Behavior Gap Round Up, 9.5.2009

Lessons of the Financial Crisis—One Year Later

So what have investors learned from all this? With a full year of hindsight, here are some lessons of the crisis:

Diversification doesn’t always work. Financial advisers have drilled into investors the need for diversification. But the past year has taught that spreading money around the globe and into different asset classes sometimes results in less safety than one would expect. The lesson isn’t to put more eggs in a single basket, but to acknowledge the limits of diversification.

Is TARP Profitable? (via Marginal Revolution)

As we approach the one-year anniversary of the Panic of 2008, it’s clear that the actual cost of the TARP will be a fraction of the original $700 billion estimate and that taxpayers are even turning a profit from the central component of the package.

…The exhaustive spreadsheets at financialstability.gov document the status of the 667 investments made under CPP since last fall. To date, 21 institutions have repaid the principal amount and repurchased the warrants, and 15 more have repaid the principal.

Yes, There’s Even a Risk in Treasuries

…Investors in long-term Treasury bonds and high-grade corporates run a serious risk of losing money in real, inflation-adjusted terms, over the next few years. They may lose money even before you count inflation.

Why?

The yields on these bonds are ominously low. If they reverted to long-term averages, the prices would tumble. You may end up losing more on the falling price than you could earn from the coupons.

This is a Main Street danger. Many ordinary Americans who have fled the stock market have moved their money into the supposed “safe haven” of bonds instead.

…Bonds are like a seesaw: If the yield rises, the price falls. Rising worries about inflation, rising interest rates, or both could cause that to happen.

How Did Economists Get It So Wrong?

Few economists saw our current crisis coming, but this predictive failure was the least of the field’s problems. More important was the profession’s blindness to the very possibility of catastrophic failures in a market economy. During the golden years, financial economists came to believe that markets were inherently stable — indeed, that stocks and other assets were always priced just right. There was nothing in the prevailing models suggesting the possibility of the kind of collapse that happened last year. Meanwhile, macroeconomists were divided in their views. But the main division was between those who insisted that free-market economies never go astray and those who believed that economies may stray now and then but that any major deviations from the path of prosperity could and would be corrected by the all-powerful Fed. Neither side was prepared to cope with an economy that went off the rails despite the Fed’s best efforts.

The New Normal for the U.S. Economy: What Will It Be?

Once the dust settles from the economic crisis of 2007-2009, we are likely to enter a period of new normality, with lower household debt, higher personal savings, and less consumption as a share of Gross Domestic Product. The effects of this transition will ripple through both the domestic and the international economy. At home, some of our bloated retail infrastructure will disappear as businesses shift their focus to producing more for export. Abroad, countries that have depended on exports to fuel economic growth will have to shift toward domestic consumption, which means lower savings rates and a diminished appetite for U.S. government debt, putting pressure on U.S. fiscal policy.

Tagged as: economists, financial crisis lessons, TARP, treasuries, U.S. economy