Five lessons we failed to learn

The credit crunch shook us, but we have yet to absorb these financial truths...

According to psychologists from the University of Exeter, we learn better from our own mistakes than from other people’s errors. This is because our brains produce an ‘early-warning signal’ that helps us to avoid repeating previous mistakes. Thus, when we ‘take the pain’ faster, we produce longer-lasting life lessons.

Five ideas that deserve to die

Before the ‘Global Financial Crash’, making money was a no-lose game. You just bought assets (such as property and shares; ideally using borrowed money), sat back and watched their prices rocket.

There’s no such thing as a true one-way bet, and the credit crunch duly arrived in August 2007. As cheap credit was choked off, asset prices tumbled. After nearly a decade of deceptively low-risk returns, we got our wake-up call.

However, I’m not convinced that we Brits have properly learnt the lessons that the financial meltdown should have taught us. These five ideas should have been taken behind the barn and shot, but somehow miraculously survived:

1. Banks don’t go bust

Until the crash, we hadn’t seen a big British bank fail for over 140 years, since Overend, Gurney ceased trading in 1866.

Unfortunately, when Northern Rock asked the Bank of England for financial help in September 2007, savers queued to withdraw their money. The government responded by guaranteeing all Rock deposits. Later, it enhanced the Financial Services Compensation Scheme (FSCS) to widen the safety-net for all savers.

Northern Rock was nationalised in February 2008, and Bradford & Bingley followed suit in September 2008. After the collapse of Lehman Brothers, Lloyds TSB and Royal Bank of Scotland were on a financial knife-edge, so the government injected billions of taxpayers’ money into these banks.

Although saving seems safe now (with the FSCS limit raised to £85,000 on 1 January), please don’t assume that banks won’t get into trouble in future. Instead, keep an eagle eye on your savings and don’t keep all of your eggs in one basket.

Recent question on this topic

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  Is it true that there has been an increase in the limit of the Financial Services Compensation Scheme from £50,000 to £85,000 with effect from today?

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    MikeGG1 answered "There is also a faster payment system and gross payment instead of net payment. But don't..."
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2. Governments are safe

Another intellectually bankrupt idea that limps on is the view that government finances are essentially solid.

Throughout modern financial history, governments have defaulted on their debts and devalued their currencies in order to survive. Indeed, some governments repeatedly default on their ‘sovereign debt’, notably Spain (seven times in one century), Russia, and a string of Latin American and southern European states.

Contrary to popular belief, government bonds are far from the risk-free investments they allege to be. Financial recklessness has contributed to the decline and fall of all great empires. Hence, if history is any guide, then it’s entirely feasible that the UK or US government could one day default on its debt.

3. Easy credit is endless

During the go-go Noughties, companies and individuals borrowed like there was no tomorrow. Companies leveraged up with debt in order to make big, bold acquisitions, or expanded their operations using cheap credit.

Likewise, consumers gorged themselves on low-rate mortgages and easy-to-get loans and credit cards. At its peak, personal debt was rising by an incredible £100bn a year, with easy access to mortgages seen as a right.

Today, mortgage lending has dwindled and non-mortgage debt fell slightly last year. Nevertheless, millions of us continue to supplement our lifestyles using borrowed money, even though interest rates are sure to rise soon. For many, ‘plasticmania’ is still a way of life.

4. PLCs are better than mutuals

During the Noughties, directors constantly boasted how well their companies and shareholders were doing. Indeed, some pundits predicted that shareholder capitalism would kill off the mutual (customer/staff-owned) model which has flourished since Victorian times.

Today, these shareholder cheerleaders have egg all over their faces. While scores of public limited companies folded in the recession, mutuals such as the Co-operative Group and the John Lewis Partnership thrived. Likewise, risk-averse building societies rode out the crash much better than the big banks did, avoiding another round of taxpayer-funded bailouts.

Furthermore, since the late Nineties, investors in listed companies have made poor returns. Today, the FTSE 100 index is just above 6,000 points -- a level it first breached in March 1998. Therefore, I make the score Mutuals 1, PLCs 0.

5. Bumper bonuses make for brilliant bosses

As share prices soared in the 2003/07 stock-market boom, the bonus bandwagon gathered speed. Million-pound bonuses became commonplace in the City and in company boardrooms. At the top end, top hedge-fund managers banked nine-figure bonuses (£100m+).

While bankers and other high earners argue that they need big bonuses to perform at their best, the man in the street sees people being paid twice for the same job.

Bonuses may bring out the best in people, but excess payouts encourage executives and traders to take ever-greater risks. This short-termism makes sense, as success brings huge personal rewards, yet failure leads to someone else losing out.

Alas, despite the global financial crash, many top employees still put their personal enrichment before their job responsibility. Greed may not be as rampant as it was during the boom, but it’s not dead yet.

And finally...

In summary, despite the financial equivalent of the meteor which wiped out the dinosaurs 65m years ago, we still cling to beliefs that should be dead and buried. It’s vital that we identify and kill off these ‘zombie beliefs’ before the next big bubble arrives!

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