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Lessons from the Financial Crisis
 Economic Predictions from the World's Top Economists - Wall Street Most Influencial Economists

Research Questions:

  • What are the lessons we can learn to avoid future crises?
  • What the the economic policy lessons?
  • What are the investment lessons?
  • Do we need more financial market regulations or less regulations?

Who Predicted the Financial Crisis - The Financial Crisis Winners and Losers

Research Findings:

We identified several government policies, investments strategies and risk management lessons. The following section lists some of these lessons:

Who Predicted the Financial Crisis

Policy Lessons

On May 7, 2009 , Chairman Ben Bernanke concluded in a speech at the Federal Reserve Bank of Chicago Conference on Bank Structure and Competition, Chicago, Illinois (via satellite) the the best way to avoid future crises is to improve supervision of the banking sector by Strengthening Capital, Liquidity, and Risk Management. He also said

Looking forward, I believe a more macroprudential approach to supervision--one that supplements the supervision of individual institutions to address risks to the financial system as a whole--could help to enhance overall financial stability. Our regulatory system must include the capacity to monitor, assess, and, if necessary, address potential systemic risks within the financial system. Elements of a macroprudential agenda include
  • monitoring large or rapidly increasing exposures--such as to subprime mortgages--across firms and markets, rather than only at the level of individual firms or sectors;
  • assessing the potential systemic risks implied by evolving risk-management practices, broad-based increases in financial leverage, or changes in financial markets or products;
  • analyzing possible spillovers between financial firms or between firms and markets, such as the mutual exposures of highly interconnected firms;
  • ensuring that each systemically important firm receives oversight commensurate with the risks that its failure would pose to the financial system;
  • providing a resolution mechanism to safely wind down failing, systemically important institutions;
  • ensuring that the critical financial infrastructure, including the institutions that support trading, payments, clearing, and settlement, is robust;
  • working to mitigate procyclical features of capital regulation and other rules and standards; and
  • identifying possible regulatory gaps, including gaps in the protection of consumers and investors, that pose risks for the system as a whole.
Precisely how best to implement a macroprudential agenda remains open to debate (Source: Federal Reserve Speech)

Who Predicted the Financial Crisis

On  June 26, 2009, William Dudley, President & CEO of New York Federal Reserve Bank gave a speech on Lessons Learned from the Financial Crisis  at the Eighth Annual BIS Conference, Basel, Switzerland. He concluded: In assessing the lessons of the past two years, I will focus on five broad themes that are interrelated:

  1. Interconnectedness of the financial system
  2. System dynamics - How does the system respond to shocks?
  3. Incentives - Can we improve outcomes by changing incentives?
  4. Transparency
  5. How should central banks respond to asset bubbles?

A recommended article can be found at the  New York Federal Reserve Bank

Who Predicted the Financial Crisis

Med Jones outlined several policy and investment lessons in an interview with CEO Quarterly Magazine

Policy lessons from the global economic crisis

  1. Lack of regulation is as bad as over-regulation. Governments should not regulate free market choices, but they should regulate to protect investors against conflict of interests and negligence by investment bankers. Regulations should also ensure full transparency and disclosures and should effectively penalize violators. To be more specific, I mean investment banking firms who knowingly sold investments to their clients and later betted against them without informing the same clients; those who invested in fraudulent funds without proper due diligence on behalf of their clients; and rating agencies that mis-rated subprime junk derivatives as grade A assets.
  2. Short-term policy orientation can have adverse affect in the long-term with huge price to pay. The deficit spending, multiple stimulus and bailout programs fall into this category.
  3. The US and other political leaders should not allow private interest groups to dictate national economic policies and if they are too powerful and can influence their elections, leaders can mitigate the conflict of interest by including equal number of independent advisors and opposing schools of thought in the advisory and policy committees
  4. Insanity is defined as doing the same thing and expecting different results. Hiring the same people who got us into the economic recession in the first place or hiring those who did not foresee the financial crisis to design the recovery policies is not the right solution. Most of the economic advisors of Bush and Obama did not see the crisis until it was too late and some of them championed the policies that led to the crisis in the first place. Recently Obama was forced to change his economic advisors, but the question is whether the US can afford another trial and error approach to solving the crisis, be it the Democrats or the Republicans.
  5. Countries that quit producing real products, spend more than they produce, lag in education, burden their middle class with higher taxes, and continue to import billions from other countries, bail out failed businesses and reward bad behavior instead of investing in good businesses, will eventually lose their leadership and wealth.
  6. Countries pay a big price not only for their wrong economic policies, but also for wrong foreign policies. Countries that allow foreign lobbies, special interest groups or extreme nationalist movements to dominate their foreign policies by becoming active participants in international conflicts will end up creating more enemies and wasting their valuable resources in defending their own security. Countries that try to spread their ideologies by force, be it religion, socialism, capitalism, democracy or something else, will be overwhelmed by the human and economic cost of conflicts. Those countries will lag behind other countries that are focusing on developing their economies and advancing their interests via global partnerships and trade. The global economic landscape is not like it was after World War II; at that time, the US had no real competition in rebuilding war-destroyed European and Asian countries. With the new global knowledge and global competition, if you take your eye off the economic ball someone else will pick it up. This lesson is not only for the Americans but also for the Chinese, Russians, Indians, Middle East and countries all over the world.
  7. Globalization of markets, competition, partnerships and risks should carry far more weight in the designing of strategic national development plans. It is not enough to think about government budgets anymore, you need to build your economy and businesses for global markets and competition. The challenge is that CEOs now think like global investors, while the political leadership thinks like local civil servants. A new model for socioeconomic development with global partnerships is emerging. Getting the right policies to attract and develop talented labor, capital and diversify the income sources will determine the prosperity and wealth of the people of each nation.

