I knew the cause of the economic crisis before it happened.
So did Robert Shiller. And Andrew Smithers. And John Walter Russell. And Rob Arnott. And all other Valuation-Informed Indexers. If you understand that stock valuations affect long-term returns, you understand that bull markets of the size we saw in the late 1990s always cause an economic collapse a few years later.
But most do not share my perspective. Most of us are Buy-and-Holders. The Buy-and-Holders were shocked to see the events of September 2008 play out. When people are in shock, they feel a need to come up with explanations of the shocking thing that has happened to them. The 90 percent of us who don’t follow Valuation-Informed Indexing strategies began offering explanations within days of the beginning of the collapse.
The explanations fall into two categories. Liberals argued that it was the weakening of the regulation of Wall Street that caused the trouble. Conservatives pointed to recent policies that encouraged the issuance of mortgages to low-income people who in earlier days would not have qualified for such mortgages.
Neither explanation hits the nail on the head, in my assessment. Neither contains zero truth. I am a conservative. But it is my belief that in this case it is the liberals who have the better of the argument. The liberals came closer than the conservatives to getting this one right.
It is my hope that enough time has passed that we may be able to begin to make some real sense of what is going on without our fears blinding us to the realities and causing us to hold tight to our ideological security blankets.
The good thing about conservatives is that they favor fiscal integrity. So their first reaction when they heard about the crisis was to look for irresponsible spending. They found it in the new policies regarding subprime mortgages. Puzzle solved!
The problem here is that, while subprime mortgages may well have been a bad idea, it is more than a little hard to accept that the new policies on subprime mortgages would be enough to bring on a worldwide economic collapse. You might be able to make a case that it served as the straw that broke the camel’s bank. But, if that’s the case, the true cause of the crisis was the thing that added the first 10,000 straws to the camel’s back, not the last one. There is more than a bad policy regarding subprime mortgages at the root of this.
The bad thing about conservatives is that they are hyper-vigilant of mistakes made by government and hyper-tolerant of mistakes made by private companies. I once contacted a conservative blogger offering to write a guest blog entry arguing that it was the reckless promotion of Buy-and-Hold investing strategies that served as the primary cause of the crisis. He said “no.” Not because he didn’t buy the argument. He seemed generally sympathetic to it. He told me that he was saying “no” because Buy-and-Hold was not promoted by the government and thus there was no news value in identifying Buy-and-Hold as the primary cause of the crisis. Oh, my!
The good thing about liberals is that they are sensitive to the injustices that follow from excessively unequal distributions of wealth. Liberals are well aware that the financial sector has been capturing a larger share of the nation’s wealth production in recent years. That settle’s it! It’s those bad guys and gals on Wall Street who did the dirty deed!
The comedian John Stewart had a funny line re this aspect of the story. There was a debate in the early days that executives of firms in the financial sector should be denied bonuses because they would be out of work but for the bailouts they received from the U.S. taxpayers. One executive complained that, without bonuses, “we won’t be able to hold onto out best people!” Stewart observed (I’m paraphrasing) that: “You don’t seem to get it. That’s just the problem. You don’t have any best people! That’s why we’re in this mess!”
That hits close to the truth but not precisely in the way that Stewart meant the words. It’s true that Wall Street doesn’t have any “best people” today. It has plenty of smart and hardworking people, however. The problem is that smart, hardworking people learn what is in the textbooks very, very well, and we happen to be living in a time when most of what is written in the financial textbooks is outdated gibberish (Modern Portfolio Theory was discredited years ago but is still used in the analysis of financial transactions because there are so many powerful people who have made careers promoting it and who don’t want to acknowledge having made such fundamental and widely destructive mistakes).
The bad thing about liberals is that they too easily give in to the temptation to see things in us vs. them terms. Did Wall Street mess up? Big time! But Wall Street messed up by playing up to our human weakness for Get Rich Quick schemes (Buy-and-Hold is a Get Rich Quick scheme because it encourages investors to treat bull market gains as real).
The people who push Buy-and-Hold are in positions of added responsibility. So they are more to blame than the average investor. But the average investor shares in the blame. Wall Street would have stopped pushing Buy-and-Hold if we had reacted poorly to their marketing efforts. We ate it up! Liberals want to blame only the rich and that limits their ability to offer a 100 percent clear and accurate explanation for the crisis.
This shouldn’t be a liberal or conservative issue. It is in the best interests of all of us for us to see a recovery before we find ourselves in the Second Great Depression. We need to encourage liberals to be clearer and more forthright and more complete and more detailed n their assertions that Wall Street is to blame. And we need to encourage conservative to stop the government bashing long enough to demand that private firms practice the financial integrity that conservative are always happy to demand of government.