Risk Is Back in Fashion on Wall Street

Here we are again. Nearly the mirror of a pop culture that loves retro, vintage and déjà vu, financial markets are repeating past mistakes.

If a recording studio can sell a “new” Michael Jackson album, if in New York and Los Angeles the girls mimic the Elizabeth Taylor look of the 1960s and if an antique story like “La Grande Bellezza” (“thanks to Fellini,” said Paolo Sorrentino at the Oscars) is so successful, it’s not surprising that Wall Street wants to relive the years that preceded the financial crisis.

With typical short-term memory, investors are buying ever riskier assets. From the garbage bonds in stock markets in difficult countries like Nigeria, Argentina and Vietnam and the houses built out of pure speculation constructed through incomprehensible derivatives, this is a movie we have already seen — a little bit like “La Grande Bellezza.”

In the boom years between 2005 and 2007, the optimism of the markets had inflated a gigantic bubble in similar investments: the stuff of thrill-seekers, which nevertheless offered the promise of bigger bank accounts or Treasury bond earnings.

The rest, as they say in America, is history. A painful story about the crumbling of Lehman Brothers, an excruciating unemployment rate in the United States, and a very long recession on two continents.

For now, however, the past does not matter. We look ahead even if the future could be a mirage.

Wall Street has coined a term in order to explain the comeback of the risk bug: “search for yield,” which is a technical euphemism — a little professorial and a little bit Indiana Jones-like — that aims to reassure both sellers and buyers.

But mellifluous words cannot mask the reality of a financial system that seems to be following the Pied Piper of Hamlin.

In order to understand the psychology, or madness, of the current markets, it is necessary to go from the post-crisis present back to those dark days when the world economy was on the brink of a depression, as in the 1930s. At that time, the central banks were doing the only thing they could do: lower interest rates, inject money at low prices into the economy, and refinance the financial system in the hopes that businesses, banks and consumers would start doing what they normally do again.

The strategy only partially worked. The monetary policies of the Federal Reserve, European Central Bank and Bank of England (Japan joined in only later) were successful in preventing the Great Recession from turning into another Great Depression. “It’s the difference between saving on lunches at restaurants and living under bridges,” a Fed worker who was in the control room in 2008 told me. He is right. The post-crisis period could have been much, much worse. But the long-term plan of the central banks failed. The idea was to administer significant stimulus doses for a short period of time and let Keynes’s “spirit animals” — the desire to intrinsically generate producers and consumers — step on the gas pedal of capitalism.

But almost six years since the crisis, the economies of Western countries are still stuck in neutral. In America, growth is minute, unemployment is still high and the real estate market is not healthy. In Europe the situation is even worse with the specter of deflation that hovers over the eurozone.

And now, interest rates must remain low and the ECB has to think of stimulus methods that are similar to those of the Fed and its Japanese colleagues. But if the rates stay the same, “secure” assets like the bonds of the U.S. Treasury and the dollar will not return much. The only solution for investors is to turn to riskier goods because they have higher returns. “Look for his wife,” the French say when they want to explain strange behavior on the part of men. For investors, the saying goes, “search for yield.”

Seen through this prism, the choices of the masters of money seem rational. Ford O’Neil, who oversees $14 billion in investments at the savings giant Fidelity, explained it well to The Wall Street Journal: Low interest rates are “forcing folks into riskier strategies in which they feel they will be more richly compensated.”

What are the risks of this return to risk? There are two in particular: a relapse into recession for a leading economy, like the U.S. or Europe, and an increase in interest rates that markets do not anticipate.

For now, neither scenario is probable. It’s true that economic growth on both sides of the Atlantic leaves much to be desired, but the chances of a slowdown are not high, especially while the central banks are on alert. The risk of a rapid rise in rates is also low, partly because it would make no sense in the current economic fray and partly because the Fed and ECB have learned to deliver their decisions without shocking markets.

The financial bubble exists, but we are just in the beginning stages — a period when the earnings could justify the risks. At times like this, it’s possible to make money, even a lot of money, if you hit upon the right investments.

The dizzying rise in American stock markets last year proves it. The fall of those same markets this year — especially stocks in the tech and biotech sectors — are the counterproof of the dangers of an uncertain period, in which prices go up but the macro economy stalls. Sooner or later interest rates will go up again, the psychology of investors will become more conservative and the bubble will deflate.

But for now, as Citigroup’s old CEO Chuck Prince used to say, “as long as the music is playing, you’ve got to get up and dance.” Careful though about where the chairs are.