Editor of the Financial Times: "Mea Culpa"

Aren't journalists supposed to be our canaries in the mine? Where were the warning signs for the financial crisis? I don't know enough about the journalism business but Lionel Barber, the editor of the Financial Times does.

Barber acknowledges that the media has failed us, and this is why:

SUMMARY
- Journalists did not understand the consequences of the proliferation and use of complex derivatives; did not understand the consequences of implicit state guaruntees to "too big to fail" institutions like Fannie Mae and Freddie Mac; did not understand the consequences of off-balance sheet financing; did not understand the consequences of an imploding financial sector on the real economy.

- Excacerbating the fact that the journalists didn't fully grasp alot of important things, it was in their interests to "run with the good news". Why pursue stories on mortgage lending scandals or predatory lending practices when your biggest advertiser is the property industry? Why would anyone give Jim Cramer a hard time when most of his viewers are Wall Street bankers and traders?

- The public's addiction to 24 hour news. Credit markets, where derivatives are transacted, are just too opaque. People want to hear day-to-day news, and derivatives can lie dormant for months or years before terms mature or get triggered. The need for market noise is simply filled in by comments on stock movements and public company earnings disclosures.

- Other important unanticipated events included: the rise of radical islamic terrorism; opening of the Chinese economy; two giant credit bubbles.

An abridged version of his recent speech at Yale University can be found here.

COMMENT
Just pause awhile and reflect on this admission. It must be truly humbling for the editor of the Financial Times to come to this conclusion, let alone mention it publicly. So if the bankers, regulators and guys who write about the industry didn't anticipate any of this, what chance do we have?

The sad thing is that we had plenty of opportunities to see it coming. Most of us suspected something, but lacked the persistence to seek the truth. Here are some questions you may have asked: How did housing prices rise so quickly and why are they suddenly a good investment? How did oil get to $150 a barrel and why are gas prices $4 a gallon? How does a guy who earns $50,000 a year move into a $2 million house? Why did prices of everything in NYC shoot up almost overnight? Why are there so many fresh college grads earning six figure salaries out of school? And why do they all seem to work in finance?

These were all common sense questions and have one answer in common. Ultimately, these anomalies were only made possible by the massive credit boom, the era of easy money. The past two decades saw a shifting of one giant asset bubble to another to another (stocks, housing, credit...etc) which was made possible by the de-regulation of safeguards put in place after the last big credit bubble--the Great Depression.

Why was it so hard to be contrarian? Three main reasons:

1) Because it is really that difficult to go against the crowd. We were stampeding along with the herd. How dare you impugn the knowledge and wisdom of the Head Analyst for a Wall Street firm who tells you otherwise? How can I be the only one thinking this is unsustainable when everyone else goes on with life?

2) Someone once told me that there is "nothing more unsettling than watching your neighbors get rich". The truth is, I am no exception to this. The fear of "missing out" when everyone else seems to be raking in the good times can be emotionally exhausting.

3) We've become enamoured by the personalities and the products of the financial industry. Goldman Sachs CEOs are as widely revered on Capitol Hill as they are on Wall Street. We admire success and often choose to ascribe superhuman characteristics to those who are successful, it's convenient and a story we like to hear. "John Doe is so successful, it must be because he's a financial genius." I've heard people talk about financial personalities in the same way a golf fan would talk about Tiger Woods, "what amazing natural born talent"! It is downright nauseating.

I also want to re-emphasize the need to fully understand consquences. A potential pitfall for many investors is the ego massage they get from understanding a derivative instrument. "I just got my banker to structure an XYZ instrument for me, as long as the volatility remains moderate, I'll make a healthy profit even in a flat market." Understanding how something works, isn't the same as having a full appreciation of the risks involved. Although you'll feel smarter when you get glazed looks after throwing out fancy financial terms at a cocktail party, the only thing you've succeeded in doing is locking yourself into an expensive and dangerous investment that could wipe you out.

The other ego massage pitfall is the "hard to access" trap. Imagine one of your buddies boasting about how he's gained access to the latest private equity or hedge fund. The fund hires the smartest people and they get fantastic returns and they don't let just ANYONE invest. Well, it turns out, sometimes genius fails. And those fantastic returns could turn out to be too good to be true.