Identifying and Using Principles

Identifying and using principles isn't important to every endeavor. For example, knowing how to properly gap a spark plug or replace brake pads are things a good mechanic can learn quickly through experience and practice without much theory. But to design an engine you need a higher level of thinking. You need to understand the principles that make a car engine function. Of course you can be a mechanic and a designer at the same time, but the thinking that goes into the making of an engine will usually have greater impact than that which goes into maintaining it (though understanding the principles involved can certainly help with the latter too).

Okay, so you don't want to either fix car engines nor design them. But you do want to think more effectively, in ways that relate to whatever it is that you do want in life. Then you need to train your mind to think about the principles involved in things. The consequences of not understanding basic principles are often made obvious in life in big and small ways. Let's see how, starting with one of the "small" examples.

Years ago a friend of mine wanted to cool his apartment with an air conditioner, but he didn't have a window that was suitable for installation, nor a another easy way to vent the unit to the outdoors. He thought he could just set the machine in the middle of the room and it would somehow create coldness that would then be blown out into the surrounding space.

Most air conditioners work by compressing freon gas, which gets hot as a result, and then running this high pressure gas through coils that dissipate the heat (venting it to the outside air) and condensing it into a liquid, which then evaporates into gas form again in another set of coils, which causes it to cool. Air is blown over the cold coils and into the room to cool it. It then cycles through the same process over and over.

The relevant principle here is that air conditioners transfer heat. They cannot "uncreate" heat, but only move it. If they can't transfer it outside, they just remove heat and add it back to the same air. If you just take heat out, add it back in, and add the heat created by the motor, the room gets hotter, not cooler. Had I not been able to convince my friend of this he may have sat there getting hotter and hotter and perhaps he would have returned the machine, complaining that it didn't work.

Thinking Without Understanding Important Principles
More Serious Examples

Obviously, a lack of understanding of such simple principles can lead to discomfort. Another example is people (and countries) who don't quite get the principle of spending no more than they make or of investing for the future or planning for unpredictable circumstances. They get into serious troubles due to their lack of understanding. Let's look at a more detailed example having to do with mortgages and foreclosures.

Suppose in the name of "fairness" new laws made it difficult for mortgage lenders to foreclose on the homes they lent money for. At first glance, many people would like this idea. Nobody wants to lose a home nor see others lose theirs. It seems to many that such laws would be good for families or anyone buying a house. Unfortunately, this just isn't true, which becomes clear if you look at the principles involved - especially the ones that are being ignored or just not understood.

The Important Principles

1. Home lenders lend money to make a profit.
2. They will stop lending if they can't make money at it.
3. Lending involves the risk of loss.
4. That risk is reduced by having the right to take the home if the loan isn't paid on time.
5. The potential loss of the home through foreclosure makes borrowers more likely to pay.
6. The more difficult it is to foreclose on and take the home, the less willing lenders will be to lend.
7. The less lenders lend, the more difficult it is for people to own homes.

These crucial principles are mostly ignored by those seeking to "help" people by making foreclosures more difficult. They answer the question of why any lender would ever risk large sums of money to make a little interest each month. It is because they have collateral and the borrower has consequences for not paying. A house is mortgaged as collateral for a loan. If the lender can take the house easily when the terms of the loan aren't met, then the lender can more safely lend the money to buy it. The buyer, meanwhile, will try hard not to violate the terms of the agreement if faced with the consequence of losing the home.

With those principles in mind, let's look again at the idea of laws making it tough for a lender to take a home. They make loans riskier for lenders, don't they? A house which the lender has to fight for years to take (while possibly receiving no payments) isn't the same kind of collateral as one he can foreclose on in months. And if a home owner can't lose his home too easily, the consequences of not paying on time are less severe. We can safely predict that under such laws there will be more loan delinquencies, but more importantly, we can predict that lenders will be less likely to risk their money on such loans.

That, by the way, has been proven true in experience. Several recent articles in financial magazines reported on the home mortgage situation in Brazil. It used to be that it was very difficult for a bank to foreclose on a home and take it. The process took over ten years as I recall. As you might imagine, there was almost no mortgage lending industry in the country, making it extremely difficult for most people to buy a home.

After changes that simplified and shortened the process, there are suddenly lenders who will finance home purchases. More people than ever are starting to buy their own homes in Brazil. Of course, if the foreclosure process is ever reduced in time to a few months, lenders will probably make it even easier for buyers, offering lower down payment options, for example.

So are laws "protecting" people from foreclosure good for them? Experience argues the opposite. If "good" in this context is defined as the opportunity to have a home of one's own, then making it legally easy to lose that home is ironically the best way to go - perhaps a counter-intuitive solution for those who are not in the habit of looking at the principles involved in things. The United States, with one of the more streamlined processes for a lender to foreclose on a home, has one of the highest rates of home ownership in the world. But if laws made foreclosure difficult enough, there would be few loans made - a disastrous consequence of making laws in ignorance of the principles involved.

Thinking Using Principles

Here is a basic formula for generating new ideas or just new understandings:

1. Identify the principles involved in a process, event or thing.

2. Test their validity (ideally by finding supporting evidence, but at least by logical supposition).

3. Consider or reconsider the subject based on these principles.

4. Look for new solutions or ideas based on your new understanding.

This probably isn't anything new to those who visit this site or read the brainpower newsletter, but sometimes we need reminding or a new explanation. Then we need to actually apply and practice what we know. In this instance you might want to pick out any issue suggested by the evening news and see if you can find some important principles that are being overlooked and generate some new ideas from those. Do this until it becomes a habit. Making processes like this habitual is how you become a powerful thinker.