I've found myself within two bubbles - Internet 99-00 and the Mortage Industry 05-07.
I ended up fully immersed within the first one, believing (like many people did) that we were experiencing a new paradigm - a new economy, new productivity, therefore new valuations. I ended up believing that the traditional valuation models were not accurately measuring the potential of the new economy - forget Graham, Buffet, or any other traditional financial mind. Buffet himself said he would never invest in MSFT because he didn't understand it. I left the bubble promising myself that I would never committ the same mistake twice - traditional finance will never grow old, stick to traditional fundamentals when evaluating any business.
With that same mindset I arrived in the mortgage industry in late 05. I had been following the "housing bubble" for quite some time (since late 2001), and the fact that it had not burst yet, made me doubt, but, sticking to fundamentals had been deeply ingrained by then. Applying that traditional logic to the mortgage industry didn't lead me to doubt about its sustainability. Mortgages were originated and then sold off into securities (that had many forms - MBS, CDOs, etc), so as long as the market was willing to invest in these securities, mortgage origination equity would never go bad. The housing bubble did burst (as expected), but, it took with it the whole non-agency mortgage origination industry. Where had I been wrong? Was I fooled for a second time? I was inside and I ended up believing in things in the same way I did in 1999?
Yes and no. Yes, I could have seen what happened within before, in fact I did see it, but, I wasn't able to understand the ramifications until they really hit the industry.
Here was some of my faulty logic:
Stated Income loans - I knew it was pretty crazy; I questioned why lenders would ask for the income in the first place (if it was a lie anyway), but, I believed that since the market was pricing that risk, it was already being taken into consideration (by means of a higher yield).
I should have asked myself if the market was actually pricing it correctly and if the market actually knew the fundamentals of this type of lending (no and no)
Negative Amortization loans - I fully understood what they were and understood that you needed high FICO scores to get them... should I have asked myself that in a situation where property prices are depreciating, not even high FICO scores would repay those loans.
Fee structures not being transparent to borrowers - instead of taking it as industry practice, should I have asked myself if that was actually right and if things needed to be that way?
The whole market banking on eternal home price appreciation -> pretty foolish, but, we all got carried away.
In hindsight, everything is easy, the hard part is really learning from every single situation.
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