The Myths and Realities of Financial Crises

Dec 4, 2020 | Insights

Pulling together this conference for clients, shareholders, and friends is something we look forward to every year. In addition to the opportunity to share our story, it is a chance to present information related to the economy and the stock market which may be of interest to our guests. The remarks presented by our guest speakers represent their own views and do not necessarily reflect the views of Chase Investment Counsel. Like you, we review a lot of data as a basis for drawing our own conclusions.

Dr. Bob Bruner, CICC 47th client conference, Nov. 18, 2020

Dr. Robert Bruner, professor at the University of Virginia’s Darden School of Business, addressed the myths and realities of Financial Crises.  We have seen many financial crises, said Dr. Bruner, yet they keep occurring and puzzle laymen and expert alike. Common myths about them include:

  • Financial crises are all alike
  • Financial crises are rare
  • Crises erupt surprisingly and end quickly
  • Anyone can see them coming
  • Financial crises are mainly about big banks
  • Financial crises are preventable

The reality, he added, is quite different.  They include:

  • Financial crises differ greatly
  • Financial crises are frequent
  • Crises have long “tails” before they occur and after they occur
  • Financial crises are very difficult to forecast
  • Banking crises generally begin on the periphery rather than the center of the financial system
  • Crises are difficult and costly to prevent and mitigation may be a better solution

The financial crisis of 2007-2009 illustrates many of these points. The crisis, Dr. Bruner believes, had its origins in 2005 and can be traced to real estate problems developing after Hurricane Katrina and other ocean-front states.  A peak in real estate prices occurred in 2006, yet continued lending led to weakness and failure of non-bank financial companies that eventually spread to major investment and commercial banks. No one focused on the dangers caused by rising leverage, frothy pricing in various financial markets, poorly understood new financial products and general overconfidence in the investing public. This crisis, as did most in the past, ultimately took a great toll on both financial markets and the real economy with high levels of bankruptcy and unemployment that took major government stimuli to mitigate.  The effects of the crisis led to various protest movements and to calls for more regulation of financial institutions and markets that we still have today.

Despite the many crises that we haves seen, predicting them remains difficult for various reasons:

  • They are generally all different
  • They are relatively rare “black swan” events with low probability but high impact
  • They have multiple causes
  • The public tends to ignore or be biased against evidence one may be building
  • Our forecasting models tend to look backwards not forwards.

Preventing a future crisis would be costly and would stifle innovation, Bruner concluded, and policy makers efforts may better be spent in mitigating crises when they occur.

Click play below to listen to Bob Bruner’s presentation.