Basically, It's Over: A parable about how one nation came to financial ruin. - By Charles Munger

In the early 1700s, Europeans discovered in the Pacific Ocean a large, unpopulated island with a temperate climate, rich in all nature's bounty except coal, oil, and natural gas. Reflecting its lack of civilization, they named this island "Basicland."

The Europeans rapidly repopulated Basicland, creating a new nation. They installed a system of government like that of the early United States. There was much encouragement of trade, and no internal tariff or other impediment to such trade. Property rights were greatly respected and strongly enforced. The banking system was simple. It adapted to a national ethos that sought to provide a sound currency, efficient trade, and ample loans for credit-worthy businesses while strongly discouraging loans to the incompetent or for ordinary daily purchases.

Moreover, almost no debt was used to purchase or carry securities or other investments, including real estate and tangible personal property. The one exception was the widespread presence of secured, high-down-payment, fully amortizing, fixed-rate loans on sound houses, other real estate, vehicles, and appliances, to be used by industrious persons who lived within their means. Speculation in Basicland's security and commodity markets was always rigorously discouraged and remained small. There was no trading in options on securities or in derivatives other than "plain vanilla" commodity contracts cleared through responsible exchanges under laws that greatly limited use of financial leverage.

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But even a country as cautious, sound, and generous as Basicland could come to ruin if it failed to address the dangers that can be caused by the ordinary accidents of life. These dangers were significant by 2012, when the extreme prosperity of Basicland had created a peculiar outcome: As their affluence and leisure time grew, Basicland's citizens more and more whiled away their time in the excitement of casino gambling. Most casino revenue now came from bets on security prices under a system used in the 1920s in the United States and called "the bucket shop system."

The winnings of the casinos eventually amounted to 25 percent of Basicland's GDP, while 22 percent of all employee earnings in Basicland were paid to persons employed by the casinos (many of whom were engineers needed elsewhere). So much time was spent at casinos that it amounted to an average of five hours per day for every citizen of Basicland, including newborn babies and the comatose elderly. Many of the gamblers were highly talented engineers attracted partly by casino poker but mostly by bets available in the bucket shop systems, with the bets now called "financial derivatives."

Many people, particularly foreigners with savings to invest, regarded this situation as disgraceful. After all, they reasoned, it was just common sense for lenders to avoid gambling addicts. As a result, almost all foreigners avoided holding Basicland's currency or owning its bonds. They feared big trouble if the gambling-addicted citizens of Basicland were suddenly faced with hardship.

And then came the twin shocks. Hydrocarbon prices rose to new highs. And in Basicland's export markets there was a dramatic increase in low-cost competition from developing countries. It was soon obvious that the same exports that had formerly amounted to 25 percent of Basicland's GDP would now only amount to 10 percent. Meanwhile, hydrocarbon imports would amount to 30 percent of GDP, instead of 15 percent. Suddenly Basicland had to come up with 30 percent of its GDP every year, in foreign currency, to pay its creditors.

How was Basicland to adjust to this brutal new reality? This problem so stumped Basicland's politicians that they asked for advice from Benfranklin Leekwanyou Vokker, an old man who was considered so virtuous and wise that he was often called the "Good Father." Such consultations were rare. Politicians usually ignored the Good Father because he made no campaign contributions.

Among the suggestions of the Good Father were the following. First, he suggested that Basicland change its laws. It should strongly discourage casino gambling, partly through a complete ban on the trading in financial derivatives, and it should encourage former casino employees—and former casino patrons—to produce and sell items that foreigners were willing to buy. Second, as this change was sure to be painful, he suggested that Basicland's citizens cheerfully embrace their fate. After all, he observed, a man diagnosed with lung cancer is willing to quit smoking and undergo surgery because it is likely to prolong his life.

