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| Friday's Phrase: "bounded rationality" |
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| Friday, 08 October 2004 | |
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08 October, 2004: With minor
eruptions of bullish activity occurring on the surface of the tech
sector c.2004, it’s time to revisit some of the vocabulary of the last
dot.com-led ‘boom/bust’. Here’s a cracker: “bounded rationality”…
Fame – or notoriety – is attached to the comment of US Federal Reserve Chairman, Alan Greenspan, first aired in 1996, when he coined the phrase “irrational exuberance” with regard to unsustainable investment trends. His foresight, years ahead of the technology sector’s implosion, at least demonstrates why he is Fed Chairman and nobody else reading this holds that post. To expand the soundbite into its original form, what Greenspan asked on speaking to The American Enterprise Institute on 05 December, 1996, was: “how do we know when irrational exuberance has unduly escalated asset values, which then become subject to unexpected and prolonged contractions…?”. It took those slaving away in the engine-rooms of the financial community nearly four years to absorb his words. They were too busy stoking the fires of expansion and cranking up the ratchets of the ICT/dot.com roller-coaster. Along the way, they invented their own soundbites with which to feed the public appetite for success. The contrast with Greenspan’s sober assessment is clear. No limits? This is not the place to discuss the culpability of brokers and analysts when talking up technology shares or siphoning profits off IPOs at the height of the boom. It’s sufficient to say that some have since been disgraced or imprisoned, while others find their personal ‘stock’ at an all-time low. In the interest of non-recrimination, we won’t name the culprits here, although an email to the following clickthrough will ensure that you have it by return. So the unnamed broker (although it's not too late to click here and request to find out who it was!) sat in January 2000 attempting to issue a note on the UK Internet service provider, Freeserve (now part of France Telecom’s ‘Wannadoo’). The shares were trading at UK£4.50; the broker’s valuation placed them as being worth UK£2.00 at that moment in time; it’s target valuation for 12 months into the future was UK£6.00. This last figure represented a 75% premium on the actual price and a 300% premium on the broker’s own valuation. A whole new wardrobe, your Imperial Highness Even the heady hedonism of the technology boom could not explain this. The analyst/broker could – with the right phraseology. “Our analysis is limited by bounded rationality”, it said in its note. This was written by way of an apology for the fact that its numbers did not add up and as an alternative to a declaration that the numbers did not add up and investors should therefore beware! ‘Bounded rationality’. It’s exquisite. To the rest of us, ‘bounded rationality’ equals ‘common sense’. Greenspan’s much earlier reference to ‘irrational exuberance’ equated to ‘a lack of common sense’. Both of these phrases along with their meanings – and the messages contained within – were ignored. The risk is that when things start to look good and when the industry’s pulse begins to look stronger, the temptation will be to slip beyond ‘the limits of bounded rationality’. And the lessons of phrases coined nearly five years ago (‘bounded rationality’) and almost ten years ago (‘irrational exuberance’) will be forgotten once more amid the green mist of greed. Jim Chalmers |
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