The day risk died

Share

Exactly two years ago, Lehman Brothers, one of Wall Street's most storied investment banks, was fighting for its life. In the days that followed, regulators and bankers worked frantically to save the 158-year-old firm. They failed, and in the early hours of Monday, Sept. 15, it filed for bankruptcy.

The result was chaos. The Dow Jones Industrial Average tumbled 4.4 per cent in a day. By Tuesday, the bread-and-butter funds used by Americans as a substitute for bank accounts threatened to collapse. The same day, the government rescued the giant insurer American International Group, as it, too, tottered on the edge. On Wednesday, the stock market plunged again, by almost 5 per cent.

Within a week, Wall Street was unrecognizable, its marquee firms gone, swallowed or radically transformed in an effort to survive.

By the end of September, some of the nation's largest banks had begun to crumple.

There are many ways to tally the casualties of the worst financial crisis since the Great Depression: hundreds of failed banks; millions of people out of work; trillions of dollars in home values and retirement savings vaporized.

But two years after the stunning events of September, 2008, there is another entry to the list. Those dark days and the months that followed saw institutions that appeared solid vanish overnight; cherished certainties about investing and the economy were swept away. The end result is that Americans, once enamoured with taking risks, are now shunning them. And when the world's great dice-rollers stay away, there are global consequences.

Across the US, the appetite for taking chances is in retreat. Individuals are saving more, spending less and hunkering down in more conservative investments. Companies, too, are demonstrating an abundance of caution, amassing record piles of cash but hesitating to spend it or to hire workers.

Such behaviour is, on one level, a much-needed tonic to the years that preceded the crash, where Americans borrowed and spent in a mode that might be described as blind to risk.

But something is also lost when the world's most stubbornly optimistic gamblers turn reluctant. In order for the current sluggish recovery to become robust, economists say, some of them will have to come back to the table.

Others suggest that the current environment squelches some of the productive craziness that has helped to make Americans prosperous over time. John Gartner, a psychologist who teaches at Johns Hopkins University, has argued that, thanks to successive waves of immigration, the US has more than its share of "hypomanic" personalities - energetic, grandiose types with a propensity for taking risks.

Such temperaments are fixtures in US history, from industrialist Andrew Carnegie to auto pioneer Henry Ford, from the dot-com evangelists of the late 1990s to the real-estate buccaneers of recent years. The downside is a built-in weakness for market bubbles, but the upside is entrepreneurial activity and innovation.

"Right now, we're in the 'why did we listen to these idiots?' period," Mr. Gartner says. Once enough time has passed, that will change. "We will fall for it again - in a good way and a bad way."

The casino is closed

To get a sense for the average American's appetite for risk, it helps to pay a visit to a favourite casino: the stock market. So far this year, Americans have yanked $45-billion (US) out of mutual funds that invest primarily in US stocks, according to the Investment Company Institute. In the same period, they have plowed $185-billion into bond mutual funds.

The continued retreat from stock funds is not what you would expect to see at this point in time, notes Brian Reid, chief economist at the ICI, given that the market bottomed last year and the economy has pulled out of its tailspin.

It's "anomalous," he says, but not exactly surprising. Investors have experienced two massive busts - first in technology stocks and then the 2008 crash - over the past decade. The end result is that U.S. stocks have effectively gone nowhere since 2000.

For now, America's long love affair with risk shows no signs of being rekindled. Indeed, the country appears caught in a vicious cycle where little growth in jobs reinforces the caution of consumers, who are reluctant to spend, which makes companies hesitate to hire.

In a recent discussion with analysts, John Chambers, chief executive officer of tech giant Cisco Systems, remarked how the company's customers had become unusually cautious.  Even though they saw improvements in their own businesses, he said, they were not at all confident the trend would continue.

Breaking out of the loop of precautionary behaviour will be difficult, Doug Cliggott, chief equity strategist at Credit Suisse, noted in a report last month. A central feature of today's environment, he wrote, is "an acute sense of uncertainty - about future economic growth, about the security of our savings and the value of our assets, and about our governments' ability to keep their promises."

Liquidate or perish

Kevin Hussey, a telecom executive and father of three who lives in Ashburn, Va., remembers that after Lehman Brothers collapsed, he chalked up some of the turmoil to overreaction. He traded in and out of some stocks, looking for bargains.

But as that fall stretched into spring, the economy tanked. Friends began losing jobs and weren't finding new ones. "You just kind of looked around at the landscape and understood that we're here for the long haul," Mr. Hussey, 35, says. "Most of us planned for a rainy day, not a flood, and we're knee-deep right now."

He took money out of stocks and placed it in safer investments. He doubled the amount of cash put aside in case he found himself out of work, enough to last a year.  He made extra mortgage payments because he didn't want to be saddled with too much debt.  The crisis, he says, was a wake-up call.

Ron Munn, a 69-year-old retiree from Green Valley, Ariz., remembers that as US banks began to totter in September, 2008, he decided that he had had enough. He sold all of his stock holdings - then about two-thirds of his portfolio - and now holds only bonds and cash.

He jokes that he's a "big sissy," but he adds that he sleeps peacefully at night. Speaking of his conservative holdings, he says: "The return on them is terrible, but at the same time there's less risk."

And in his situation, taking chances is exactly what he can't afford. "In retirement, if you lose it, it's goodbye Charlie," he says. "You might find yourself a greeter at Wal-Mart."

One of the striking aspects of the new sobriety is the way it cuts across generations. While it might be logical to expect people nearing retirement age to watch their step, the same isn't necessarily true of people in their 20s and 30s. Yet that's exactly what recent surveys of investors seem to indicate they are doing.

In a poll of affluent Americans conducted earlier this summer by the Bank of America, more than half of the individuals 18 to 34 years old described their tolerance for risk as "low." The only other age group that demonstrated a similar amount of caution was people 65 and older.

A lost generation

Such pessimism is leading some to wonder whether the current cohort of investors will be a kind of "lost generation," with a long-lasting distaste for risk-taking. This has happened before, particularly among Americans with first-hand experience of the Great Depression.

Scott Kays, a financial adviser in Atlanta, recalls that his father, who lived through the Depression, did not touch stocks for his entire working life. His mother, meanwhile, told him never to invest in the stock market except what he could afford to lose.

Unlike his parents, Mr. Kaye sees investing in stocks as a "very calculated risk." But he adds that the US may very well be in the middle of a period where, for 15 to 20 years, the stock market more or less treads water.

Some experts say the current changes in behaviour - moving to more conservative investment strategies, cutting back on consumption - are happening on the margin and do not reflect a massive shift in the public mood.

Amar Bhide, a professor at Tufts University, has argued that risk-taking by consumers is a central feature of American life and a key input in the country's capacity to innovate. The failure in the housing bust came from a different quarter, he says.

"What is worrisome is not that people have become reckless - Americans have always been reckless - it's that the restraint, which ought to come through the banking system, was lost."

When Mr. Bhide calls Americans "reckless," he means it in a positive sense - a notion that tomorrow will be better than today; a willingness to try or buy or invest in something new, even when the risks and potential returns are nebulous.

That attitude is alive and well today, he notes, citing as one example the way that millions of iPads went flying off the shelves soon after they were introduced, even during a time of economic stress. "It's not clear to me what the heck it does," he says of Apple's new device. "It's not the same as buying a $200,000 house, but it is nonetheless a risk."

Joanna Slater is The Globe and Mail's New York bureau chief.