Investment lessons from the financial crisis

  1. Be careful of whose advice and what advice you buy. Many of the top investment bankers lost money because they could not foresee the crisis. You will be more surprised to learn how many people lost money because they invested with fraudulent investment schemes, such as that of Bernard Madoff. Just Google the list of Madoff's victims and you will see that the list includes the largest investment banks and funds around the globe. That should tell you a lot about the soundness of the current investment strategies and risk management practices in the industry. Most of them treated their investments as black box with no real due diligence. Madoff's Ponzi scheme defrauded about $65 billion from top investment firms and lasted more than 15 years.
  2. Economists and financial analysts are not much better; most of them are academic experts, statisticians or quantitative analysts, with little or no real-life business experience. Very few have strong knowledge of the business drivers and qualitative forces that drive investment and operational decisions. Without that knowledge, you cannot accurately determine the performance of assets and markets
  3. Investment by imitation is not an investment strategy. So do not invest in an asset just because everyone else is doing so or because the largest investment bank has invested in it. When you decide to buy the advice of anyone, buy it based on the merit of the advice not on who is the source. Those are the ABC of critical thinking and sound decision making.
  4. Informed investors can make money in any environment including recessions. More millionaires were made during the Great Depression in the US than any other time, and more millionaires will be made globally because of this crisis than ever before. In my opinion, the markets now are full of undervalued assets that can make you rich; but you have to be very careful of which ones to pick.
  5. The adage that knowledge is power is true. In the world of financial markets and investments, knowledge is the ultimate power. Educate yourself before you invest. If you know something that others don't, you will make a lot of money.
  6. Success in the investment world is all about decision-making. Wrong decisions are based on lack of information or misinformation. If you are an investor or a CEO, try not to invest in an asset, a project or a product line, if you are not sure that the information is complete and accurate. Making the right investment decision requires a detailed set of information about macro and microeconomics conditions, markets, sectors, industries, companies, qualitative and quantitative analysis, fundamental and technical analysis, behavioral finance and risk management. Unfortunately, a substantial part of the information available in the media is just noise and the advice of many analysts is based on either incomplete decision-making frameworks or contaminated with biases and misinformation. The ability to distinguish between valid and invalid assumptions, more important vs. less important information, and to control the emotions of fear and greed during the ups and downs of markets are keys to the success of the investor. Because there are many uncontrollable variables, no one can forecast the future with 100% accuracy. However, by refining your investment decision-making framework and processes and by cleaning your information inputs, you can increase your success rate significantly. You only need to be right 70% of the time to be a very successful investor.

(Source: CEO Quarterly Magazine)

Who Predicted the Financial Crisis

Research Comment:

Knowing something on Wall Street that others don't know can make you very rich. John Paulson, John Paulson, Philip Falcone, Kyle Bass, and Jeff Greene  profited tens of billions of dollars by betting against mortgage backed securities and the banks that invested in them. Though there is no evidence that they predicted the economic aftermath of the subprime collapse, the knew to a point of certainty to invest their money in a sector that made them some of the richest people in the US. They were not lucky in their prediction, but they were lucky to be in the right industry with the right money connections to use their knowledge to their advantage.

Who Predicted the Financial Crisis

On November 4, 2008 An opinion article appeared on Wall Street Journal by Stephen Schwarzman. The article outlined seven lessons

First, we need to finalize a common set of accounting principles across borders. In global markets, you cannot have global institutions abiding by differing standards of accounting and disclosure simply because they are headquartered in different countries.

Second, the financial regulatory regimes in the world's major markets need to be structured along broadly the same lines. Each country needs a finance minister at the political level, a central bank and one single financial services regulator with a very broad mandate.

The regulatory agencies in the U.S. are too small, too fragmented and often not powerful enough to cope with a system-wide crisis. Our hodgepodge of regulatory agencies also encourages financial institutions to play regulatory arbitrage, seeking the most compliant and accommodating regulator. No major financial market can afford that.

Third, you need full transparency for financial statements. Nothing should be eliminated. Off-balance-sheet vehicles that suddenly return to the balance sheet to wreak havoc make a mockery of principles of disclosure.

Fourth, you need full disclosure of all financial instruments to the regulator. No regulator can do its job of assessing risk and systemic soundness if large parts of the financial markets are invisible to it. A regulator must be able to monitor all derivatives, including, for example, $60 trillion in credit default swaps.

