Borrowed Conviction

I was recently listening to a podcast interview with a well-known and successful hedge fund manager. During the conversation, the subject of FTX, the failed cryptocurrency exchange, came up. Like many investment firms, his fund had invested in the company before its spectacular collapse.

We all know that even the greatest investors make mistakes. But what stood out was his candid admission that they had relied on assumptions that, in hindsight, should have been independently verified, and that the FTX experience had led them to strengthen their due diligence process.

As I listened, other examples came to mind: Theranos, Silicon Valley Bank, Wirecard — high-profile failures that attracted the backing of respected investors, institutions, and industry leaders who, by any measure, should have known better.

As I reflected on these stories, I found myself asking the same question each time: how do intelligent, accomplished people with access to information and teams of experts end up making consequential mistakes that seem obvious in hindsight?

Where did their conviction to get involved come from?

When uncertainty is high and information is imperfect, all of us look for clues. We pay attention to who else is involved, who is endorsing an idea, who has already committed capital, and who appears confident. The participation of respected investors, prestigious institutions, or successful entrepreneurs becomes a form of validation.

This process is so natural that it doesn’t feel like outsourcing thinking and judgment. It feels like being informed. But there is an important distinction between gathering information and borrowing conviction.

Information should inform our thinking. It should not replace it.

Yet many costly investment mistakes share a common characteristic: too many people took comfort from the fact that other supposedly intelligent people had already reached the same conclusion.

The greatest investment risks often emerge not when nobody has done the work, but when everybody assumes somebody else has.

That is the essence of borrowed conviction — and the stories below are what it looks like in practice.

Silicon Valley Bank

In March 2023, Silicon Valley Bank collapsed in 48 hours, becoming the second largest bank failure in American history. The speed was not surprising — bank runs move fast once they start — but the blindness that preceded it was.

SVB was the bank of the technology world. The concentration of the biggest names in venture capital, life sciences, and Silicon Valley startups that banked there was remarkable. In that tightly connected ecosystem, the sheer density of prestigious names had become its own form of validation. If Sequoia banked there, if the best-known founders banked there, it felt safe. Nobody asked the next question.

For anyone who read SVB’s financial statements carefully, the picture was alarming.

The bank’s deposits had nearly quadrupled from $50 billion in 2018 to nearly $190 billion in 2021 — approximately eight times the average rate of deposit growth in the banking industry. As of the end of 2022, 94 percent of SVB’s deposits were uninsured. In a conventional bank, roughly 55 to 60 percent of deposits are FDIC-insured. At SVB, that protection was nearly absent.

The structural problem ran deeper. In a typical bank, depositors and borrowers offset each other. SVB’s clients — flush with venture capital funding — had little need to borrow, so the bank had no offsetting loan demand. To generate yield in the low-rate environment, SVB bought long-dated bonds and designated them as “hold to maturity” assets, meaning they would not be marked to market on the balance sheet. When the Federal Reserve began raising rates aggressively, the value of those bonds fell sharply. The market value of SVB’s bond holdings declined by $21 billion.

When word of the losses spread, depositors withdrew $42 billion in a single day. To meet those withdrawals, the bank was forced to sell bonds and crystallize losses it had been carrying off-balance-sheet. It was shuttered the following morning.

None of this required inside information. Everything was in the public filings. But nobody in the ecosystem appears to have asked the fundamental question: setting aside the fact that everyone I respect banks here, is this actually a safe place to park our money?

In the tightly connected world of Silicon Valley, reputation had gradually become a substitute for scrutiny. The social proof that created SVB’s sense of safety also made the panic swift and total. Confidence borrowed from others evaporated overnight.

Theranos

The book Bad Blood chronicles one of the most remarkable corporate deceptions in business history. At the center of the story was Theranos, a company that claimed it could perform hundreds of laboratory tests using just a few drops of blood from a finger prick. If true, the technology would have revolutionized healthcare.

Elizabeth Holmes founded Theranos in 2003, dropping out of Stanford at nineteen to pursue what she said was a revolution in medical diagnostics. Her pitch was compelling: a proprietary device she called the Edison could run more than two hundred blood tests from a single finger prick. No needles. No labs. Catch disease earlier. Save lives.

As it turned out, none of it was true. The technology did not work.

History is full of charismatic founders making ambitious claims. The more interesting question — the one worth sitting with — is how so many accomplished, intelligent, and well-connected people were misled for so long.

The Theranos board arguably had more political, military, and business prestige than almost any private company in America. At various points it included former U.S. Secretaries of State George Shultz and Henry Kissinger; former U.S. Secretaries of Defense William Perry and James Mattis, who was also a retired four-star Marine Corps general; and former U.S. Senators Sam Nunn and Bill Frist, the latter a heart and lung transplant surgeon by training. Other directors included Richard Kovacevich, former CEO of Wells Fargo; William Foege, former Director of the CDC; Riley Bechtel, Chairman and former CEO of the Bechtel Group; and David Boies, one of the most prominent litigators in the United States.

The investors were equally distinguished. Rupert Murdoch invested $125 million. The Walton family of Walmart fame invested approximately $150 million. The DeVos family committed roughly $100 million, as did Cox Enterprises. Other backers included Oracle founder Larry Ellison, Mexican billionaire Carlos Slim, New England Patriots owner Robert Kraft, and the Pritzker family. In total, Theranos raised more than $700 million and reached a peak valuation of $9 billion.

