Short-sellers, or the bogeymen as they are also called, are the real culprits of the credit crisis. At least, that is what some would have you believe – and indeed, the man who may well be the world’s savviest investor seems to think that.

Yet, take another look, and there is evidence to say that if we had adopted the derivatives market more enthusiastically, then the whole sorry tale of a housing bubble could have been avoided.

So, in one corner, we have the world’s richest man; in the other corner, we have a professor of economics at one of the world’s most famous universities, and a man whose track record with timely predictions is impressive indeed.

Human nature has a lot to do with it, too – madness of crowds, and the herd instinct.

But first, consider how we judge wisdom.

The wise-in-hindsight brigade never go away. In his book The Black Swan, Nassim Taleb told the story well. Imagine the billionaire who is an absolute workaholic, who sleeps, breathes and eats work. It is obvious how he had made his money, and therefore, we conclude, we know what you have to be like in order to make it rich.

But then another billionaire is so laid back he is horizontal. He is lazy and workshy, but creative. And there’s your answer; because he kept his mind free of the day to day rumblings of business, and allowed insightful ideas to jump into his head, he became great.

The truth, though, is that there are plenty of workaholics who don’t make it. The workaholic bankrupt is surely just as common as the workaholic billionaire. And the same applies to the lazy man, probably even more.

The point really is that there are many possible explanations for why some are rich and others are not, and luck has a lot to do with it.

Now, with the above example in mind, consider these two views on the credit crunch.

In 2003, the Sage of Omaha, the great wise man of investing, also known as Warren Buffett, made a stark, and it now appears prophetic, warning on financial derivatives. These complex tools are “financial weapons of mass destruction,” he famously opined.

So, that was rather insightful. Of course, we have become used to insightful remarks from the world’s richest man, but surely he was right there. If they had got rid of derivates, and the futures market, there would surely have been no credit crunch.

Yet, another wise man, whose claim to prescience is, in some ways, even more impressive than Mr Buffett’s, reckons that if we had adopted derivatives more enthusiastically, crashing house prices, which created financial crisis in their wake, could have been avoided.

Robert Shiller, Professor at Yale, the man behind the Case Shiller US property prices index, and author of the book Irrational Exuberance, published at just that moment when dotcoms peaked, has a rather different take on things.

Mr Shiller was one of those who warned about the dangers implicit in surging house prices in the US. While all around Americans said that house prices will always go up, he looked around in disbelief.

According to the Professor, a lot of it is down to irrational human nature. It boils down to the way we behave in a crowd. That’s why we have had bubbles in history, bubbles such as the South Sea and Dutch Tulip mania.

Deviating slightly from what the Professor says, we see crowds go mad over and over again. Ancient Athens embarked on a war it couldn’t possibly win because, if you recall from your history, in Ancient Athens the mob decided everything. All free males were obliged to attend the agora and vote on all major decisions. An eloquent orator called Alcibiades sold the populace on his idea, and once the momentum had gathered pace it appeared the crowd was caught up in the moment.

Truth is, we witness crowds go mad all the time – it happened in the UK during the Falklands crisis – maybe it happened to an extent when Princess Diana died. It happens in a closed environment even more frequently – that is why a class may turn on one pupil and engage in collective bullying. We saw it in the TV programme Big Brother last year during that notorious racist row, and most dangerously of all we saw it in Nazi Germany.

The Professor also reckons that the US housing craze occurred in part because not enough people enjoyed a sufficient education in financial matters, while in the US during the time when housing madness was especially severe, good financial advice was only available to the wealthy.

Finally, from a career point of view, it can make sense to run with the crowd, even if the crowd is running the wrong way. The fund manager who loses a small amount of money when all around others make huge profits will get fired. The fund manager who loses a vast sum of money at a time when just about everyone is doing the same, will probably hold onto his job – at least in the short-term. So we are disincentivised to go against the crowd – even if we think they are wrong.

In a way, you can understand why this made sense in the Rift Valley of East Africa when Homo Sapiens were first emerging. Team work was necessary for our survival – and it never made sense to go against the pack.

So, how could it have been avoided? Professor Shiller reckons that a futures market for housing would have brought balance to the equation. If people had been allowed to bet against rising house prices, the whole madness would never have occurred.

In a way, it is like using the wisdom of crowds to counterbalance the madness of crowds.

© Investment & Business News 2013