You don't really know where you are in the battle until the fight is almost over, when the benefits of time and distance afford you the perspective to see clearly the long arc of your life.
Now that the dust has started to settle on the battle that was the third worst year in the history of the stock market (and one of the worst decades in its history), a clearer picture is emerging as to the underlying forces and currents that moved the markets. In retrospect, of course, the picture seems so clear, as does a battle when studied by historians. But for most of us, these forces were invisible, working their pernicious influence while we went happily about our business.
There were a few sages who clearly saw what was unfolding (and who are all over television and the Internet these days), but they were mostly dismissed as cranks and perma-bears, burdened (in our view) with an excessively pessimistic view of the economy and financial system.
In essence, the risk pendulum swung too far in one direction.
If, after the Great Depression and the Second World War, investors shunned the riskiness of stocks for the safety of bonds, the period from 1982 through 2008 saw investors grow increasingly comfortable with risk, and they feasted on stocks and leveraged up on debt.
The Federal Reserve under Alan Greenspan rescued Long-Term Capital in 1998 and minimized the damage from the bursting of the tech bubble by creating the conditions for a housing bubble, encouraging the belief that failure in the financial system would always be contained and limited.
The appearance of too much stability created great instability. The success of the Great Moderation led to the insanity of 2008. Dubious assumptions were made about the direction of housing prices (they would always go up), the complexity of financial engineering destroyed one of the keys of the financial system — transparency — and poorly designed incentive systems drove the short-term decision-making of Wall Street's leaders.
What, Me Predict?
Given that this past is now coming into focus, does this mean that we can see more clearly into the future? After a year like 2008, you'd have to be a maniac — or an economist — to make a prediction for 2009.
Short-term, there are too many unknowns: Will the government's attempt at another round of Keynesian spending work? Will the global community come together and coordinate their response to the crisis?
Nevertheless, it doesn't seem too rash to suggest that the party is over and the hangover effects will last. There will be less debt, more transparency and a healthier attitude toward risk — all of which is good. The danger going forward will be that we'll overdo it in the other direction, and we'll see less risk taking and excessive regulation and a continuation of tight credit conditions.
The pendulum will swing back and forth, from a laissez faire government to excessive regulation, from a willing suspension of disbelief about the most absurd investment ideas to a destructive skepticism about the purpose of the entire financial system, from overconsumption to the hoarding of cash, from too much debt to too little.
If it's true that life is all about balance, it's unrealistic for us to think that we'll ever get it exactly right.
It was a tough year, but we avoided disaster. The payment system still works. You can write checks, withdraw money from your bank account, shop online, and use your credit card. Maybe your bank failed (like Wachovia), and you probably barely noticed.
Our currency is still the world's most trusted; you don't have to resort to barter to buy things, like exchanging half of your clothes closet for a tire.
And a silver lining in this crisis is that we may no longer take for granted things we shouldn't have. (In Zimbabwe this year, the inflation rate reached 11,200,200 percent. A $200 iPod would now cost $2.2 billion).
We are still standing. The lights go on. We can heat our homes and watch TV. We are safe.
Going forward, the battle will continue, and other unseen forces will pop up to test our mettle and throw us off balance. As we have in the past, we'll have no choice but to adjust, and only after the next crisis is over will we be able to understand what really happened.
In the meantime, America will weather this painful crisis as it has others in its past, and emerge more cautious yet still optimistic, with a healthier attitude toward risk and debt, a sounder financial system and a renewed appreciation for what we do have, rather than a yearning for what we don't. u
Fred D. Snitzer is the chief operating officer in the investment-management firm of Prudent Management Associates. For information, go to: www.prudentmanagement.com.