It's a sobering time for everyone, The Guardian (a UK newspaper) agrees with me: The City's Greatest Lie was Convincing Us We Were All Rich. Replace "The City" with "Wall Street" and you have the American equivalent. Henry Porter of The Guardian sums up a lot of what I've been feeling lately:
"...[W]e were told we were living through an epic boom many people who were paying attention and did not borrow heavily felt no better off."
When you look at it that way, the lie that we were told is pretty obvious. Perhaps I'm just too cautious or risk-averse or (as I like to think) I am not easily swayed by marketing; but for whatever reason I've basically managed to not end up exposed to this crisis. Sure, my 401(k) is hurting a little, but I cut my exposure to MBS to a level that I can live with in mid-March and besides, I'm young. All I'm doing right now is building a base that will earn for me over the next 30-40 years. So if stocks drop in value and remain stagnant for awhile it just means that I get more for my money. I plan to be debt-free in February, which will allow me to amass assets more quickly. I've kept a fair portion of my savings in cash or CD's because I decided I wanted flexibility with the money, so I haven't lost value there.
The hardest part of personal finance is the ego thing. I'm not getting a great return on my money and it's very difficult admitting that I'm just not smart enough to figure out how to do that. Well, I'm probably smart enough, but I don't have the time and dedication to do it. So I have to accept that. In my opinion personal finance is way too emotionally charged to be approached rationally. It feels an awful lot like gambling in the way you react to investment gains or losses, or at least how I react to them. I'd like to figure out a better way to divorce myself from those feelings, but until I do I have to be very careful about the investment decisions I make.
So that's basically how I've ended up with little direct exposure to the financial crisis. I don't own a home. I don't have any variable interest rate debt. The little debt I do have could be paid off from savings if necessary. The debt payments I make could be greatly reduced if necessary, but I'd rather just make the payments since the point where I will be debt-free is so near.
This is the lie that we, the American public, were sold. The financial position that I am in is so crazy that almost no one can relate to it. Why keep your money in a savings account when you can open a brokerage account? Don't you know that historical stock market returns are way better than savings account interest? If not the stock market, buy a house! Don't you know about the tax deduction?
Those personal finance advisors seem like they know a lot. They've doctored all sorts of numbers to show how you can expect 8-10% annual returns. I'm not saying that they are outright lying, they put the assumptions in there, but they are also acutely aware of human psychology and how people fail to properly evaluate the fine print. Most people haven't read about the different biases associated with lazy measurements of stock market returns. They don't understand the difference between real increases and nominal increases. Worst of all, they don't LOOK for them. For some reason, there seem to be a lot of people that, when presented with a good deal, ask "Where do I sign?" instead of "What are you getting out of this?"
Ask yourself, why does Yahoo! Finance provide you with all those updated stock quotes? It's not out of the kindness of their hearts, it's because it presents an opportunity for show advertisements. They write articles on personal finance to promote more individual people investing. It's not because individual investing is good (statistically proven to be a terrible, terrible idea and probably a destruction of wealth), it's because individual investing is a profit center for some companies.
You have to realize, the information you get is provided by self-interested parties. All those people telling you that buying a house was a great idea probably had horse in that race. Did your home-owning friends tell you to go buy something? Is it possible that some small part of their desire to see you follow in their footsteps was to validate their own decisions?
As far as I can tell, trying to actively manage your personal finances for profit is a loser's game. A vast number of resources exist solely to convince you otherwise. Just walk by the personal finance section at Barnes & Noble. Don't buy the hype. In the words of Tyler Durden, "You are not a beautiful and unique flower." You're just as dumb as every other slob who has received sub-par investment returns when guiding his own investments. Sure, everyone knows a relative or a friend of a friend who got rich directing their own investments, but I'd guess that statistically it doesn't happen. Statistics are how we tell the difference between things that are true, things that might be true, and things that are definitely false. It takes quite a compromise of ego to admit that statistics apply to you, but it's true.
Which brings me back to the financial crisis. A few years ago I bought the analysis that these giant financial institutions had gotten really good at handling risk. They had very sophisticated models for pricing risk and they were doing a good job of it. The problem in that statement is that it assumes a number of things that we now know to be false:
1) The guys making the models are really smart.
2) Counter-party surveillance works.
3) People understood what they trading.
#1 is clearly wrong. Ask any engineer that graduated in the last 10 years. Up until maybe this year we were kicking ourselves for not getting into finance. It pays so much better than engineering and all of the classes at school were so easy. The guys making the models were just smart enough to convince their management that they knew what they were doing. If the management team didn't come up through that division they probably didn't know enough to really dig into the models. I would guess that they compensated for this (if they bothered digging deeper at all) by asking a subject-matter expert that they trusted or by comparing themselves to industry standards. Those are pretty well accepted ways for doing things like that, but I think we can all see the problems with that. It's a great way to breed group-think and systemic problems.
#2 is wrong because of the sorts of people you have doing this work. It's pretty clear that the counter-parties weren't keeping a close enough eye on each other. The problem is, again, that managers are paid to make deals. I'm sure risk managers are a pain in the ass and generally seen as an obstacle to getting work done. Besides, how can you judge a company poorly for using the same "best-of-industry practices" that your institution follows?
#3 makes me sad. It seems obvious that you shouldn't get involved in things that you don't understand, but it sounds like that pretty much happened all the time. People buying mortgage-backed securities just because of their credit rating? Seriously?
Maybe I'm crazy, but buying things you don't understand is a terrible, terrible idea. I can't believe people bought homes without considering what might happen to their payments under a variety of circumstances. Everyone believed the lie that they were rich and acted like they could afford to lose a lot of money. We didn't read the fine print and now we're all fucked. And it's everyone's fault, it was the same problem at the top as at the bottom. We got too lazy too really do our homework, we got used to a rising tide lifting our boat for us, so we didn't do the work.
There is only one way that wealth is created - produce more value than you consume. We haven't been doing that for the last few years, so now we really have to tighten our belts and move forward. Just like any person teetering on the edge of insolvency we have to budget carefully, buy only the essentials, and pay down the debt.
I'm sorry America, we're not as rich as you've been told. The government is not going to be able to provide all the things you'd like them to. You're going to have to pay higher taxes to get the things we already get from the government. You're going to have to stop bitching and start saving. You're going to have to admit that there's no shortcuts to saving for retirement. You've got to stop trying to goose results in the short term and start thinking of stocks you purchase as things you'd like to hold for years.
It kind of sucks, but it's what being an adult is all about. You don't get everything you want and you have to be happy with what you've got. Because if you don't, you're going to drag us all down.
And if you work in the financial services industry, try to stop contributing to the problem. Seriously, you guys get paid a shit-load of money, try adding enough value to justify that paycheck.
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