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As it worked out, the politicians ignored the Good Father one more time, and the Basicland banks were allowed to open bucket shops and to finance the purchase and carry of real securities with extreme financial leverage. A couple of economic messes followed, during which every constituency tried to avoid hardship by deflecting it to others. Much counterproductive governmental action was taken, and the country's credit was reduced to tatters. Basicland is now under new management, using a new governmental system. It also has a new nickname: Sorrowland.

TED Talk: Bill Gates on energy: Innovating to zero!

Hussman Weekly Market Comment: The Federal Reserve's Exit Strategy: Unlegislated Bailout of Fannie and Freddie

If one is alert, it is evident that the Federal Reserve and the U.S. Treasury have disposed of the need for Congressional approval, and have engineered a de facto bailout of Fannie Mae and Freddie Mac, at public expense.

Below is a chart of the composition of the Federal Reserve's balance sheet, in billions of dollars. Against these assets, the Fed creates currency and bank reserves, which comprise the "monetary base." Clearly, the volume of Fed-supplied stabilization funding in the system is still enormous. As James Hamilton has observed, "it seems not coincidental that, when you look at the total of all the assets the Fed is holding, the expansion of MBS purchases exactly offsets the declines from phasing out the short-term lending facilities. As a result of the MBS and agency purchases, the total assets of the Federal Reserve today exceed the total reached at the peak level of activity for the lending facilities in December 2008."

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My impression continues to be that current concerns such as the Greek debt crisis are far less important that the incipient backlog of foreclosures and mortgage losses we are likely to observe on all classes of adjustable rate mortgages in the next few quarters. The latest report from RealtyTrac, for example, notes " January foreclosure numbers are exhibiting a pattern very similar to a year ago: a double-digit percentage jump in December foreclosure activity followed by a 10 percent drop in January. If history repeats itself we will see a surge in the numbers over the next few months as lenders foreclose on delinquent loans where neither the existing loan modification programs or the new short sale and deed-in-lieu of foreclosure alternatives works.”

Frankly, it is too early to declare that the government interventions in the financial markets last year "worked." They were certainly effective over the short run, particularly in fostering a significant reduction in the level of investor risk aversion. But to "work" in a larger sense would require that we've solved the problem in a way that will allow us to avoid a second round of credit losses and institutional insolvencies. The evidence on that is unconvincing. The rate of mortgage delinquencies is currently more than double what it was a year ago, even without the impact of Alt-A and Option-ARM resets that can be expected to substantially amplify those difficulties this year. In January, delinquency rates on commercial mortgage backed securities jumped by a greater amount than in any prior month of the recent downturn. Though we've observed a great deal of forbearance in translating those delinquencies into new foreclosures, it is unlikely that this gap between delinquencies and foreclosures will persist much longer.

In short, the Greek debt crisis is interesting in its own right, but I suspect that it is not the most important story to follow.

Smart People, Dumb Decisions - By Michael Mauboussin

Originally found via Simoleon Sense.

If you ask people to offer adjectives that they associate with good decision makers, words like “intelligent” and “smart” are generally at the top of the list. Yet, history contains plenty of examples of smart people who made poor decisions as the result of cognitive mistakes. These mistakes can have horrific consequences, from the space shuttle Columbia disaster to the scores of bank failures across the United States since the start of the 2007 recession. But faulty decision making is also avoidable. Every day, research is offering new insights into the decision- making process. A science of choice is emerging, and the good news is that everyone, from students to stockbrokers, can learn how to make better decisions.

Smart people make poor decisions because the mental software that we humans inherited from our ancestors isn’t designed to cope with the complexity of modern day problems and systems. In short, smart people, like everyone else, face two major obstacles to making good decisions. The first obstacle is the brain, which evolved over millions of years to make decisions unlike what we face in modern life. The second obstacle is the growing complexity of the world in which we live.

Overconfidence: The Biggest Factor in Poor Decisions

Our natural decision-making process makes us vulnerable to certain mental mistakes. One example is what psychologists call the “inside view,” which explains that we consider problems by focusing on a specific task, use information that is close at hand, and make predictions based on that narrow and unique set of inputs. This approach is common for all forms of planning and almost always paints too optimistic a picture.

