The 2008 economic crisis was a big event. No one disputes that. However, given how significant it was, I don’t believe that sufficient effort has been put to the task of understanding how it came to be. When a puzzle is created because something unexpected happens, the smart thing to do is to drill down hard until we figure out what piece of the story we are missing that caused us to be surprised by the unexpected event.
I believe that it was the high CAPE values that applied from 1996 on that served as the primary cause of the crisis. If Shiller is right about how stock investing works, those high prices were not the result of positive economic developments, they were caused by a flood of irrational exuberance that was fated to disappear once investors came to their senses re the true value of their stock holdings.
Shiller predicted the crisis in his book Irrational Exuberance (published in March 2000) when he wrote: “"If, over some interval in the first decade or so of the twenty-first Century, the U.S. stock market is going to follow an uneven course down, as well it might - back, let us say, to its levels in the mid-1990s or even lower - then individuals, foundations, college endowments and other beneficiaries of the market are going to find themselves poorer, in the aggregate by trillions of dollars. The real losses could be comparable to the total destruction of all the schools in the country, or all the farms in the country, or possibly even all the homes in the country."
Given that Shiller was able to predict the crisis long before it arrived, we all should have paid careful attention to his descriptions of how stock investing works when the crisis actually arrived on our doorstep. It was a huge missed opportunity that we failed to do so.
One of the rationalizations that we have employed to justify failing to do so was to describe the crisis as a "Black Swan" event. The idea here is that it was just one of those things that happens out of the blue form time to time and that there really was nothing that anyone could have done to prevent it. Describing something as a Black Swan takes accountability out of the picture.
Matt Taibbi recently wrote an article for Rolling Stone explaining how the Black Swan excuse was used by political prognosticators to explain why they were not able to imagine that Donald Trump could win the presidency in 2012. “The across-the-board failed prognostications of last election season were a thing to behold. They constituted one of the larger industry-wide failures in a journalism business that has seen a few of them since the Iraq fiasco. Literally every major news outlet called the 2016 election wrong,” Taibbi wrote.
That’s all fair. As he notes, “The failure of all that cash, institutional muscle and media clout to reel voters back to any ‘traditional’ Republican — to the latest Bush, McCain or Romney — was evidence of a massive crack in the political establishment…. 2016 was an indication that voters had traveled so far off the reservation that any choices they made going forward were likely to be hard to predict. Pundits however didn’t go back and recalibrate after 2016.” He adds that: “The press is a club full of presumptuous conformists who regularly ignore data they don’t like or understand.”
I believe that something similar is going on in the economic realm. Shiller’s understanding of how the stock market works and of how it influences the economy is shocking stuff. It represents a complete break with the Buy-and-Hold Model, which has been the dominant model for understanding how stock investing works for five decades now. Those who have come to be known as experts in this field are resistant to new ideas that put their valuable expertise in question. So they continue to cite the old rules and the old explanations for events in a day when analyses that do a better job of describing the realities affecting us all are available to them.
The 2008 crisis was not a Black Swan. Buy-and-Hold encourages price indifference when it advises investors not to practice market timing. Widespread price indifference causes bull markets to get out of hand. Then, when the market performs its core function of getting prices right by crashing them (it’s not possible to get prices right in any other way in a nation of Buy-and-Holders), trillions of dollars of spending power are removed from the economy and we all suffer the consequences.
The economic crisis was a predictable event. In fact, it was predicted by the leading voice challenging the Buy-and-Hold Model. We all should be taking the warning that it delivered to us to heart before we repeat the mistakes that brought it on.
Rob’s bio is here.