Crisis Breeds Bad Habits
Since the dawn of the financial markets, they’ve been marked by freewheeling highs and gut-wrenching lows. The Economist pinpointed five meltdowns that shaped the financial world we live in today (sometimes we read The Economist on the train so people think we're smart), and there are some useful real estate takeaways:
1) Be careful what you wish for, Alexander Hamilton
The bleeding from America’s first crash in 1792—a product of Alexander Hamilton’s (above) First Bank of the United States growing too big and flailing—was staunched by the country’s first bank bail-out. We’ll come to learn that insulation from risk makes for unhealthy investing behavior, otherwise known as moral hazard. (Subprime mortgage crisis, anyone?)
2) Don’t buy up the BRICS blindly.
The first emerging-markets crisis in 1825 was exacerbated by a shocking lack of due diligence. It might not take months to get to South America anymore (so it's harder to make up a fake country like scam artist Gregor MacGregor’s “Poyais”), but that doesn’t mean information and cultural divides don't exist when investing in growth markets. Find a local partner when entering a new market to really learn what drives returns.
3) Ignore irrational exuberance and underwrite carefully.
Mid-19th century railway fever was accompanied by an unsurprisingly global crash in 1857. Firms like Illinois Central’s sky-high valuations were not supported by substantial earnings, and we all know a big bet on future growth can end with a splat. (Just ask those way-out suburban malls surrounded by waist-high weeds.)
4) Everyone needs a Great and Powerful Oz.
America shrugged off a lender of last resort in the late 1800s, and the decentralized system exploded until there was one bank for every 4,000 people in 1907. But without a hall monitor, scammers arose yet again and over-borrowing and embezzlement led to a snowball of irreparable losses. It took depositor runs, the national hoarding of cash at home, and an explosion of cash substitutes to establish America’s third central bank in 1913.
5) Don’t let the tail wag the dog.
The pit of America’s financial history, from 1929 to 1933, shows that no good comes from a forced hand. Thousands of banks failed, unemployment shot up, and panic ensued. The government tried for a publicly-funded capital injection, followed by the creation of the FDIC and low-cost risk-sharing, but that risk eventually fell on the taxpayer. We saw the cost of government subsidizing banking during our most recent downturn, and leverage is already on its way back up on the real estate side as each asset class bounces back. When will we ever learn?
