerous of all – because we don’t expect anything unsafe to happen. I remember playing basketball as a kid and getting into some big collisions with the ground, walls, and other players. Those impacts never hurt much because my body knew it was coming. I braced for it and was fine. My biggest collision as a kid, was with water.
I was at the local pool and trying to do a one-and-a-half from the low board. I needed to bounce high off the board and rotate quickly through the front flip. “I can do this I thought.”
I didn’t. I did smacked my face and body so hard that I nearly blacked out. I remember blackness in my peripheral vision and thinking, “underwater is not a good place to be.”
I made it to the side of the pool and wondered how the water could hurt so much.
The difference between my contact playing basketball and the pool was all in my preparation for impact. I knew to brace myself for the hardwood, but not the pool. For me, the pool was something that appeared safe but was dangerous.
We’ll have three stories in today’s post:
– Money market fund creators and investors.
– Mountain climbers.
– Art forgers and researchers.
Each of these stories have situations that appear safe but are inherently unsafe because they appear safe.
Money market investors.
Money market funds were created to be a liquid, low interest, safe place to invest. Typically earning more interest than a savings account, but less than mutual funds, money market funds grew in to $3.8 trillion by 2008.
The first of these was Reserve Primary Fund, which was well regarded and well run. It was as safe a place to put your money as any. Until 2006. As Greg Ip explains in Foolproof:
“In 2006 Reserve began investing in commercial paper, which soon represented half the fund’s assets, making possible higher yields that acted as a magnet to investors.”
Prior to 2006, Reserve’s investments were more conservative. Dollar by dollar, they started to move away from this, though the $1 price never changed – and for money market funds it shouldn’t.
Then Lehman Brothers went bankrupt, and Reserve held their corporate paper. While Reserve may have been riskier, they weren’t idiots. “Lehman’s paper retained its top rating from Moody’s and Standard & Poor’s until the day of its bankruptcy,” Ip writes. Yet, they failed.
Cliff Asness warned about this very thing in his podcast with Tyler Cowen.
“That (money market portfolios that hold short-term bonds) is to me a very dangerous asset,” Asness said, “because it tells people there’s no risk when there’s actually is risk.”
He continued, “I think the thing people don’t appreciate is how dangerous things are that you think protect you, but only mostly protect you.”
Here we have our big idea, there is danger in the things that we think protect us. Reserve thought they were safe because Moody’s said Lehman was fine. Investors thought Reserve was safe because they were a money market fund.
Mountain climbing is dangerous but has become easier. This is not to take away from the 73-year-old woman who climbed Mt. Everest, but because it’s easier, we misconstrue things as safer. Difficulty and danger are independent variables on the side of a mountain.
Laurence Gonzales writes about this is his book Deep Survival:
“The standard route up (and down) Mount Hood is not technical. It’s more of a hike on a steep snow field. On a good day, you can walk it without crampons, snap some pictures on the summit, and be back at the Timberline Lodge ski resort for New Zealand fire-broiled spicy lamb loin chops.”
Well, that sounds quite nice, but it’s not. Knowing what to look for, we can spot it already. It’s easier but still dangerous. Gonzales writes, “it’s a dangerous illusion, because success depends on doing everything perfectly.”
In the same way that Reserve needed perfection to end the day at $1, climbers on the South Route need the same luck.
On May 30, 2002 they did not get it.
Four men – hooked together “like beads on a string” – began their tragic descent.
Their plan was for them to hook together at 35 foot intervals, and climb down together. If they kept the rope pulled tight between them, then no one would slip and gain momentum before another could arrest him. There was one flaw, if the top man fell. Which is what happened.
Gonzales writes about the fall, “Before Ward’s rope went taut against Read’s harness, Ward was going as much as 30 miles an hour, the equivalent of the speed you’d attain by jumping from an eight-story building.”
Ward – the top man – plucked Reed off the mountain like a grape off a vine. They both fell, gained momentum, and pulled the other two down as well. The climbers thought they had created a system that would protect them. They needed a perfect descent to be safe.
Art researchers and art forgers.
Art forgery is an art. In both the literal skills to paint or draw, but also the psychological. A successful art forger doesn’t paint the Mona Lisa, they draw it.
“The majority of successful art forgers in the 20th century …. use provenance, or the documented history of an object, as a trap to lure the researcher to authenticate the work.”
Charney explains that rather than forge the Mona Lisa, a forger would create sketches that Da Vinci may have done which could have led to the Mona Lisa. Rough drafts of the masterpieces.
The forger uses a form of psychological jujitsu to fell his opponent, the researcher.
For a while this worked brilliantly for forgers because of two factors acting on the researchers.
- Who would forge a sketch instead of the real deal?
- If I find something new, that would be great for me.
Art researchers thought the odds of #1 were too low to ever happen and felt the pull of #2 as quite strong.
Three different groups, all fooled by the same challenge – danger veiled in safety.
What went wrong?
There are there wide sweeping conclusions to our stories.
1- We underestimate risks in situations that appear safe.
Reserve invested in companies – after decades of not doing so – because it thought the risk of a Lehman default was low.
The mountain climbers hooked together because they thought the risk of them falling together was low.
The researchers validated more work because they thought the risk of forgery of sketches was low.
2- We reach for more.
Reserve Primary wanted greater returns, and reached for them.
The mountain climbers wanted to get down the mountain more quickly, and reached for a faster way.
The art researchers wanted to be the one who found a hidden treasure (“Let’s be honest, every art historian wants to be Indiana Jones and wants to find lost treasures.” Noah Charney).
3- Conditions change in small ways and we don’t notice.
Reserve didn’t know that Lehman held debts that were about to go bad.
The mountain climbers didn’t know that the snow was turning to slush.
The art researcher didn’t know how quickly and deeply a forger could figure out the history and backstory.
How do we avoid this type of failure?
Listen to your systems and know what it means.
Thanks for reading, I’m @mikedariano on Twitter.