Viewed individually, each board member and investor added a layer of credibility. Viewed collectively, they created something even more powerful: the impression that someone else must have already verified that the technology worked. The growing list of respected names became evidence in itself.

There is a detail in the Theranos story that captures the psychology of borrowed conviction better than any balance sheet could.

Tyler Shultz, freshly graduated from Stanford and the grandson of board member George Shultz, joined Theranos in 2013. Within months he had identified serious problems with the company’s testing accuracy, its data practices, and the gap between what the technology claimed to do and what it actually did. He raised concerns internally. He was dismissed. He then went to his grandfather — a sitting board member, a man who had served as Secretary of State, Secretary of the Treasury, Secretary of Labor, and Director of the Office of Management and Budget — and told him directly that something was wrong.

George Shultz also dismissed his concerns. By that point, he had become deeply convinced of Elizabeth Holmes’s vision and credibility. When forced to choose between the concerns of his grandson and the assurances of the founder he admired, he sided with Holmes.

Tyler eventually became a whistleblower, sharing information with Wall Street Journal reporter John Carreyrou, whose investigation exposed the fraud and ultimately brought the company down. When Theranos dissolved in 2018, investors had lost approximately $950 million. Holmes was convicted of fraud in 2022 and sentenced to more than eleven years in prison.

What kept Theranos alive for as long as it did was not evidence of a working technology. It was the weight of accumulated prestige. Each endorsement made the next one easier. No one with influence appears to have independently verified the core claim on which the entire company rested. Instead, each participant appears to have drawn comfort from the fact that other intelligent, accomplished people had already signed on.

The core question was simple: did the technology actually work? Nobody seems to have asked it.

 When Prestige Replaces Due Diligence

You might expect that FTX, with its roots in the relatively young and unregulated world of crypto, would attract less rigorous investors. It attracted some of the most rigorous institutions in the world.

At its peak FTX was valued at $32 billion. Sequoia Capital, Temasek Holdings, and the Ontario Teachers’ Pension Plan were among a group that collectively invested approximately $2 billion. These are not unsophisticated allocators. Yet no major investor took a board seat. No independent audit examined the relationship between FTX and Alameda Research, the affiliated trading firm that was quietly borrowing billions in customer funds.

When FTX filed for bankruptcy in November 2022, the lawyer brought in as its new CEO was John J. Ray III — the same person who had overseen the Enron bankruptcy. He said he had never in his career seen such a complete failure of corporate controls. Sequoia wrote its $210 million investment down to zero and apologized to its limited partners. Temasek wrote off $275 million. What had passed for diligence, it seems, was largely a function of who else was already in the deal.

Wirecard tells a similar story with a different accent. For years the German payments company sat in the DAX 30 — Germany’s index of its most valuable public companies — with a peak valuation of around €24 billion. The Financial Times had been raising questions about its accounting as early as 2015. Short sellers raised the same concerns. Germany’s financial regulator, BaFin, responded by banning short selling of Wirecard shares and filing complaints against the journalists investigating the company. EY signed off on the accounts for twelve consecutive years. When the fraud finally broke in 2020, €1.9 billion in cash that Wirecard claimed to hold in Philippine bank accounts was found not to exist at all. Over €20 billion in market value was wiped out.

In both cases the people who raised concerns earliest — short sellers, investigative reporters, internal skeptics — were treated as the problem. The institutions that should have been asking questions were instead reinforcing the consensus.

The lesson is not that institutions are always wrong. It is that institutional validation should never substitute for independent thought.

 Why This Keeps Happening

The ability to think independently is genuinely rare. Information has never been more abundant, but original judgment remains surprisingly uncommon. That is not a coincidence.

Independent thinking is psychologically expensive. It means sitting with uncertainty that the people around you don’t appear to feel. It means holding a view when the crowd disagrees. It means being willing to be wrong — visibly, publicly, alone — rather than being wrong as part of a group where the failure gets distributed.

In professional settings the incentives often make it worse. A fund manager who loses money the same way everyone else did may be considered unlucky. A fund manager who loses money by going against the consensus may be considered incompetent. The first person keeps their job. The second is less certain to. When careers are structured that way — and most are — the rational response is to stay close to the herd. Not the right response. The rational one.

This is why outsourced thinking is not primarily a problem of laziness. It is a problem of incentives and psychology, and recognizing it in yourself requires a degree of honesty that most institutional environments quietly discourage.

 The Only Question That Matters

For long-term investors, understanding this tendency is not academic. Superior results rarely come from following consensus. They come from developing the ability to evaluate facts independently, arrive at your own conclusions, and maintain those conclusions when they differ from the crowd.

That means asking the foundational question yourself, every time, regardless of who else is already in the room: do I actually understand why this is a good investment?

It is important not to get carried away simply because smart people you respect believe the story, because the board appears impressive, or because the stock price has gone up. None of those things prove that the underlying thesis is correct. 

The central question is: Do I understand all aspects of this business?

Losses caused by genuine independent judgment can be reviewed and learned from. They strengthen your process. They sharpen your thinking. They leave something useful behind.

Losses caused by outsourced thinking tend to leave behind only one thing:  The comfort of “Everyone believed it.”

That sentence ends a lot of the most expensive stories in financial history. It is not an explanation. It is a confession that no one was actually doing the thinking.

The investors who endure over long periods — through markets that have a way of eventually finding out what things are worth — tend to be the ones willing to do the uncomfortable, unglamorous work of thinking for themselves. Not because they are smarter than everyone else in the room. But because they understood that thinking is the one thing in this business you cannot afford to outsource.

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