Overconfidence, in one form or another, is central to the inside view, and can lead to three illusions that can derail decisions: the illusion of superiority, the illusion of optimism, and the illusion of control.

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While people are notoriously poor at guessing when they’ll complete their own projects, they’re pretty good at guessing when other people will finish. In fact, the planning fallacy embodies a broader principle. When people are forced to look at similar situations and see the frequency of success, they tend to predict more accurately. If you want to know how something is going to turn out for you, look at how it turned out for others in the same situation.

Daniel Gilbert, a psychologist at Harvard University, has pondered why people don’t rely on the outside view more often: “Given the impressive power of this simple technique, we should expect people to go out of their way to use it. But they don’t.” The reason is that most people think of themselves as different, and better, than those around them.

Even people who should know better forget to consult the outside view. Now that you are aware of how the inside-outside view influences the way people make decisions, you’ll see it everywhere. In the business world, it will show up as unwarranted optimism for how long it takes to develop a new product, the chance that a merger deal succeeds, and the likelihood a portfolio of stocks will do better than the market. In your personal life, you’ll see it in the parents who believe their seven-year-old is destined for a college sports scholarship, debates about what impact video games have on kids, and the time and cost it will take to remodel a kitchen.

How to Incorporate the Outside View into Your Decisions

Unlike the inside view, the outside view asks if there are similar situations that can provide a statistical basis for making a decision. Rather than seeing a problem as unique, the outside view wants to know if others have faced comparable problems and, if so, what happened. The outside view is an unnatural way to think precisely because it forces people to set aside all of the cherished information they have gathered. Regardless, it can create a very valuable reality check for decision makers.

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Related book: Think Twice

Psychology at a Home Auction

I just attended an REDC home auction. I wasn't bidding; just there out of curiosity and to see how the process works. Warren Buffett has said that Berkshire doesn't participate in auctions, largely because of the concept known as the winner's curse. What I found most interesting about the process was the way the auction tried to use some psychology to get people ready and excited to bid before the auction began.

To set the tone of the morning, the auction played upbeat music to get everyone in a good, fun mood and to try and get everyone excited (maybe excited to overpay?). I showed up about 20 minutes early and entered the room to Phil Collins singing Invisible Touch. That song was followed up by Come On Eileen by the Dexys Midnight Runners, and then the song Smooth by Santana and Rob Thomas. And - to save the best for last - the final song that played just before the music stopped for the auction process to begin was James Brown's Living in America.

As the music was playing, there was also a presentation up on a big screen that was going through slides on how the auction process works, why it is good to buy a home through the auction process, and - in between every few slides - quotes from 4 well-known people. The 4 quotes were: 1) a Donald Trump quote about how great real estate is and how much he loves it (the word "love" was in the quote); 2) a quote from Andrew Carnegie about how 90% of all millionaires came through real estate; 3) a quote from Franklin Roosevelt that said "real estate cannot be lost or stolen.....it is about the safest investment in the world" (tell that to the people whose homes were being auctioned off for much less than they paid for them); and 4) a Henry David Thoreau quote about living the life you imagined.

Once it was time to start, someone who I think they said was the president of something come on to give an overview of things and introduce the guy he referred to as a "world champion auctioneer." During his overview, he told the audience that we are at the bottom of the housing market, we're currently heading into a recovery which was confirmed by an article he read in the Washington Post, that interest rates are near all-time lows and that might not last for long, and that owning a home is the American dream (again, tell this to the people whose homes were being auctioned off). He then ended his overview before introducing the auctioneer by saying/repeating "we are certainly at the bottom of the market."

As the auctioneer came on, he started by telling the audience that although things will go fast, don't be intimidated. He then did a practice run by pretending to auction off one of the auction worker's houses that he said was a 3 bedroom home in southern California. It should also be noted that the auction workers were all dressed in tuxedos and were excitable guys who look like they are having tons and fun and want to be your friend. The practice run ended, the worker's house was pretendedly auctioned off for $1 million, which they then showed on the screen as a truck with what was basically a wooden box built on the back. This of course got some laughs and got people to smile before the auction began.

