A Prescription for Panic

Years ago, I was prone to panic. When the market news was bad, I'd sell indiscriminately and head for my bunker, only to reemerge when prices were higher and everyone felt better. Over time, I learned that this approach was suboptimal, to put it kindly.

Then came the meltdown of 2008. Panic was in the air. In fact, if you panicked when Lehman Brothers went bust last September and sold your stocks, you avoided some devastating losses over the next five months.

So panic was good, right?

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Too much gloom

I was confused -- and angry. Angry because I thought the media had rapidly become pro panic. As everyone and his mother began to aver that we were in the worst financial crisis since the Great Depression, many commentators began to suggest, more or less, that we were headed back to the 1930s. They were selling panic without perspective.

Was I afraid? Of course. But then I decided to do what the great investors do: Hit the books. Both Warren Buffett and his partner, Charlie Munger, have said that the best investors spend all day reading -- and I don't think they were referring to Yahoo message boards. So I started to read new books on past market horrors and reread parts of older ones, seeking sanity amid the din.

Paul Krugman's The Return of Depression Economics and the Crisis of 2008 reminded me that it was a banking crisis that truly caused the Great Depression. With the availability of deposit insurance, a repeat of that awful triggering event is virtually impossible. But Krugman also noted that panics can become self-fulfilling and that the "expectations, even the prejudices, of investors become economic fundamentals." Still, he tentatively concludes that the world will avoid a depression.

Krugman's analysis of the Latin American and Asian currency and debt crises, as well as our own, shows that governments and institutions such as the International Monetary Fund have an uncanny ability to throw gasoline on almost any economic fire. Conclusion: Blind trust in government is not a wise investment strategy.

By consulting The Panic of 1907: Lessons Learned From the Market's Perfect Storm, by Robert Bruner and Sean Carr, I relearned an age-old lesson: Leverage kills. In some ways, though, the book seems to be about not just a different age but a different planet. In 1907, there was no Fed, but there was J.P. Morgan, who almost single-handedly ended the panic. That a single, private individual could wield so much power is astonishing.

The lesson of 1907 was that we needed a Fed. One lesson of Charles Morris's excellent The Trillion Dollar Meltdown: Easy Money, High Rollers, and the Great Credit Crash is that when you have the wrong guy, Alan Greenspan, heading the Fed, horrible things can happen. Morris correctly notes how ludicrous it was to have a self-proclaimed libertarian serving as America's top financial regulator. In retrospect, Greenspan's utter faith that markets would ultimately take care of themselves seems almost criminally naive. Morris's book is also a reminder that Wall Street rocket scientists will always find ways to bring the financial world to its knees. Never forget the idiocy of portfolio insurance, which caused the crash of 1987.

I reread Frederick Lewis Allen's Only Yesterday and John Kenneth Galbraith's The Great Crash of 1929, and read William Cohan's House of Cards, about the demise of Bear Stearns. All the reading made me feel better, in a know-thine-enemy sort of way. When it comes to investing, the enemies are legion: incompetent government officials, executives, monumental greedheads and misguided investors.

But the biggest enemy of all may be heedless panic. The only way to buy low and sell high is to stay sane when prices are low. And I did a lot of buying while reading these books. Human folly may be eternal, but so is our ability to recover from it.

Columnist Andrew Feinberg writes about the choices and challenges facing individual investors.