Monday, November 3, 2008

Boomers, Risk Aversion and the Stock Market Debacle

I've come across another theory that blames the global financial meltdown in part on Baby Boomers. While the author, Christopher Carroll at RGE Monitor offers not a shred of hard evidence to back it up, he does lay out a plausible argument, basing his logic on the established economic principles, not some supposed hideous moral flaw that mysteriously infected tens of millions of Boomers in different societies across the world.

The theory goes like this: October's massive losses on global stock markets cannot plausibly be blamed upon the creditwortheness of American subprime mortgage-backed securities alone. The value of vanished global wealth dwarfs the value of all subprime mortgages put together. Something else must account for the incredible shrinking stock market, and that "something," Carroll suggests, is a sharp global increase in risk aversion.

One potential source of that risk aversion is Baby Boomers. As Carroll puts it: "too many baby boomers and retirees (not just in America but around the world) trying to crowd through the risky-asset exit doors at the same time."

Crowding through the risky-asset exit doors is the defining characteristics of any bear market, however. Investors of all shades and striped were panicking, not just Baby Boomers. Why does Carroll pick on Boomers? Because the conventional wisdom holds that that people approaching retirement age should reduce their exposure to volatile investments, like stocks, and increase their commitment to more stable, less risky asset classes, like Treasuries.

Carroll thinks that a lot of Boomers failed to heed this advice before stock market took a nose dive. But when prices headed south and Boomers absorbed the implication of dwindling portfolios for their retirement plans, they stampeded like lemmings. Writes Carroll: "It seems increasingly plausible that the financial panic has pushed a lot of boomers and recent retirees over a tipping point of concern; they’d been thinking for years that it was time to start reducing their exposure to that risky stock market, but never quite got around to it. Now everyone wants out at once."

There's obviously much more to this story: We're still learning the role played by derivatives, swaps, overleveraged merchant banks and overleveraged hedge funds. But if 78 million American Boomers and tens of millions more across the post-industrial world decided to reduce the risk exposure of their retirement portfolios by shedding stocks, they could well have fueled the plunge in stock prices.

We'll keep an eye open for evidence that confirms or contradicts this theory.

1 comment:

Groveton said...

I think that Boomers did rebalance their portfolios in the latest turmoil. But investor sentiment often plays a role too. It's not just subprime mortgages - look at unemployment. Look at IPOs. Look at business credit. Look at LIBOR rates. And then apply an over-reaction of investor sentiment and baby boomer re-balancing. Pretty bad place to be.

But boomers will re-balance their portfolios even more over time. So, how do we deal with that?

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