Then the auction began. Their goal was to go through 25 homes per hour, so it was a quick-moving process. The first few houses went quickly but when the bid for a house was below what I think REDC wanted as a minimum, they were willing to wait longer for a winning bid to come in. I was there for a little over an hour after the auction began and would guess that about 15 homes were auctioned off. The workers in tuxedos moved around the room and applied a little pressure to bidders to try and get some competitive bidding juices.

It was a good learning process to see how an auction like this works. The auction really uses Cialdini's weapons of influence to try and get people to pay up and participate. From the 4 quotes mentioned above, the president who spoke, the auctioneer's title, and the Washington Post reference, you can see that the authority principle was very prevalent. The low starting bids and getting bidders to come with a cashier's check probably helps influence through the commitment and consistency principle. The comments about low interest rates not lasting and it being the bottom of the housing market uses the scarcity principle. The smiling, happy workers and fun atmosphere try to help influence through the likability principle. And the American dream comment and other comments made try and use social proof to get people more willing to bid. There are probably many other things at work, but the main point of all of this is probably that there is a good reason why people often overpay and experience "the winner's curse" at auctions. And the lesson is that if you ever do participate in an auction, make sure you have an estimate of value for what you're bidding on, you know the highest amount you're willing to pay for it, and then be disciplined not to go over that number, all while keeping in mind that there are plenty of weapons of influence that may be thrown at you to try and get you to increase your bid during the process.

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Update (2/15) - Manish from India was kind enough to point me to a great excerpt from Charlie Munger on auctions from his speech "The Psychology of Human Misjudgment":

Finally, the open-outcry auction. Well the open-outcry auction is just made to turn the brain into mush: you've got social proof, the other guy is bidding, you get reciprocation tendency, you get deprival super-reaction syndrome, the thing is going away... I mean it just absolutely is designed to manipulate people into idiotic behavior.

Then there is the Warren Buffett rule for open-outcry auctions: don't go.

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Hendry, Taleb & Faber: How To Invest $100 Million In 2010

Link from Market Folly: Hendry, Taleb & Faber: How To Invest $100 Million In 2010

Link to video: Investments: Where is the Money in 2010 – What are the Risks?

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How Manufacturing's Mockingbird Sings

Thanks to Lincoln for passing this along.

From batteries to cars, BYD engineers have found that successful product manufacturing begins by copying others

Auto technician Li Xuelin never dreamed of dismantling his boss' Mercedes Benz S300. But one day, that's exactly what the boss ordered Li and a half-dozen colleagues to do.

It wasn't easy. At first, the technicians just stood beside the shiny black car, daring not to touch it. But eventually their boss and BYD CEO Wang Chuanfu broke the stalemate.

Wang stepped up to the car and, with sweat on his brow, gouged the paint job with a car key. "Now you can start," he said.

Li's team disassembled the car, piece by piece, to reverse engineer the luxury car's electronic control system. It was a painstaking but money-saving project that's now become a trademark for Wang and BYD, a highly successful Chinese manufacturer that's proud to be a master copyist.

Since its launch in 1995, BYD has expanded from OEM battery manufacturing into various unrelated fields including IT products, autos and new energy. Li's experience with reverse engineering Wang's Benz has been repeated at many levels by BYD's army of about 30,000 engineers and technicians.

By reverse engineering products made by others, BYD pushed its way into manufacturing production, eventually expanding upstream and downstream in chosen fields to build a profitable, vertically integrated enterprise. BYD won big wherever its elbows went.

BYD's success as a revolutionary copyist has drawn mixed reactions, but of course business champions seldom pay heed to grumblings from those they defeat. When carmaking, for example, BYD found that reverse engineering can cut the cost of a new vehicle by more than one-third.

