Will investors ‘find another way to be stupid’?
For those on high alert for a reprise of the crisis that nearly melted down the global financial system 10 years ago this month, a former Wall Street risk manager has eight comforting words.
“People aren’t going to be that stupid again,” said Richard Bookstaber, quoted in The Wall Street Journal. Also the author of “A Demon Of Our Own Design,” Bookstaber was referencing the derivatives used to package dubious mortgage loans in the early 2000s.
But Bookstaber also cautioned investors not to get too comfy. “So they find another way to be stupid. … I think there’s going to be other crises.”
If history is any guide, that’s a safe bet.
It’s also one the former Federal Reserve Chairman Ben Bernanke seems inclined to make, though he’s keeping his chips on the table — for now. Bernanke thinks the economy will continue to enjoy the sugar-high from last year’s tax cut for another year. And then?
“In 2020,” Bernanke predicts, “Wile E. Coyote is going to go off the cliff.”
Herd mentality
Amid the economic boom of the late 1990s and the subsequent debt-fueled rebound of the early 2000s, expanding homeownership became something of a national obsession. Credit standards were relaxed, in part because securitizing riskier loans made them appear safer.
For a time, all seemed well. Houses were credited with “saving the world” after the collapse of high-flying internet stocks in 2000 contributed to a brief recession in the U.S.
With easy credit stoking demand for real estate, house prices soared and getrich-quick infomercials (working parttime from your own home!) filled the late-night airwaves. Speculators flipped properties like day-traders flipped internet IPOs.
Houses were the tulips of 17th century Holland and the dot-coms of 1990s America.
Writing in the 1852 edition of “Extraordinary Popular Delusions & the Madness of Crowds,” Charles MacKay captured the psychology behind boombust cycles.
“We find that whole communities suddenly fix their minds upon one object, and go mad in its pursuit; that millions of people become simultaneously impressed by one delusion, and run after it, till their attention is caught by some new folly more captivating than the first.”
Initial hints of folly in the housing market emerged in mid-2007 as a major U.S. subprime lender filed for Chapter 11 and the French bank BNP Paribas noted a “complete evaporation of liquidity” in shutting down three funds with heavy exposure to the U.S. mortgage market. By December 2007, the U.S. was in recession, though few investors noted the downturn at the time.
The worrying pace of mortgage defaults finally made headlines in March 2008 when Bear Stearns, its loan portfolio stuffed with subprime debt, filed for bankruptcy.
Shortly thereafter, two governmentsponsored enterprises charged with backing mortgage loans required an infusion of taxpayer-funded liquidity. The crisis reached a tipping point on Sept. 15, 2008, when the investment bank Lehman Brothers went bust, a potentially apocalyptic event recorded for posterity in photos of numbed Lehman employees carrying their belongings out of the company’s Manhattan headquarters in — appropriately — bankers boxes.
No one knows anything
While adding safeguards to the global financial system remains a work in progress, one consequence of the crisis has been its corrosive effect on the valuing of expertise and basic facts. Socalled elites were held responsible for a lost economic decade. That bankers — long the target of ethnic prejudice — were at the epicenter energized a populist movement seemingly characterized by the notion that since no one knows everything, no one knows anything.
“Americans have reached a point where ignorance — at least regarding what is generally considered established knowledge in public policy — is seen as an actual virtue,” wrote Tom Nichols, a professor of National Security Affairs at the U.S. Naval College in the March/April 2017 edition of Foreign Affairs. “To reject the advice of experts is to assert autonomy, a way for Americans to demonstrate their independence from nefarious elites — and insulate their increasingly fragile egos from ever being told they are wrong.”
History demonstrates that erudition is no guarantee against policy mistakes. But the complete absence of respect for expertise and the institutions that employ it guarantees that something far worse eventually will happen.
Wile E. Coyote approaches the cliff. Tom Saler is an author and freelance journalist in Madison. He can be reached at tomsaler.com.