If it keep on raining, the levee’s gonna break.
Some of these people gonna strip you of all they can take.
–Bob Dylan, “The Levee’s Gonna Break”
There’s a rumor going around that Wall Street’s troubles, which have become every investor’s troubles, reach back only a year or so. In fact, the genesis of the mess goes back much further. It’s true, of course, that most investors have only been paying attention for the last year or so, thus the rumor.
The unwinding of the great bull market is now unwinding faster, and with devastating consequences. But for those who claim that they didn’t see it coming, it’s obvious that they weren’t paying attention in the 21st century. Excess has been building for some time, and the trend must reverse, as all trends eventually do.
There are many lessons one can draw from the downfall that is now in full swing, but the most important one is the same one that every crisis imparts and that too many investors ignore until it’s too late: risk management is the only salvation over a full business cycle.
The bankruptcy of Lehman Brothers, the sale of Merrill Lynch and the precarious and perhaps fatal finances of AIG are nothing new in the grand scheme of economics and finance. Businesses have been collapsing and investors have been losing money since the ancients invented the money game. What’s changed in relatively recent history is our understanding of how we should play the game, as we’ve discussed many times, such as here.
Risk management, in short, is the first and last rule in money management. Easy to say, tough to do, but always and forever essential. Unfortunately, learning this lesson is very, very difficult, if not impossible at times–especially for those at the highest levels of the financial industry.
Risk management has been ignored, or at least manipulated and distorted by too many finance heads, and the price tag is now in full view. Identifying the motivation and rationalization for going off the deep end with inane behavior in managing assets is ultimately an exercise in reviewing the flaws of the human mind as it relates to greed and fear.