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How can simple imitation win a market? The Chery veteran said BYD strategy's is based on focus, brazenness and precision.

Rather than waste effort creating new models for the sake of variety, a limited number of resources are spent on developing key products. That's the company's focus. As a brazen market player, BYD picks best-selling products and blatantly copies them, head to toe.

The company also works to rigidly control costs and quality, and learns by doing. "BYD's excellent quality imitation cars are tied to the fact that the company has accumulated experience in strict product control from its earlier practices in batteries and the IT sector," the Chery source said.

"Maybe it's right. They very well may become China's flagship auto manufacturer."

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"Why are our cars so cheap?" retorted a mid-level staffer at BYD. "Money is saved on every part, from engine to dashboard."

This do-it-yourself attitude stretches from manufacturing to distribution to sales. True, BYD's homemade company ads are a little rough around the edges. But it spends only about 20,000 yuan to build a lighted, outdoor ad which, if outsourced to an advertising agency, could cost more than 400,000 yuan.

Hands-On Success

When U.S. billionaire Warren Buffett invested in BYD in 2008, major transaction player and MidAmerican Energy Holdings CEO David L. Sokol visited BYD's Shenzhen battery workshop. He was surprised to discover employees sitting on rows of workbenches – like 18th century seamstresses – busy producing millions of batteries every year with simple tools and bare hands.

Indeed, from the start, low-cost labor has been integral to Wang's strategy for overtaking Japanese competitors. He uses people instead of machines wherever possible, supplementing humans only when necessary.

BYD is proud of this operational model which it weaves into unique staff recruiting practices. In addition to laborers, the company hires top engineering students, sometimes an entire university class immediately after graduation, as well as capable engineers and retirees with extensive experience.

In a 2003 television interview with official CCTV, Wang said he thought labor costs plus market advantages were keys to success for Chinese enterprises.

Oak Value Fund Portfolio Managers Take Questions from Morningstar - January 22, 2010

1. What’s your take on Berkshire’s investment in Burlington Northern?

When it comes to the long-distance transportation of goods in the U.S., the lowest cost, most energy efficient mode of transportation is rail. Though the capital-intensive nature of the business contributes to significant barriers to entry, the industry has historically been characterized as a low return, cyclical business with poor customer service. Variations of the expression “what a way to run a railroad” are generally viewed as less-than-complimentary for good reason.

Perceptions aside, there are several reasons why the railroad business is evolving for the better. First, with the consolidation of the players over the past quarter century, the competitive dynamics within the industry have been gradually improving. Second, the industry has embraced the use of technology to improve customer service, operating efficiency and shareholder returns. From a broader value chain perspective, the railroad industry operates as a high fixed cost, low variable cost provider while the trucking industry generally functions in an environment that involves lower fixed costs and higher variable costs. In our view, these basic structural differences that allow the rails to move goods at less cost while consuming less energy are likely to advantage the rails in periods of inflation and rising variable costs.

We view Berkshire’s decision to purchase the country’s second largest railroad as a textbook example of Mr. Buffett’s longstanding view that it is better to pay a fair price for a good business than a good price for a fair business, particularly when one has the ability to source large amounts of inexpensive capital. Burlington’s geographic footprint in the West, where long-term growth prospects appear to be above average, could make it especially compelling. The Burlington network is positioned to benefit from increased volume of imports to the West Coast, increased transport of coal out of the Rockies and increased movement of grain out of America’s heartland. As one of the industry’s largest players, Burlington should benefit from structural and competitive advantages for many years.

Shares of Berkshire Hathaway have recently treaded water as the investment community has seemed preoccupied with the task of interpreting some “hidden message” in the timing and/or structure of the Burlington transaction. In our opinion, the most important message for observers to glean from this transaction is the sheer economic power of the Berkshire Hathaway business model to accomplish such a transaction at this point in time. As a long-term investor with significant capital and a diverse collection of businesses and investments, Berkshire may well be the ideal owner for a cyclical, capital-intensive business that benefits from the basic laws of physics and is positioned to be a toll bridge on economic growth.

