Lessons from the Financial Crisis

With the S&P 500 Index up 23.5% as of November 1st, the panic that gripped the markets five years ago during the financial crisis is a distant memory. Yet, the anniversary of our economy’s biggest test since the Great Depression has prompted numerous articles reminding investors of Wall Street lessons learned that apply to Main Street. These include:  Be wary of taking on too much risk, understand that cash holds a place in all portfolios, insist on investment transparency, and don’t invest in financial instruments you don’t understand.

Among the many articles I’ve read on the anniversary of the financial crisis, two insights to help policymakers and regulators prevent future market crises stand out. First, Duncan Niederauer, CEO at NYSE Euronext, suggests that saving banks deemed too big to fail mischaracterized the problem. He writes that, for many, “Too big to fail symbolizes the cause of the crisis. But the problem really isn’t size per se, it’s the interconnectedness of institutions, creating a domino effect where a failing financial firm can bring down healthy ones as it falls.”

Because banks consolidated during the crisis and the largest financial institutions have gotten bigger, Niederauer says regulators should focus “less on size and more on the potential systemic impact of an institution having to liquidate quickly.” He advises, “The amount of capital, leverage, illiquidity and overall complexity on a bank’s balance sheet matters at least as much as the size of the balance sheet. By those measures, our banks are much healthier than they were five years ago. We ought to focus on ensuring regulators have to tools to adequately assess balance sheet health and systemic risk.”

Additionally, Sallie Krawcheck the former head of Merrill Lynch and Smith Barney, addressed another root cause of the crisis: greed. She writes, “We will never rid the industry (or any industry) of greed. Nor should we accept that the CEOs of the large financial institutions have to be “just right” supermen in order to steward their companies – and, by extension, the economy – safely.”

To keep financial institutions safe “even when the boards make the wrong choice – as even the most well-meaning of them can – and their guy isn’t smart enough, or fast enough, or forward-thinking enough,” Krawcheck advocates ensuring diversity of thought. Pointing to research that suggests that the most effective management teams and boards have diverse experiences and backgrounds, she advises reversing the “pronounced trend since the downturn of senior management teams becoming more homogenous . . . and thus even more prone to groupthink than the teams in place leading into it.”

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