The most important article you will read all week as we begin to commemorate the Great Financial Crisis, which reached its shocking apex (nadir) this month in 2008 as Lehman fell and all the dominos around it began to wobble…
Greg Ip at WSJ:
Since then, they have sought to ensure it never happens again. And thus, the world has retreated from risk. That retreat has reshaped institutions, regulations and attitudes, and in the process the economy: It’s why economic growth has been so durable yet so muted, with less of the risk-taking that both drives booms and busts and raises long-run growth.
What he’s saying is that the lack of enthusiasm and continued risk aversion partly explain the length of the current expansion – we were so afraid that we simply never got excited enough to blow back up again. This is so, so critical to understand.
This pessimism is why the bull market has lasted so long: There are fewer bulls forced to sell into downturns. The late economist Hyman Minsky anticipated the crisis with his thesis that “stability is destabilizing.” Long periods of calm induce behavior and innovation that make the next downturn more violent. The converse explains the aftermath: Instability is stabilizing. “The events of 2008-09 create appreciation for the possibility of events like 2008-09, which prompts risk-reducing behavioral changes that make the system more stable,” Mr. Thomas writes in a report. Among them: businesses hold more cash, banks are less leveraged, and policymakers intervene more to stabilize markets.
With less leverage and fewer channels of international contagion, financial disruptions burn themselves out before they become full-fledged crises.
Digest this idea. It will most assuredly come in handy some time in the future. Stability is destabilizing because of the amount of risk-taking it engenders. We may be experiencing too much stability now. Instability is stabilizing – when everyone is too afraid to take big risks, it’s hard to get a truly threatening bubble underway.