About the intelligent investor
The weekly column of ‘The Intelligent Investor’ by Jason Zweig, has been published in the Wall Street Journal for about a decade and is published exclusively in Globes. According to Zweig: “My goal is to help you distinguish between the good advice and the one that just sounds good”
About Jason Zweig
One of the senior journalists of The Wall Street Journal. Author of the book “Your Money and Your Mind: How Neuroscience Can Help You Get Rich”, and the editor of the updated version of the bestseller “The Intelligent Investor”, described by Warren Buffett as “the best investment book ever written”
do not panic. That’s the message financial regulators are sending – and it’s not really working. Last week, US authorities promised to recover uninsured deposits from the collapsed Silicon Valley Bank and Signature Bank. They also created a new plan to lend up to $25 billion to other banks whose balance sheets are unstable.
In response to these efforts to prevent a potential panic, the financial markets panicked. From March 9, when Silicon Valley Bank shares crashed, and depositors withdrew their money in droves, to March 15, regional bank shares fell more than 22%. First Republic fell more than 80% in less than six trading days – before a consortium of competitors helped save it on March 16.
Panic selling of bank stocks led to panic buying of Treasury bonds, causing traders difficulties in placing orders, due to the large fluctuations in prices.
By Wednesday of last week, these shocks had skipped over the ocean and reached Europe as well. Shares in Credit Suisse fell 24%, the biggest daily drop in the bank’s history, after investors worried that it too might need an emergency bailout. A day later the bank was indeed saved, thanks to a loan of up to 53 billion dollars from the Swiss central bank.
The end of the era of worshiping central banks and regulators
The markets may be signaling that the long worship – in the style of class leaders – towards regulators and central banks is finally coming to an end.
The attempt to erase crashes from the financial system is of course part of the wider effort in modern society to make life itself risk-free and fool-proof, such as strollers for toddlers that cannot be broken, medicine packages that children do not know how to open, cars that drive almost on their own, and removing shoes during airport security checks.
However, as my colleague Greg Ipee pointed out in his 2015 book “Foolproof,” making the environment itself safer can make many people sleepy and overly risk-averse. This encourages the concentration of enormous power in the hands of a few individuals at the top of the financial system.
Former Federal Reserve Chairman Alan Greenspan was known as “Maestro” for orchestrating a long, smooth and profitable decline in interest rates. After US authorities intervened to help calm a series of financial crises in 1998, Time magazine named Greenspan, the The then Minister of Finance Robert Rubin and the then Deputy Minister of Finance Lawrence Summers, as members of the “Conference to Save the World”.
Intervene time and time again to stabilize the markets
Over the past two decades, the Fed, Treasury and other authorities have intervened time and time again to stabilize the financial markets, as if failure was no longer an option. Here are some noteworthy intervention cases.
In 1998 – construction of a 3.6 billion dollar aid package to save the giant hedge fund Long-Term Capital Management.
In 2001 – a sharp cut in interest rates to calm investors after Internet stocks collapsed.
In the financial crisis of 2008-2009 – backing financial funds in amounts up to 50 billion dollars, transferring more than 425 billion dollars to banks and industrial companies that were in trouble and buying government securities in excess of 1.7 trillion dollars.
In most years since then – keeping the interest rate close to zero.
In 2020 – the purchase of US government bonds for almost 1.5 trillion dollars, to try to calm investors during the corona epidemic.
Unfortunately, the large impact on markets has led regulators and policymakers to err into thinking they can predict the future.
“We believe that the more extensive impact of the subprime troubles on the housing market will probably be limited,” said then-Federal Reserve Chairman Ben Bernanke in May 2007, “and we do not expect a significant spillover from the subprime market to the rest of the economy or the financial system.”
The spillover, it later turned out, was significant enough to cause the financial crisis of 2008-2009.
The effort to displace risks creates risks
In November 2021, senior Fed officials still maintained that inflation was “expected to be transitory,” a few months after cost-of-living increases hit their highest levels in 13 years. Only a few months later, inflation reached a peak, at least for the time being, of 9.1%, and has barely decreased since then.
“We’re not thinking about raising interest rates,” Fed Chairman Jerome Powell said on June 10, 2020. “We’re not even thinking about raising interest rates.” Less than two years later, the Fed began raising interest rates – by 4.5% in the meantime .
