Wall Street has infamously had its share of ugly Octobers, so Alison Southwick and Robert Brokamp chose this month to offer their listeners a special treat: a four-part series on the history of market crashes in the United States.

In this Motley Fool Answers podcast, guest and former Fool Morgan Housel helps them wrap things up with a post-mortem on the downturn we all think we know best, because it's so recently behind us: the Great Recession.

A full transcript follows the video.

This video was recorded on Oct. 24, 2017.

Alison Southwick: This is Motley Fool Answers. I'm Alison Southwick and I'm joined, as always, by Robert Brokamp, personal finance expert here at The Motley Fool.

Robert Brokamp: Hi, Alison.

Southwick: Hello, Bro.

Brokamp: Hello, Alison.

Southwick: We're going to be doing it in our low and slow NPR voices today. No, we're not! Today's episode is the fourth and final installment of our series on market crashes with the help of the Collaborative Fund's Morgan Housel, and we're ending with one that a lot of our listeners remember all too well, the Great Recession. We'll also answer your question about the right mix of index funds and individual stocks you should hold. All that and more on this week's episode of Motley Fool Answers.

[...]

Southwick: It's time for Answers, Answers and today's question comes from Victor. Victor writes, "I am new to The Motley Fool and I am confused by seemingly conflicting advice."

Brokamp: Aren't we all, Victor?

Southwick: Here's where we say that we are motley...

Brokamp: That's right.

Southwick: ... and we bring together many different opinions. But you came here, Victor, because, you want Bro's opinion. So I'll get back to your question. "In Stock Advisor's 'Guide to Foolish Success' you wrote that, 'We think that index funds should be the foundation of your portfolio and for every dollar you put in individual stocks you roll the same amount into an index fund.' Yet, in other articles you suggest that investors don't need funds if they own enough stocks." In a nutshell, what the heck? That's how Victor just should have ended it. What am I supposed to do?

But he's nicer about it. He said, "In a nutshell, should I consider a portfolio that is 50% stocks and 50% index funds, or should I avoid funds once I've gotten up to speed?"

Brokamp: Well, as Alison pointed out, we're a motley crew, so I think if you were to ask anyone who works at The Motley Fool for an answer to this question you'd get a slightly different response.

Southwick: Ask five Fools, you'll get six different answers.

Brokamp: But I will say the advice that you got from Stock Advisor, which is our flagship membership service, I think is a great way to start, and that was basically 50-50 in terms of how you allocate the two. And I would say you know when to move more toward individual stocks and away from index funds when you feel like you've got a handle on investing in individual companies. You've been doing it for a few years. When one of those stocks goes down 50-70% you don't freak out and sell. You manage to hold on. You've established a record of being able to pick good individual stocks.

One of the reasons why I like index funds is I believe in hedging all kinds of things and being an individual stock picker, as I am, and owning index funds like I do, I have the index funds basically as a hedge against my own failed ability to pick individual stocks if that happens. So far I've done OK, mostly with the help of The Motley Fool, but I think everyone should have that foundation of index funds.

A lot of people might find that surprising coming from The Motley Fool, because 98% of what we say and write about is about individual stocks, but really from the beginning we have believed that everyone should have a foundation in index funds.

The only thing I'll add on top of that is when we say index funds, people usually think of the S&P 500, but what I really think is you should split that up between something like the S&P 500, also a small-cap index fund, and an international stock index fund. So while I think 50% of your portfolio in index funds is good, you should spread it out among the types of index funds.

[...]

Southwick: Well, it's the fourth and final episode on our series on market crashes and Morgan joins us again. Hi, Morgan!

Morgan Housel: Hi, guys! Haven't seen you in a long time.

Southwick: I know. It's been a while. For many listeners they remember very dearly the Great Recession because they lived it, so let's revisit it, because they said it was great for a reason. The odds got off to a rough start with 9/11, which is actually the day after I moved to D.C.

D.C. isn't a warm town and there's a reason they call it "the city of Northern charm and Southern efficiency," but in the wake of 9/11, everyone was walking around looking for a hug. And perhaps it was all this coming together that helped fuel Web 2.0, which was a new wave of the internet built around community and social media. We did a lot of sharing back then. Music, blogging, pictures, videos. So many feels.

And while as a nation we ramped up watching cat videos, we also ramped up buying houses and here's where the fun begins. The Great Recession kicked off in December of 2007 [I Googled it and that's the answer I got, but Morgan may correct me on when it actually began]. So yes, we're coming up on the 10th anniversary.

Morgan, it's your turn to talk. As much as I want to blame Twitter, what led us into the Great Recession?

Housel: Let's just go with Twitter.

Southwick: I like Twitter!

Housel: Why not? I think if you start with the 1990s boom and then the .com bust, something happened after that. Jason Zweig of The Wall Street Journal is one who brought this up where he said investors are very good at learning their lesson, but they've learned too precise a lesson.