Fifth, the regulator should have oversight over all financial institutions that participate in the markets, regardless of their charter, location or legal status. For example, it makes no sense if you are worried about leverage in the system to exclude major categories of borrowers, such as hedge funds.

Sixth, we need to abolish mark-to-market accounting for hard-to-value assets. There is now emerging a broad realization that mark-to-market accounting has exacerbated the current crisis. We are not talking about publicly traded equities with a readily ascertainable value. The problem involves securities held for investment purposes, and those instruments during certain times of the cycle for which there is no readily observable market. These securities and instruments would be fully disclosed to the regulator. However, a financial institution would not be forced to suddenly take huge write downs at artificial, fire-sale prices and thus contribute to financial instability.

Finally, we have to move to a principles-based regulatory system rather than a rules-based system. A system of rules and regulations is utterly incapable of dealing with the speed and complexity of the modern financial system. Current SEC and bank regulation was unable to stem the current crisis. 

(Source: Wall Street Journal)

Who Predicted the Financial Crisis

In 2009 OECD (A United Nations Agency) published a report, authored by Grant Kirkpatrick, and titled The Corporate Governance Lessons from the Financial Crisis

The report analyses the impact of failures and weaknesses in corporate governance on the financial crisis, including risk management systems and executive salaries. It concludes that the financial crisis can be to an important extent attributed to failures and weaknesses in corporate governance arrangements which did not serve their purpose to safeguard against excessive risk taking in a number of financial services companies.

Accounting standards and regulatory requirements have also proved insufficient in some areas. Last but not least, remuneration systems have in a number of cases not been closely related to the strategy and risk appetite of the company and its longer term interests. The article also suggests that the importance of qualified board oversight and robust risk management is not limited to financial institutions. The remuneration of boards and senior management also remains a highly controversial issue in many OECD countries. The current turmoil suggests a need for the
OECD to re-examine the adequacy of its corporate governance principles in these key areas. (Source: OECD)

Who Predicted the Financial Crisis

In February 4, 2009 the IMF published a report titled: Lessons of the Financial Crisis for Future Regulation of Financial Institutions and
Markets and for Liquidity Management,
Prepared by the Monetary and Capital Markets Department (Principal contributors: Luis Cortavarria, Simon Gray, Barry Johnston, Laura Kodres, Aditya Narain, Mahmood Pradhan, and Ian Tower) and Approved by Jaime Caruana

This paper draws particular attention to the following issues:

  1. Instituting a macroprudential approach to supervision and assigning a clear mandate to a systemic stability regulator.
  2. Expanding the perimeter of financial sector surveillance to ensure that the systemic risks posed by unregulated or less regulated financial sector segments are addressed.
  3. Ensuring that prudential regimes encourage incentives that support systemic stability and discourage regulatory arbitrage, and assure effective enforcement of regulation.
  4. Addressing the procyclicality of existing capital requirements and other prudential norms, preferably in a manner that is rules based and counters the cycle.
  5. Filling the information gaps, especially with regard to lightly regulated financial institutions and ‘off balance sheet’ transactions, ensuring that both supervisors and investors are provided more disclosure and a higher level of granularity in information provided.
  6. Resolving the political and legal impediments to the effective regulation of cross-border institutions, develop special insolvency regimes to be used for large cross-border financial firms, and harmonize remedial action frameworks.
  7. Strengthening the capacity of central banks to provide liquidity and respond to systemic shocks.
  8. Improving the capacity of national authorities to respond to systemic crises, including by establishing mechanisms for coordination both within and across borders.
  9. Establishing the basis for fiscal support during the crisis containment and restructuring phase, and an exit strategy for withdrawing public support and for a transition to a new and more stable financial market structure.

(Source: IMF)

Who Predicted the Financial Crisis

Other research questions and findings

  1. Why did the world's top economists fail to predict the financial crisis? (Others who missed the crisis, include government leaders, award-winning scientists, market analysts and investors). Was the crisis predictable or was it a Black Swan (unpredictable) event? Are government policy makers competent enough to manage the nation's financial freedom and security? Are economists and their policies helping or hurting our economic growth? Do we need to re-define the education of economic science and the role that economists play in our financial markets, government policies and business regulations? 
  2. Who is to blame for the financial crisis?  Who contributed to the creation of the crisis? Can they be held responsible for their actions or inactions? Was there a conspiracy by some Wall Street executives and government officials? Do investors have legal cause to seek compensation for damages caused by Wall Street firms?
  3. Who predicted the financial crisis and the ensuing economic crisis? Is there a documented evidence supporting their claims? Were those who warned about the crisis lucky or did they have a clear logic behind their predictions? Can we use their knowledge to predict future crises? What are their future predictions? How do their predictions compare with each other? Where do the experts agree and where do they disagree? How accurate are their economic predictions? Can they be relied on for investment decisions?
  4. Who are the top winners and losers of the financial crisis? Top investors, economists, intellectuals, government officials, think tanks, and universities that lost or won because of the crisis.
  5. What are the lessons we can learn to avoid future crises? What the the economic policy lessons? What are the investor's lessons? Do we need more or less financial regulations?


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