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A crisis in confidence

14 May 2008

How times have changed in the property market was neatly illustrated by one of the many programmes on UK television recently. Over the last decade as the value of this asset class has risen in the UK so has the number of programmes about buying, selling, redeveloping, renting and building houses. The underlying, and largely unspoken, premise of each of these shows is that property prices will rise forever and owning property is a one-way bet to riches.

This particular programme left the UK in search of property 'hot spots' around (for the UK couch potato at least) far-flung parts of Europe, including the likes of Croatia and Albania. Now, let's be clear: I don’t mean to do any disservice to the property market in downtown Sarajevo. But from what could be gathered, the couple being trailed by the camera crew knew as much about property trends in Tirana as I do, which is to say next to nothing.

But while our would-be overseas property investors were shown on TV being prepared to buy into a relatively unknown market, the news was headlining the fact that UK banks and building societies were withdrawing mortgage offers quicker than you could say 'substantial deposit'.

Banks have rediscovered the idea of counterparty risk: they no longer have confidence in other financial institutions that they had been happy to deal with without thinking for years. It is this sort of attitude - in sharp contrast to the risk-taking attitude of speculative asset acquisition - that could lead us all into a global recession. Businesses stop investing in staff and products and new markets, not because any of the fundamentals of the business or the economy have changed, but that our collective mood has turned from one of cheerfulness and confidence in the future to one of uncertainty and gloom. The strength and weakness of our economy is not built on some immutable scientific law; rather, it is constructed largely on the frailty of human perception.

Alan Greenspan, back in 1999 when chairman of the US Federal Reserve (who has incidentally been blamed, at least in part, for the credit crunch by stoking the flames of cheap money and easy liquidity during his time in charge), gave a speech explaining the beneficial role the market plays in diversifying risk. In that speech, he claimed that while financial markets may have become more sophisticated, there is little in our historical annals to show that human nature has changed much over the generations and that we cannot alter deep-seated uncertainties inherent in the human evaluation process. What Greenspan meant by that was that the less that is known about the current state of a market or a venture, the less ability to project future outcomes and, hence, the more those potential outcomes will be treated with scepticism. But the strength of this scepticism waxes and wanes without any rational basis.

Greenspan said on more than one occasion that history tells us that sharp reversals in confidence occur abruptly, most often with little advance notice. Those reversals can be self-reinforcing processes that can compress sizeable adjustments into a very short period that soon descend into panic. These panic reactions in a market are characterised by dramatic shifts in attitudes that are intended to minimise short-term loses. This intriguing pattern of human behaviour holds true for the Dutch tulip bubble of the early 17th century as much as for the dotcom collapse early this century.

What is most intriguing about this is that while we can describe the process no economist, psychologist or sociologist appears able to predict these sudden reversals in confidence. Such moods sweep through human beings as surely as an influenza epidemic. If you seem cheerful, so do I (or not). Maybe I should go and talk to that couple on TV who have just invested in a condo in Sofia. They must have reasons for such confidence.

Peter Williams is a journalist and a chartered accountant. He writes on accounting, financial reporting and auditing issues.

This article appears in the May 2008 edition of accounting & business.