CARDIFF GARCIA, BYLINE: The financial crisis that started almost exactly 10 years ago has left a giant imprint on the economy, on financial markets, and some would say on our politics as well. But what about on us as individuals, for people who directly experienced its consequences like people who maybe lost a job or lost their house or their retirement savings, or even for people who kept their job but just felt insecure about their finances because their neighbors or friends or loved ones had suffered? What were the effects of the financial crisis on them and how they interact with the economy, with their work, with their money?
The ways in which living through an experience like this can change us is a topic that's been studied by Berkeley economist Ulrike Malmendier. I'm Cardiff Garcia, and this is THE INDICATOR FROM PLANET MONEY. Today on the show, a chat with Professor Malmendier on the ways in which many of us might have been affected by the crisis maybe even without realizing it and why that matters for the economy.
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GARCIA: Professor Ulrike Malmendier, how are you?
ULRIKE MALMENDIER: Great. Great to talk to you, Cardiff.
GARCIA: So based on your work, what can we say about the experience of living through an event like the financial crisis? What can we say about its likely effects on us?
MALMENDIER: What my research suggests is that living through crisis in a particular market - say, a housing market crisis or stock market crisis - will affect your willingness to take risk in that specific market for decades to come. You will be in the crisis case more averse to taking risk in that market, less willing to invest in that market. And that is importantly after controlling for the, you know, usual culprits - for negative wealth impact, income, unstable employment situation. Even after controlling for all of these traditional economic factors, it turns out that your attitude to take risk in those markets is altered.
GARCIA: So if I think back to the financial crisis - right? - I would imagine that the financial crisis would have left a very deep imprint on most people because it was so all-encompassing. I mean, there was a massive stock market decline. A lot of people lost their homes. There were a lot of people who lost their jobs or had their incomes stagnate for a while. It seems like an event that would be hard to avoid psychologically.
MALMENDIER: That's exactly right. So if everybody lives through the crisis - say, the housing crisis, the mortgage crisis - then one clear prediction is, well, they will be more reluctant to become a homeowner, more reluctance to leverage up your home equity than we observed before. And we clearly see that in the data. Both economists and policymakers have started to worry about the missing generation of homeowners, people in their 30s, 40s being less willing to own their home compared to past decades. And I think that is a closely related long-run effect.
GARCIA: I'm wondering if there are any other examples where we can see this newfound caution in the economy itself.
MALMENDIER: Yeah. It is not only in the housing market and mortgage market where we observe these effects. Take the stock market. Financial crisis clearly affected returns to your personal portfolio. And our calculations suggest that a person who was about 30 when, say, in 2008 the financial crisis hit will drastically reduce her inclination to be a stock market participant. And it will take about 30 years until this effect is not detectable anymore in the data.
Now, I should add, if I may, that an interesting implication of the experience effect hypothesis is it varies by age. So if you were relatively young, your generation - you just graduated from college, you go for your first job and, boom, you're hit with the crisis - that has a really long-lasting impact. You can think about all your economic experience basically consisting of that crisis.
And so you're fully affected by it while then 60-, 70-year-old person, you know, surely didn't like the financial crisis but is averaging that experience, so to speak, with a lifetime experience of decades before, and we find a much weaker effect. So it is also important to look in terms of asset markets who are we interested in. And so in housing, relatively young generation whom we may want as policymakers to buy their home - on them, unfortunately, it has the strongest impact.
GARCIA: Very interesting. So those are some of the effects on people. I'm curious to know if there are any potential effects on companies, on institutions or on banks because of course those institutions are run by people who themselves might have been affected.
MALMENDIER: That's a very good point. We researchers in behavioral economics often focus on the individual. But at the end of the day, companies and banks are run by those individuals. So if I have the hypothesis that individuals are affected by personal experiences, that should translate into corporate decision-making, decision-making for their company. And indeed that's exactly what we find. So we do see then - if you think about a company as a person just for a second, you do see that, say, a bank who has gone through periods of difficulties, being close to maybe having to be closed down, being close to a bank run, et cetera, that this experience in quotation marks of the bank stays with the company for decades to come, that they're more conservative in their risk-taking.
GARCIA: I have to say I have a kind of a mixed feeling about whether we should think of the caution after the financial crisis as a good or a bad thing because it seems to me like we need people to be willing to take risks in order for the economy to grow. You need people who are willing to borrow money to start a business, right? We need people who are willing to invest in the stock market so that companies can have the money to fund their operations. On the other hand, there was maybe too much risk-taking before the crisis. And it seems like a little bit of caution now means that we'll take smarter risks and that maybe the recovery since the crisis can last a bit longer. But I'm not totally sure what I should make of it. What do you think?
MALMENDIER: Yeah, that is a really good question. So on the one hand, you're pointing out that if the crisis makes me more cautious in my risk-taking and maybe a little bit less optimistic about whether, say, as an entrepreneur I will be successful, that can be a good thing. That can be a good thing if my beliefs before were upward biased. Also, you know, we have been talking a lot about crisis experiences, but our research shows that the - you know, the opposite direction works very similar. If you have periods of good economic performance, maybe even bubble periods in the stock market and other asset markets, people tend to get - become overly optimistic.
So, you know, if you say, well, maybe these experience effects of the crisis are not so bad, you do have to also take then the experience effects of the bubbles. And they of course can lead to tremendous bad decision-making of over-investment into very risky assets. So on net, I would think making sure that people have realistic beliefs about the returns to these various asset markets we've been talking about would probably still be my preferred world to live in.
GARCIA: All right, professor Malmendier, thank you so much.
MALMENDIER: You're very welcome. Thanks for having me.
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