Okay, Peter, so how’d we get here?
There are so many ways of saying the same thing. Of course, the word “greed” comes to the top of the list. Greed has always been there.
In this case, it was so easy to borrow, and people tend to follow the leader. There was a period of time where we had no recessions and there was great confidence that the Fed had inflation under control. We also believed there was this kind of understanding — with Asia, and China, in particular — that we would buy their stuff and they’d buy our bonds.
We had a low-risk environment. If so, it was perfectly rational for someone to take a high risk — to issue or buy a subprime mortgage, for example, a risky piece of paper. The appetite for risk was high. In time, environments changed. With more and more people taking higher risks, it’s no longer a low-risk environment. Now’s it’s high-risk. The bubble burst.
Do you think Wall Street will radically change?
Yes. And this concerns me, because even if we stop going down, getting out of the hole will be difficult. Securitization — taking a bunch of loans and bundling [them] as collateral as a bond and then selling that bond — had a lot of rotten stuff in it this time. But it was a wonderful way of expanding the capacity of the system to grant credit.
Didn't securitization cause the crisis?
Well, saying that is like condemning the messenger because he brings bad news. It’s true, but the system itself — the idea of securitization — enormously increased the capacity to give credit. And rebuilding a banking system that goes beyond taking deposits and lending money to people down the street is going to take a long time. Economic growth needs credit.
What modern market theories need reexamining?
They all deserve a reexamination. Everything has fallen apart in the crash. None of those theorists ever said the market was macro-efficient, that the market as a whole was perfectly valued. They said that stock A was perfectly valued relative to stock B or the market. In this case, when the whole structure crumbles, nothing is valued correctly. Capital ideas and all of portfolio theory dealt with markets that were much calmer; they weren’t totally rational, but they weren’t macro-irrational to the degree it is now. They depend on a financial structure that’s functional. Now we’ve moved into a dysfunctional financial structure, so you can’t say anything is working right.
What are the lessons for an individual investor?
The one thing that was missing in the bubble, and is characteristic of bubbles, was asking the questions, "What are the consequences if I’m wrong?" "What if home prices stop going up?" These were never asked. Now investors need to ask themselves, "If I sit on my cash for the next five years and I’m wrong, what are the consequences?" I’m very gloomy, and I don’t see a way out of this, but I’ll never be all cash.
Have you made big changes to your own portfolio?
We’ve jiggered some things, but we still own stocks. We own some corporate bonds. We own some municipal bonds. We’ve changed the proportion, but we’re still exposed as broadly as we can be for our risk tolerance.
Is diversification still useful?
It’s uncomfortable, because diversification ain’t what it used to be. A lot of things are now moving in sync. The only things that went up were government bonds; everything else went down. There was no place to hide recently.
Should most investors own index funds?
Yes. That hasn’t changed. [MoneyWatch columnist Patrick McDevitt agrees.] The average investor doesn’t have the expertise or the time [to manage individual investments], and it’s very expensive. There are mutual funds that charge too much, too, and trade too much. That’s why most of the mutual funds I hold are indexes. Places to look are where diversification is broad and turnover is low. I don’t play any games.
So many experts steered us wrong. Who can we trust?
I sure as hell don’t know. This is an experience that has no precedent, so nobody is very smart on this occasion. I’m old enough to have lived through the Depression. The Depression was caused by and magnified by things entirely different. The Depression has very little to teach us. We’re really flying blind.
So, is it time to buy stocks?
If it’s an L recovery and not a V recovery, people are going to get very impatient with the equity market. I’m just diversified across the board and holding on.
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