All of this demonstrates an even bigger problem: central authorities are neither omniscient nor omnipotent, and their efforts to remove any risk from the system may end up making it more dangerous, not less dangerous.
Even as the rules multiplied and the bailouts happened again and again, the US stock market suffered four crashes of at least 20% since 2000.
The expectation that government authorities would rescue bankers and investors from their reckless behavior may have become a self-fulfilling prophecy.
“Every crisis becomes more complex than the one before it”
“Trying to control risk by lowering interest rates reduces the price paid for taking risks, thus increasing the cumulative amount of risk in the system,” said financial historian and investment strategist Edward Chancellor, author of The Price of Time, a history of interest rates.
“In the last 25 years or so,” he said, “each crisis has become more complex than the one before it, each one has increased in losses, each one has spread more widely across industries and countries.”
The belief that governments would control the frenzy of markets is a relatively new idea, accelerated by the creation of the Board of Governors of the Federal Reserve in 1913 and the Federal Deposit Insurance Corporation in 1933. Both authorities were created following financial crises: the Fed after the banking panic of 1907, and the Insurance Corporation after the economic depression of 1929 and the bank collapse that followed.
In the 19th century, investors and economists almost universally recognized that panics were inseparable from prosperity, and were an inevitable part of the business cycle. Every decade, stock trader DeCourcy Thom wrote in 1893, typically includes “a few months to a few years” of panic.
And though these panics were caused by men, they were compared to earthquakes, storms, tornadoes, hurricanes, raging seas, and high tides—forces of nature beyond any hope of human control.
Without the modern magic of computers and complicated formulas, regulators in earlier times were realistic about what they could do. Regulation relied more on personal responsibility. If a bank collapsed, the managers, directors – and shareholders – would not only suffer losses in the stock market. They also faced “double responsibility” – the obligation to pay an amount up to the value of the shares they had, in order to participate in the compensation to the depositors.
Banks still collapsed – but not as much as one might imagine. Between 1864 and 1913, 501 of the approximately 10,000 national banks collapsed, with cumulative losses to depositors of only $44 million, just over a billion dollars in today’s money. It was less than 1% of GDP, according to Rutgers University economist Eugene White.
In other banking crises, when modern regulators handled the cases, the losses were much greater. Prof. White estimates that the cost of the collapse of banks and loan and savings institutions in the 1980s reached at least 3.4% of GDP, and the losses from the 2008-2009 crisis reached perhaps more than 7% of GDP.
The government’s role as the guardian angel of the markets has become much more complex. Social networks accelerate and increase fear, and smartphones serve as instant ATM devices. In a matter of seconds, panicked depositors are able to withdraw – and indeed have withdrawn – their funds from banks surrounded by rumors and fears.
“Capitalism without collapses is like religion without hell”
Once the regulators present themselves as the guarantors of stability in such a tense atmosphere, they have little choice but to intervene. “Capitalism without crashes is like a religion without hell,” Berkshire Hathaway Vice Chairman Charlie Menger once said, paraphrasing the words of the late economist Alan Meltzer.
But this week, Menger sounded much more serious when he told me: “I would prefer to live in a world where nobody does anything undisciplined or stupid and so on, but we don’t live in that kind of world. So the decisions have to be made about the world as it is, not as we were We want it to be.”
He added: “The way the world does exist, the government has no choice but to back up all deposits. Otherwise we would be facing an attack on banks that we have never seen before.”
The mistaken belief in the omniscience of regulators created another problem: it became more difficult for them to change direction. To fight inflation reliably, said Carmen Reinhart, an economist at the John F. Kennedy School of Government at Harvard University, “you need consistency over time: to avoid unplanned U-turns.” In the midst of this latest banking crisis, the Fed may no longer be able to raise interest rates as aggressively as it had planned.
Ultimately, the legacy of overconfidence in the limitless brain power of regulators is overconfidence: too many people think their money is safer than it really is, and therefore take more risks than they should.
“If everyone thinks there’s a rich uncle who’s going to bail them out every time they make a mistake, it’s going to lead them to make riskier decisions,” said Mary Ellen Stanek, associate chief investment officer at Baird Advisors, which manages more than $115 billion. “How can you back out of this?” a question. “It becomes second nature, and then you expect it.”