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10 Years and 10 Lessons from the Financial Crisis

10 years. It feels like yesterday. Then again, sometimes when I look at the economic data it feels like it never even happened. Whether you feel like the crisis is a distant memory or still lingering I think we can all agree that these kinds of big events serve as important lessons for understanding how we will navigate the future. So, 10 years later, here are 10 big lessons I take away from the financial crisis:

  1. Fear wins in the short-term and loses in the long-term.  This is probably the number one lesson from the crisis. Human beings have been making tremendous progress for thousands of years. The financial markets are largely a function of irrational short-term beliefs inside of a one way upward trend of progress. So while there will be plenty of times to be scared the high probability bet is that optimism will generally beat pessimism.
  2. Politics in investing is poison. 80% of the content on this website is debunking politicized nonsense about how certain things work. I can’t even count all the times I’ve read an econ or financial view that was a political argument meshed with a clever enough sounding narrative to make that political view appear accurate. The thing is, the markets aren’t dictated by politicians who are mostly just rulemakers and referees. There are bigger and more important trends at work and allowing politics to dictate economic and investment decisions puts the cart before the horse.
  3. Behavioral biases kill portfolios. Behavioral finance has experienced a huge boom in the post-crisis period. It’s about time. While markets get a lot of things right in the long-term they also get a lot of things wrong in the short-term. And nothing drives these errors more than behavioral biases. Understanding behavioral biases and learning to overcome them is an essential part of any good finance and economics education.
  4. It’s important to get the big things right. The financial crisis taught us that the big picture matters. A lot. This is true of most things in finance. If you get the big things right then the little things tend to fall into place.
  5. Perfect is the enemy of the good. The financial crisis left many people searching for holy grails – that portfolio that handles the ups and the downs flawlessly. Investors flocked into strategies that had performed well during the crisis. But it turned out that most of these investors were just chasing past performance. Yes, the grass always looks greener on the other side, but it’s usually turning yellow (on its way to dying) by the time you move across the street.
  6. Open-mind > Closed-mind. Most of the big lessons in finance and economics require a very open mind. Economists and investors often act like the whole puzzle has been solved and that there isn’t much to learn, but we now know that’s largely wrong. For instance, most people would have guessed that trillions in new government debt and a 5 trillion Federal Reserve balance sheet would cause hyperinflation and higher interest rates. But you needed to have an extremely open-minded approach to see why these views were wrong. The crisis taught us that things aren’t always as simple as they appear.
  7. Short-termism kills portfolios. The financial crisis reminded us that life is short. And many people shifted their portfolios in a manner that was irrationally short-term. But the bull market has reminded us that most of the assets we invest in are inherently long-term instruments. Give them enough time and they do what they’re supposed to do. Thinking in irrationally short-term OR long-term perspectives is usually a recipe for disaster.
  8. Low cost indexing > high fee active management. Low cost index funds have crushed more active management since the financial crisis. This is another case of macro strategies beating micro strategies. Stocking pickers have done terribly since the crisis. But any broadly diversified strategy that tried to own big broad pockets of the market has generally done better. This was even more magnified if you did so within low cost index funds.
  9. The financial system matters. Economists were blind-sided by the crisis in part because they viewed banks and financial firms as simple intermediaries. But heterodox economists knew this was bunk and those of us who understood banking and the financial system proved to have a far superior understanding of how the economy works and what the outcomes might look like. There’s still a lot of work to do here, but economists are slowly learning that the old model with banks as intermediaries is wrong.
  10. First principles rule everything around us. The monetary system is a machine that we have created. It has specific components and rules that dictate how those components interact. It is, in many ways, like a car with a driver who generally operates the machine well, but makes mistakes at times because they are, well, a person. While it’s difficult to understand what is going on in the driver’s mind we can formulate a sound understanding of probable outcomes by better understanding the vehicle they are driving.

As humans we tend to spend much of our lives “fighting the last war”. In finance and economics the next war is rarely like the last war. But by better understanding the lessons of the last war we can at least be better prepared to fight the next war when it comes.