Here is a useful chart. It is useful because it can be used for lots of different reports, such as:

• Value of my house
• Earnings per share for our company
• Price of my favorite stock
• Expected value of my bonus

There are two main parts of the chart:

We will start with the last half, because we are all too familiar with it.

This part of the chart depicts a sudden, steep fall from a peak, that some would call a Collapse, or a Crash, but today we are going to use the more sonorous term, Debacle! Regardless of the terminology, a Debacle is unexpected, fast, destructive, and once you are in it, almost impossible to get out of. If you are a skier or a snowmobiler, you might agree this is a fair description of the dreaded avalanche.

Rule 1: The only practical way to survive an avalanche is to be somewhere else when the mountain decides to have one.

Before the Debacle, there is a longer period of general success and prosperity. The last part of this period can be called a Bubble, the bit before the Bubble considered a Boom, and so on, but there has not been a comprehensive word the whole half-cycle until now, for from now on, we will call it the Bacle. Now we have a simple but complete cycle; Bacle followed by Debacle.

Can you avoid the Debacle by not entering the Bacle? Possibly so, but if we are talking about a stock market cycle, and you want to make a living as an analyst or portfolio manager; you have to play, and you should, for there is a lot of money to be made in a Bacle. To make money, and then keep it, we must dissect the structure of the Bacle.

Phase one of a Bacle is when prices are low, and there is not much going on, until a Good Idea Shows up. The Good Idea will spread and create profit and excitement, and eventually generate the whole cycle.

Rule 2: Every bad idea starts as a Good Idea

An idea that is a bad idea to begin with doesn’t go anywhere. Your company compliance manual does not have to have a rule forbidding you to drop a cinder block on your foot. Only good ideas have staying power. For instance, when you go to a party, but feel intimidated by a large number of people you don’t know, a glass of champagne is a fine way to help you relax, strike up conversations with the other guests, and even make some witty remarks. The first glass is a Good Idea. The second glass makes you even wittier, a trifle ribald perhaps, but your new friends certainly enjoy your stories. You get on the dance floor and discover you can still do some fancy steps, and wondrously, you are now sexually irresistible. Is a third glass of champagne still a Good Idea? Nope. You are entering the last stage of your Bacle, and it is time to switch to club soda or the Debacle will be swift and humiliating.

Rule 3: Bacles have three parts.

Just as our cocktail party had three levels of intoxication, and chess games have three phases (opening, middle game, end game), Bacles have three parts too. My brilliant friend Paul McCulley (the sage of Pimco) describes three phases of investment in a Bacle. He in turn pinched the idea from the economist Hyman Minsky (1919-1996, Professor at Berkeley and later Bard). Minsky had three Bacle investment levels of interesting intoxication.

1. Hedged assets
2. Speculative assets
3. Ponzi assets

What do these three levels refer to? Now we all know all about the home mortgage business, so we will pick examples from mortgages. A “Hedged asset,” is safe and old fashioned. You lend a buyer money to buy a house subject to a 20% down payment and verified adequate income on the buyer’s part. You can make a decent return on the spread between your bank’s cost of funds (say 3%) and the mortgage (say 6%). You have a secure investment because you have a trustworthy borrower whose home equity is worth more than the mortgage.

After a few years, mortgage defaults have been so low that your boss tells you the portfolio is too conservative Profit margins are fine, but we are losing market share. We can grow faster if we relax standards and finance “Speculative Assets.” A speculative mortgage has a down payment of only 10%, and the house carrying costs relative to buyer’s income is dangerously high, but a higher interest rate spread will cover the increased risk. Besides, house prices have been rising, even in foreclosure you won’t take a loss.

Obviously, this is close to the peak, and Debacle looms.

One of Professor Minksy’s insights into the process was to explain why stage one, “hedged assets,” wasn’t permanent. He showed that the cause of instability was stability! The stable profits made during stage one convince market participants that risks are very low, so taking on more risk means more profits—and for the next few years that is absolutely correct! The first phase of stable prosperity seduces us into level two and then level three which is unstable.

Rule 4: The Debacle is caused by the Bacle.

How can you tell you are in the third and final stage of the Bacle? One sign is that “everyone is doing it.” I remember well the Internet Bacle. It was founded on a Good Idea (the Internet will change the way we live) but by 1999, it had gone clearly to the speculative stage. If you held back from buying the whimsical IPO’s of the time, the scornful putdown was “You just don’t get it!”, making you feel that you were the only at the party not making out by the swimming pool. The Debacle was awesome.

Technical Appendix

The word-pair Bacle-Debacle will not withstand serious scholarly analysis, but so what? The “x: de-x” construction is growing in popularity. We all board airplanes, but apparently now we can Deboard them too.

Dewater your flooded basement. Deflate your economy. Decumulate your assets. These words really get used.

The game doesn’t always work, though: What is Mentia? Vorce?....Is a good kid a Linquent?

One last thought: Beethoven is dead. Do you suppose he is decomposing?

Ralph Wanger is a Senior Advisor to Wanger Investment Management, Inc.