Wall Street is a strange, ever-evolving experiment, and like automobiles, stock markets are fairly predictable. You get to know the little tics and noises and what they mean. But once in a while, the “Check Oil” warning light quits working. So cruising along, thinking everything is fine, there’s actually severe, irreversible damage occurring. Then one day, the motor just blows, and you’re in for a huge repair bill. There’s a reason they call those little warning lamps on the dash “idiot lights,” and just like cars, most Americans can only scratch the surface when it comes to understanding the machinations of the economy.
Bull market, bear market, indexes, consumer confidence, quarterly yields — all that terminology can get confusing. So in late 2007, when some financial gurus began chattering about a “coming recession,” many market watchers — whether 401k laymen, day traders or seasoned investors, still intoxicated after 15 years of unprecedented growth — couldn’t make sense why.
Business Week published a brilliant article today by Pablo Triana called “Why Business Schools Are to Blame for the Crisis,” and it’s the first time, to my knowledge, that any money writer has so accurately identified the culprit. Structuring real-time financial models on theory, business academia has essentially held sway as the mastermind behind the American economy since time immemorial. While most theories have panned out through the ages, academia always factors out human foibles such as greed and irresponsibility. Business has too many variables to be approached with rigid science, and theories, while they often work, fail to consider your Bernie Madoffs and things like insider secret-trading. “And, mind you,” Triana wrote pointing to 1987 and 1998 crashes, “the current meltdown is not the only case of theory-caused troubles.”
To understand the current American financial crisis, compare it to Augusto Pinochet’s Chile during the late 1970s. Following the 1973 coup d’etat of Salvador Allende, Pinochet was saddled with rebuilding an essentially broken economy. In response, he hired a handful of Chilean economists trained at the University of Chicago’s business school. Known as the “Chicago Boys,” these 25 slick young grads were charged with reshaping the Chile into a modern free-market model. First, they opened up the economy to foreign investment, and with major infusions of new capital, banks began giving easy credit to Chile’s all-new consumer class, as a generation of entrepreneurs was born. By lifting import tariffs, cheap Asian products soon flooded the marketplace, and the country’s bedrock industrial sector — unable to compete — shifted into a service economy, as a slough of jobs went overseas.
But the spell was short-lived. The spitfire growth created over-valuated markets, and when the dominoes began falling, the whole game went into quick collapse. As unemployment soared with inflation and bankruptcies, to stem an imminent hyperinflation, the government was forced to nationalize the banks, buying the bad debts at a dime to the dollar. Sound familiar? Chile’s financial crisis was the first of its kind, as the new free-market model — bomb-proof in theory — fell flat on its face. As Triana asks in his article about the American financial crisis, “Why not focus on understanding what truly happened and on making sure that it can never happen again?”
Now that’s the trillion-dollar question. Like a car, a little preventative maintenance feels a whole lot better than painful hindsight. And a big repair bill.
Photo courtesy of Kevin Dooley via Flickr.