The Depressing News About Antidepressants - By Sharon Begley

Thanks to Chris (my brother in pharmacy school) for passing this along. I love stories like this where people question conventional wisdom and the theories and studies that made it become conventional, especially when they appear to be doing objective research and then get criticized by their peers. This article reminds me last week’s post related to diet and exercise.

Studies suggest that the popular drugs are no more effective than a placebo. In fact, they may be worse.

Although the year is young, it has already brought my first moral dilemma. In early January a friend mentioned that his New Year's resolution was to beat his chronic depression once and for all. Over the years he had tried a medicine chest's worth of antidepressants, but none had really helped in any enduring way, and when the side effects became so unpleasant that he stopped taking them, the withdrawal symptoms (cramps, dizziness, headaches) were torture. Did I know of any research that might help him decide whether a new antidepressant his doctor recommended might finally lift his chronic darkness at noon?

The moral dilemma was this: oh, yes, I knew of 20-plus years of research on antidepressants, from the old tricyclics to the newer selective serotonin reuptake inhibitors (SSRIs) that target serotonin (Zoloft, Paxil, and the granddaddy of them all, Prozac, as well as their generic descendants) to even newer ones that also target norepinephrine (Effexor, Wellbutrin). The research had shown that antidepressants help about three quarters of people with depression who take them, a consistent finding that serves as the basis for the oft-repeated mantra "There is no question that the safety and efficacy of antidepressants rest on solid scientific evidence," as psychiatry professor Richard Friedman of Weill Cornell Medical College recently wrote in The New York Times. But ever since a seminal study in 1998, whose findings were reinforced by landmark research in The Journal of the American Medical Association last month, that evidence has come with a big asterisk. Yes, the drugs are effective, in that they lift depression in most patients. But that benefit is hardly more than what patients get when they, unknowingly and as part of a study, take a dummy pill—a placebo. As more and more scientists who study depression and the drugs that treat it are concluding, that suggests that antidepressants are basically expensive Tic Tacs.

Hence the moral dilemma. The placebo effect—that is, a medical benefit you get from an inert pill or other sham treatment—rests on the holy trinity of belief, expectation, and hope. But telling someone with depression who is being helped by antidepressants, or who (like my friend) hopes to be helped, threatens to topple the whole house of cards. Explain that it's all in their heads, that the reason they're benefiting is the same reason why Disney's Dumbo could initially fly only with a feather clutched in his trunk—believing makes it so—and the magic dissipates like fairy dust in a windstorm.

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To be sure, the drugs have helped tens of millions of people, and Kirsch certainly does not advocate that patients suffering from depression stop taking the drugs. On the contrary. But they are not necessarily the best first choice. Psychotherapy, for instance, works for moderate, severe, and even very severe depression. And although for some patients, psychotherapy in combination with an initial course of prescription antidepressants works even better, the question is, how do the drugs work? Kirsch's study and, now, others conclude that the lion's share of the drugs' effect comes from the fact that patients expect to be helped by them, and not from any direct chemical action on the brain, especially for anything short of very severe depression.

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Two other factors are at work in the widespread rejection of Kirsch's (and, now, other scientists') findings about antidepressants. First, defenders of the drugs scoff at the idea that the FDA would have approved ineffective drugs. (Simple explanation: the FDA requires two well-designed clinical trials showing a drug is more effective than a placebo. That's two, period—even if many more studies show no such effectiveness. And the size of the "more effective" doesn't much matter, as long as it is statistically significant.) Second, doctors see with their own eyes, and feel with their hearts, that the drugs lift the black cloud from many of their depressed patients. But since doctors are not exactly in the habit of prescribing dummy pills, they have no experience comparing how their patients do on them, and therefore never see that a placebo would be almost as effective as a $4 pill. "When they prescribe a treatment and it works," says Kirsch, "their natural tendency is to attribute the cure to the treatment." Hence the widespread "antidepressants work" refrain that persists to this day.

