Slow, Second-Level Thinking

Many of you have probably, if not read, at least heard of the bestseller "Thinking, Fast and Slow" by Daniel Kahneman. For the purposes of this blog post, I just mention that "slow thinking" is something that is called for when making certain decisions where "fast thinking" is vulnerable to different kinds of biases - in other words, it's needed so that we don't get fooled by ourselves. It is thinking that requires sometimes considerable effort. That's the slow-thinking part of my title today.

What is a lot more relevant to this post, and comes from a book that should in my opinion be read by every person who wants to make investments, is "second-level thinking". It is something that Howard Marks, a renowned investor, calls for in his book "The Most Important Thing: Uncommon Sense for the Thoughtful Investor" (not as catchy a title?). This excerpt from the book explains the concept:

First-level thinking says, "It's a good company, let's buy the stock". Second-level thinking says, "It's a good company, but everyone thinks it's a great company, and it's not. So the stock's overrated and overpriced; let's sell."

By the way, Daniel Kahneman is also one of the gurus in the field of "behavioral economics", which

[studies] the effects of social, cognitive, and emotional factors on the economic decisions of individuals and institutions and the consequences for market prices, returns, and the resource allocation.

Very well. Now that we're in the world of slow, second-level thinking, let's examine how the situation in the Norwegian housing market looks like:

• The vast majority of people agree that real estate is a safe investment
• The vast majority of people also expect the house prices to continue their climb in the coming years
• There are very good explanations for the rise in house prices, presented daily by experts in newspapers, telling that there is no bubble and we shouldn't worry
• Mortgage rates are at historic lows and expected to remain low for years to come
• You'd struggle to find an economist in Norway who would publicly admit that there could be a bubble - the "no bubble" consensus among professionals seems to be very strong
• Norway is a rich country, so we can't be the next Ireland or Spain - oil has brought us well-being for decades to come

First-level thinker looks at the bullet points above and says: "It's a safe investment, there is no bubble, so let's take out the cheap loan and buy our dream house.".

Second-level thinker looks at the evidence and says: "Everybody thinks it's a safe investment, everybody says there is no bubble, so everybody takes out the loan and buys the dream house, and not just that, but also a second house to make some easy money. If no one thinks of the price, if no one fears a bubble, and the mortgage rates are at historic lows, then there must be a bubble."