Eight Things That the Recent Financial Crisis (Should Have) Taught Us

By Peter Ponzio

The recent financial crisis seems to have arrived, full-blown, without warning. While a few people predicted that we would experience a credit crisis, most people were caught unawares when the credit markets, and larger economy, seized-up. A number of key assumptions regarding the working of our economy have been given the lie by the current state of affairs; this article addresses some of our changed assumptions.

1. Prior to the current recession, many periodicals across the country declared an end to the business cycle, proclaiming that recessions were no longer possible. According to these publications, we had entered into an era where the economy would keep growing due to an increase in globalism; more efficient credit and financial markets; a growing demand for technology that would lead to more and better use of people's time and abilities; and recent history, wherein we experienced no significant recessions for something like six or seven years. Guess we got this assumption wrong.

2. The stock market would keep growing, since it is a rational system where knowledge is perfect (or as close to perfect as possible); knowledge is readily accessible; everyone can access all knowledge all the time; events can be predicted with relative assurance. Let's see: I suppose we could say the market was rational when the Dow topped 14,000; it was probably just as rational when it hit a low of 6,800 some 16 months later. It would be just as easy to argue that everyone had perfect knowledge of financial derivatives, sub-prime mortgages, and hedge funds. Just one thing: too bad the people who designed these financial products couldn't understand the risks involved much less everyday investors.

3. Real estate would continue to rise in value, and since we would experience no further boom and bust cycles in the economy, real estate was the best investment that most people could have. Since real estate investments were so attractive, it made sense to load up your portfolio with houses that could be "flipped", and since money was so cheap, it made sense to take on ever-increasing debt loads. Anyone want to buy spec house for sale in California, Las Vegas, New York, Florida or Illinois? Enough said.

4. Federal regulation of the financial industry is a bad idea. In fact, the financial industry could grow exponentially if the government took a hands-off approach. Besides, government didn't understand derivatives, hedge funds, mortgage-backed securities, or options. The only people who understood these often arcane financial instruments were the people who designed them. Naturally, these people should be left in charge of regulating themselves. Do you cringe when you hear a banker or stock broker say "trust me?" If you don't, please see number three above-I have some land in a semi-aquatic environment that you might be interested in.

5. Management is a science, and as such, follows the scientific method. Do I really need to comment on this? I guess management is a science and follows the scientific method if you believe that results don't have to be independently verified; if you believe that results can be "tailored" to fit your desired outcome; if you believe that rigorous testing does not have to be done to ensure that outcomes can be replicated.

6. Schools used to teach that there are three kinds of risk inherent in any security, mutual fund, or bond. The first is specific security risk; the second is sector risk; the final type of risk is systemic risk. I started out by saying that schools used to teach about three types of risk; for awhile, they were only talking about specific stock (fund) risk and sector (or industry) risk. You see, people actually believed that we had eliminated systemic risk. Ever hear of the credit crisis? If so, go back and review the definition of systemic risk.

7. Again referring to schools (and to a larger extent the business community as well), the theory used to be that market forces acted as corrective agents. If a company was poorly run over a long period of time, the theory went; it would eventually shut down in the form of a bankruptcy, merger or dissolution of some kind. As we recently learned, these market forces needed to be revised, because of a newly emergent theory. That theory is known as the "too big to fail" theory. As a corollary to that theory, we now know that the "pay large bonuses after a government bailout" rule also applies.

8. In the event that a financial crisis happened (which was largely dismissed as being unlikely), world governments would act in concert to avoid a world-wide financial meltdown. In fact, due to increasingly global marketplaces, governments across the world would be better served to act together. Unfortunately, this conventional piece of wisdom seems to be suspect, as well. To date, the EU has not acted in concert; several contingents in the U.S. are calling for increased protectionism; and Far Eastern countries have not developed a plan to help relieve the financial crisis. Well, at least we got one thing right in the U.S.: we exported our financial problems to the rest of the world.

Well, I for one am glad to see that recessions no longer occur; that regulations are wasteful; that management scientists are busy working on their next round of employee-morale boosting downsizing; that my real estate investments will continue to go up in value, and that I have nothing to fear in terms of systemic risk to my savings. BY the way, if anyone is interested in that semi-aquatic land that I have, please call.


Article Source: http://EzineArticles.com/?expert=Peter_Ponzio