The Berkshire Hathaway 2017 Annual Shareholders Meeting kicks off on Saturday May 6. Ahead of the event, we decided to lookback at some nuggets of wisdom on investingfrom Warren Buffett himself.Back in 2010,Buffett answered several questions about what he thought caused the housing and credit bubble in an interview with the Financial Crisis Inquiry Commission (FCIC).Mid-way throughthe interview, he also gave a clear explanation of how bubbles are formed, which we pulled and shared below.It's a stunningread for anyone interested in investing or behavioral economics ' or, more broadly, in human behavior.The interview comes from a document dump from the National Archives, which released transcripts, meeting agendas, and confidentiality agreements from the FCIC. The group was set up in the aftermath of the crisis by Congress to look into the causes of the event.Anyway, here's Buffett (emphasis ours):"... My former boss, Ben Graham, made an observation 50 or so years ago to me that it really stuck in my mind and now I've seen evidence of it.He said, 'You can get in a whole lot more trouble in investing with a sound premise than with a false premise.'If you have some premise that the moon is madeof green cheese or something, it's ridiculous on itsface. If you come out with a premise that common stockshave done better than bonds [... that] became the underlying bulwark for the [1929] bubble. People thought stocks were starting to bewonderful and they forgot the limitations of theoriginal premise [....] So after a while, the original premise, whichbecomes sort of the impetus for what later turns out tobe a bubble is forgotten and the price action takesover.Now, we saw the same thing in housing. It's atotally sound premise that houses will become worth moreover time because the dollar becomes worth less. [...]And since 66% or 67% of the people want to own their own home and because you can borrow moneyon it and you're dreaming of buying a home, if youreally believe that houses are going to go up in value,you buy one as soon as you can. And that's a very soundpremise. It's related, of course, though, to houses selling at something like replacement price and not faroutstripping inflation.So this sound premise that it's a good idea tobuy a house this year because it's probably going tocost more next year and you're going to want a home, andthe fact that you can finance it gets distorted overtime if housing prices are going up 10 percent a yearand inflation is a couple percent a year. Soon theprice action 'or at some point the price action takesover, and you want to buy three houses and five housesand you want to buy it with nothing down and you want toagree to payments that you can't make and all of that sort of thing, because it doesn't make any difference:It's going to be worth more next year.And lender feels the same way. It reallydoesn't make a difference if it's a liar's loan or you know what I mean' [...] Becauseeven if they have to take it over, it's going to beworth more next year.And once that gathers momentum and it getsreinforced by price action and the original premise isforgotten, which it was in 1929.The Internet was the same thing. The Internetwas going to change our lives. But it didn't mean thatevery company was worth $50 billion that could dream upa prospectus.And the price action becomes so important to people that it takes over the ' it takes over theirminds, and because housing was the largest single asset,around $22 trillion or something like that, not abovehousehold wealth of $50 trillion or $60 trillion orsomething like that in the United States. Such a hugeasset. So understandable to the public ' they mightnot understand stocks, they might not understand tulipbulbs, but they understood houses and they wanted to buy one anyway and the financing, and you could leverage upto the sky, it created a bubble like we've never seen."You can check out the full interview with Warren Buffett at the National Archives.SEE ALSO:An Ivy League professor explains chaos theory, the prisoner's dilemma, and why math isn't really boringJoin the conversation about this storyNOW WATCH: Warner Bros. might have to pay $900 million if it can't prove ghosts are real
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