Perhaps more than any other profession, lawyers are keenly aware of the need to manage liabilities – both real and perceived. The liabilities being managed can range from overlooking evidence to underestimating opposing counsel to reputational risk to out and out malfeasance. All professionals need to be careful, but lawyers need to be especially careful.
One way of managing risk is to proper due diligence and risk being overprepared when comparing alternatives. But what if the thing that requires your attention somehow escapes it? What if, despite your best intentions, you miss something that is staring you in the face? Sometimes, things that are tangential to our careers might avoid detection as material risks.
My bet is that the current economic climate might be one of those things. Some think it is looking more and more like it did at the end of the roaring twenties… aka the decade just before the dirty thirties. There’s a good deal of irrational exuberance out there – as evidenced by massive amounts of household debt, leverage borrowing, consumer confidence that is unsubstantiated by the facts and valuations that have very few precedents – especially in the United States.
Like the proverbial frog in a slowly boiling pot, there has been a steady stream of cautionary stories about market frothiness that have ‘always been there’ yet might not be fully appreciated. It is almost as though the ‘stream of consciousness lightbulb’ hasn’t quite gone on. Stock markets and real estate markets have been on an absolute tear for well over a year now. We should be taken aback, but we almost yawn when we see a new news item about a home selling for $300,000 above asking or news of markets hitting new all-time highs. Here’s the thing: valuations are stratospheric. That means there’s a huge amount of risk baked into buying into those asset classes in the summer of 2021. Now that you’ve been told to turn your attention to these risks, allow me to draw your attention to a couple of prominent legal terms.
Willful blindness is defined as ‘contrived ignorance’ or ‘intentional ignorance’. It is a term used in law to describe a situation in which a person seeks to avoid some form of liability.
Plausible deniability is having the ability to deny knowledge of – or responsibility for – any damnable actions committed by others in an organizational hierarchy because of a lack or absence of evidence that can confirm their participation.
This does not necessarily mean that something awful will happen regarding stocks or real estate, but that is certainly one possible outcome. What it does mean is that you need to understand that there are massive risks associated with investing at what looks like the top of the cycle. Currently, prices look severely stretched and seem to be based on the premise of a ‘goldilocks’ scenario remaining in place for the foreseeable future. That scenario is simply not sustainable. Happy outcomes are possible, but far from probable.
The point that needs to be clearly recognized – for you and your clients – is that a high degree of financial liability may be lurking around the corner if you’re not careful now. The pollyannish would have us believe that we are in for a prolonged period of comfortable growth coming out of a global pandemic much like what happened in the 1920s. Others, including yours truly, think the analogous decade has been compressed into the last 16 months or so and that the summer of 2021 is akin to the summer of 1929.
History is full of stories about smart people who simply refused to acknowledge evidence owing to their being too close to the situation. For example, in 1929, merely weeks before the biggest downturn in recorded history, noted American Economist Irving Fisher opined that markets had hit a new permanent high. Isaac Newton is said to have lamented about his own limitations after losing virtually all he owed in the South Sea Bubble. He said: “I can calculate the motion of heavenly bodies, but not the madness of people”.
If some of the greatest thinkers of their time can be taken in by market manias, what chance do the rest of us have? Therefore, my request to you is to not be willfully blind regarding the risks associated with investing in this market. If you choose to do so anyway, and especially now that you have read this article, you will have no one to blame but yourself regarding the liabilities associated with negative outcomes. If you are investing in anything this summer, the words caveat emptor most certainly apply.