I am not sure if I am dumb or lucky but I continue to be taken aback by other people’s stock market woes.
Consider this assertion in a recent letter to the editor: “My parents worked hard for 30 years. In the past year and half, they’ve lost decades of savings. My husband and I set aside money for our children’s college education. A fraction remains.”
Gee, is it really as bad as all that? If so, who is to blame and what policies or institutions could be changed to prevent such apocalyptic losses?
I think it is clear we need some reforms. It is also clear no one was forced to invest “years of savings” or college education funds in stocks. Fraudulent misrepresentation of corporate finances may have induced some prudent investors to take on more risk than they realized, but contemporary investors also receive more warnings that their grandparents did in 1929.
A bubble has just popped and some people got hurt. But the whole cycle eventually will happen again regardless of what we do or whom we blame.
Historical perspective is always useful. The current downdraft in stock markets is apparently the worst since the one in 1929-1930 that ushered in the Great Depression. But there are also major differences between the two eras.
After the 1929 crash, households lost savings in a variety of instruments: bank accounts, stocks, bonds and insurance policies. Financial institutions of all sorts went broke, but mostly banks. Millions of households lost savings when the banks where they had accounts closed their doors. Many owned whole life policies that became worthless when the insurers failed or bonds lost all value when the issuing firms failed.
In 2002, virtually no one has lost money due to a bank closing. Some insurance companies are in financial straits, but there is little threat of loss to households. Some bonds have declined in market value, but only a miniscule proportion of them have been defaulted on.
Losses are highly concentrated in stock markets and particularly in those stocks–high tech, Internet and telecommunications–that experienced the giddiest appreciation from 1994 to 1999. But even within stock markets as a whole, many firms have not lost value precipitously and many mutual funds and 401(k) plans have suffered little.
Prudent households that maintained diversified portfolios and avoided high levels of risk did not lose “decades of savings” or all but a fraction of their children’s college money. Risk-averse widows who kept everything in bank CDs did not “lose” anything at all, though the interest they received was only slightly above inflation.
I have not had big losses. I don’t own any stocks directly, but I do have a significant (for me at least) amount in some 403(b) accounts accumulated during 22 years of teaching and in a 401(k) account from seven years at the Minneapolis Federal Reserve. So, I am exposed to financial market risk.
As of Oct. 15, my 403(b) accounts, which are a mix of fixed income, stock, “social choice,” “equity index” and “international equity” funds, are down about 11 percent from the peak they hit in early 2001. My 401(k) is down about 6 percent. This is unpleasant, but far from catastrophic.
I’m not bragging. I am risk-averse and lazy. Financial advisers repeatedly told me I should be more aggressive in my choice of funds. Other households that were willing to take on more risk during the 1990s probably gained much more than I did and may be well ahead even after their dot-com stocks bombed. Two of my college pension funds, to which I contributed nothing after 1992, grew only by 9 percent per year in the ensuing decade. I am content, but some people are still ahead of me.
My experience, and that of others who did not put all their eggs in any one risky basket, shows that not everyone was doomed to lose “decades of savings.” While accounting scandals from Enron to Imclone clearly defrauded investors, they were not the sole cause of market declines.
The Fed could have let some air out of the bubble by tightening the money supply in 1998. But with Asia and Russia reeling and the mutual-fund party at full whirl, they would have faced universal condemnation.
The public cannot say it was not warned. We all know the trite adages meant to protect us from ourselves: “High returns indicate high risk.” “Past performance is no guarantee of future performance.” “What goes up must come down.” “Caveat emptor.”
Some of us simply chose to ignore these well-known warnings.
© 2002 Edward Lotterman
Chanarambie Consulting, Inc.