Principles the crisis hasn’t changed

By Dr. Johnny Noet Ravalo
INQUIRER.net

The headlines are blaring, sound clips are plenty and online coverage seems never ending. Amidst all the financial difficulties, someone asked me what new lessons should be learned. I did not have to pause very long. I still think that the main lessons are no different from those that we have tried to share in this column on various occasions even though this crisis is unprecedented in many respects. For me, six lessons particularly stand out.

1. We simply do not have the ability to perfectly foresee the future. Lehman was after all an AA-rated credit so who would have imagined what would become of such a venerable Wall Street name. This human limitation is the best reason why we should be saving. We should save because it is the only way we can transfer purchasing power from when we have a surplus to when we may suddenly need more of it. In other words, saving during normal times helps us manage the difficult times. When difficult times kick in, our financial plans often shift to prioritizing liquidity over profitability. Unless we have a fool-proof way of either marrying into or inheriting liquidity just at the right time, we simply cannot maximize liquidity when we have no saving to speak of in the first place.

2. Change is the one constant in financial markets. With change, perceptions and fortunes can very well change as well. What may be heralded today may suddenly be frowned upon when market conditions change. Mortgage-Backed Securities (MBS) and Collateral Debt Obligations (CDO) were positioned as financial engineering responses to the needs in the housing market. They provided the means for more individuals to obtain their own home via mortgage while allowing financial institutions to re-package the exposures. Yet as market rates reversed, what were once labelled as “innovations” had evolved into the “sub-prime” saga.

3. Financial value is a relative concept. A trader, for example, would have a different mindset from an investor. This matters because ultimately the portfolio of a trader should be different from the portfolio of an investor. There is always that natural urge for any investor to get a bit more but without realizing it, some of us cross over and mimic a trading position and get consumed in the day-to-day changes in market values. This will be a problem because traders build their portfolios based on different investment objectives and look forward to “re-balancing” the portfolio to generate returns. Most retail investors would not have the “information infrastructure” to monitor the markets ticker-by-ticker and adjust their portfolios accordingly. Instead, it may be more prudent to give up on higher risk instruments for those that can provide a reasonable gain over longer periods, with due consideration to our shifting liquidity needs and the changing fortunes of the credit quality of the instrument issuer.

4. Financial markets provide a value-added service but they do not have to be “equal” to all to get this job done. This is perhaps the hardest lesson of all and it does not mean that financial markets are inherently unfair. What it simply says is that the financial market cannot accommodate everything that each of us want because trade-offs are necessary. For example, we cannot generate the highest return without taking more systemic risks. And no matter how we work on it, a pool worth P5,000 is much less flexible than a pool worth P500,000. This is not being unfair. Rather, it is a testament to our differences; differences that make markets work so that differentiated products are offered for different needs.

5. Market dynamics have a way of containing excesses. Unfortunately, the realignment is never painless because it may mean getting a bump, a bruise or a bleeding cut every now and then. This is not a critique of the financial market but more of a blunt reminder that there needs to be a certain amount of balance in what we do in these markets, both for our individual portfolios and our collective behaviour as stakeholders. It is important that we identify what we want out of our investments, make sure that our investment objectives are consistent with our own capacities and have the discipline to stay within our means. This is often not easy and this is where we really need the objective eye of financial advisers and brokers.

6. Finally, information is supreme in financial markets. It is important that we know what’s going on in the market because it is our saving that is at stake. The difference between an informed investor and a panicky investor is often the absence of quality information. Deal with financial institutions that make a clear effort to communicate with you and take the time to keep the lines open. This is not an excuse to abdicate on making financial decisions. That part still rests with us because it is the action item that comes from gathering the relevant information.

These are the lessons that I always keep in mind. I don’t mean to suggest that it is an exhaustive list and I do not also represent them to be a recipe for financial success. For me at least, it helps in maintaining a perspective and all day-to-day financial choices are anchored on that broad view.