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The boy who said the emperor had no clothes didn't endear himself to his fellow subjects, and Kirsch has fared little better. A nascent collaboration with a scientist at a medical school ended in 2002 when the scientist was warned not to submit a grant proposal with Kirsch if he ever wanted to be funded again. Four years later, another scientist wrote a paper questioning the effectiveness of antidepressants, citing Kirsch's work. It was published in a prestigious journal. That ordinarily brings accolades. Instead, his department chair dressed him down and warned him not to become too involved with Kirsch.

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Right about here, people scowl and ask how anti-depressants—especially those that raise the brain's levels of serotonin—can possibly have no direct chemical effect on the brain. Surely raising serotonin levels should right the synapses' "chemical imbalance" and lift depression. Unfortunately, the serotonin-deficit theory of depression is built on a foundation of tissue paper. How that came to be is a story in itself, but the basics are that in the 1950s scientists discovered, serendipitously, that a drug called iproniazid seemed to help some people with depression. Iproniazid increases brain levels of serotonin and norepinephrine. Ergo, low levels of those neurotransmitters must cause depression. More than 50 years on, the presumed effectiveness of antidepressants that act this way remains the chief support for the chemical-imbalance theory of depression. Absent that effectiveness, the theory hasn't a leg to stand on. Direct evidence doesn't exist. Lowering people's serotonin levels does not change their mood. And a new drug, tianeptine, which is sold in France and some other countries (but not the U.S.), turns out to be as effective as Prozac-like antidepressants that keep the synapses well supplied with serotonin. The mechanism of the new drug? It lowers brain levels of serotonin. "If depression can be equally affected by drugs that increase serotonin and by drugs that decrease it," says Kirsch, "it's hard to imagine how the benefits can be due to their chemical activity."

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Which returns us to the moral dilemma. In any year, an estimated 13.1 million to 14.2 million American adults suffer from clinical depression. At least 32 million will have the disease at some point in their life. Many of the 57 percent who receive treatment (the rest do not) are helped by medication. For that benefit to continue, they need to believe in their pills. Even Kirsch warns—in boldface type in his book, which is in stores this week—that patients on antidepressants not suddenly stop taking them. That can cause serious withdrawal symptoms, including twitches, tremors, blurred vision, and nausea—as well as depression and anxiety. Yet Kirsch is well aware that his book may have the same effect on patients as dropping the magic feather did for Dumbo: without it, the little elephant began crashing to earth. Friends and colleagues who believe Kirsch is right ask why he doesn't just shut up, since publicizing the finding that the effectiveness of antidepressants is almost entirely due to people's hopes and expectations will undermine that effectiveness.

It's all well and good to point out that psychotherapy is more effective than either pills or placebos, with dramatically lower relapse rates. But there's the little matter of reality. In the U.S., most patients with depression are treated by primary-care doctors, not psychiatrists. The latter are in short supply, especially outside cities and especially for children and adolescents. Some insurance plans discourage such care, and some psychiatrists do not accept insurance. Maybe keeping patients in the dark about the ineffectiveness of antidepressants, which for many are their only hope, is a kindness.

Or maybe not. As shown by the explicit criticism of drug companies by the authors of the recent JAMA paper, more and more scientists believe it is time to abandon the "don't ask, don't tell" policy of not digging too deeply into the reasons for the effectiveness of antidepressants. Maybe it is time to pull back the curtain and see the wizard for what he is. As for Kirsch, he insists that it is important to know that much of the benefit of antidepressants is a placebo effect. If placebos can make people better, then depression can be treated without drugs that come with serious side effects, not to mention costs. Wider recognition that antidepressants are a pharmaceutical version of the emperor's new clothes, he says, might spur patients to try other treatments. "Isn't it more important to know the truth?" he asks. Based on the impact of his work so far, it's hard to avoid answering, "Not to many people."

Warren Buffett and Hank Paulson's Credit Crunch 'Conversation' In Omaha