So after the .com bust people lost all this money trading .com stocks, and the lesson that they learned was the stock market is dangerous, but they didn't learn the lesson of leverage and going into things that they don't understand. So basically a lot of people, who lost a fortune in the .com bubble, packed up, took what money they had left, and went straight to real estate. It was almost instantaneous between that movement and then what the Fed was doing with interest rates; making leverage really appealing in the early 2000s. The real estate bubble happened basically the day the .com bubble ended and real estate prices started rising. And even though we had a recession in 2001-2002, real estate prices were rising all during that time. It had no impact, whatsoever, on real estate prices.

And this is what Robert Shiller talks about with the psychology aspect of bubbles. When you have something like optimism with an asset, that just feeds on itself, and it snowballs on itself, and you see your neighbors getting excited, and your brother and your sister, and your parents making money on real estate. And then optimism just spreads and it grows. So everyone knows what happened then.

Southwick: So no one was making money yet, right? They were just being able to afford more and more house than they could.

Housel: No, I think a lot of people were making money. It was the early 2002-2003...

Southwick: Just like flipping them? OK.

Brokamp: Flipping them and taking out the home equity to buy things.

Housel: ... is really when things started getting big. You had a lot of people that purchased homes in the '80s and '90s for a mortgage interest rate of maybe 8-9%, which in the '80s and early '90s that's what a mortgage cost. And now you could refinance your mortgage at 3-4%. So people were doing that and getting a dramatically lower payment or just pulling a ton of equity out of their house that they could use to buy jet skis, and remodel their house, and whatnot.

Southwick: Always jet skis.

Housel: I know. Twitter and jet skis get blamed for everything.

Southwick: They should!

Housel: These poor products!

Southwick: There's a reason why. So what was the tipping point? So everyone is buying these houses they can't ultimately afford. What caused the Great Recession?

Housel: I think it's not necessarily the people who own homes, but it was the banks and the investors that owned all of those mortgages. When they started defaulting on their loans -- these big banks, hedge funds, and sovereign wealth funds that owned all these subprime mortgages -- that's when credit markets really started seizing up.

So the first one was a group of hedge funds. In the summer of 2007 there were big credit funds and all of a sudden one day out of the blue they shut their doors. If you were an investor you couldn't have your money back because they had no liquidity in their portfolio. They couldn't sell their subprime bonds. There's no market for them. So subprime bonds and mortgage bonds, which was a trillion-dollar industry back then, happened very quickly in 2007 when the market just shut down and you couldn't sell them anymore. And that's really when the panic began.

Southwick: And what happened in the panic?

Housel: So you had all these banks around the world that were leveraged 20-30x. They had 30x as much assets as they did equity. This huge amount of leverage, so if anything even went slightly wrong, they were in a lot of trouble. And so because of that, they started really cutting back on the loans that they were making to the rest of the economy. Cutting back on business loans and cutting back on personal loans to creditworthy borrowers who at any other time would have had no problem getting a loan [they were a great person to lend to], but the banks, themselves, were in so much trouble that they started shutting down those loans, as well.

During this time I worked at a private equity firm in Los Angeles in the summer of 2007 and we experienced, as well, taking out loans and financing for great, healthy companies. These were not sketchy subprime loan companies. These were really healthy, prosperous companies [for which] virtually overnight the credit spigot just stopped. So things happened really quick with the credit crisis.

I think Ben Bernanke, to his credit, recognized this very quickly in 2007, a year before most people started recognizing it. This is when the Fed, in late 2007, really started slashing interest rates and stepping in.

But the stock market, during this time, didn't really blink. So the credit market started shutting down in the summer of 2007. The stock market hit an all-time high in October of 2007. So even after the credit markets were going through all kinds of mayhem, the stock market kept going up.

Southwick: So the stock market is still just doing fine. Doesn't care. But that ends. At some point the stock market starts to care. When is that?

Housel: It starts to decline a little bit, but even as you get into early 2008, it was still doing pretty well. Down a little bit. 5% or 10%, but still at a pretty high valuation that would be associated with optimism. People really weren't that aware of what was going on yet. And I think that's a good takeaway from the Great Recession, is that it's easy to sit here in hindsight and say it was so obvious. Anyone could have seen this coming.

If you just think about stock prices, which is a good reflection for the average opinion out there, even a year after credit markets started tumbling, the stock market really didn't care that much, which I think is something to reflect on of how hard these things are to spot. Even with a year's worth of data in your face, most people really didn't see it.

Southwick: I feel like I also see this tweet [Twitter] at least once a month where someone who's like a financial journalist says the stock market is not the economy. But we kind of always kind of think it is.

Housel: I think that's wrong. It is. I think the stock market is a reflection of people's moods. Of optimism and pessimism. And that also drives the economy. Another aspect of it is that the savings rate, during this period, didn't increase that much. So people with the incomes that they had, unemployment was still fairly low in late 2007. We're still optimistic enough to go out there and spend a ton of money on restaurants, and vacations, and whatnot.

So late 2007, early 2008 the economy started slowing a little bit. But it was still going at a pretty good clip. By a lot of metrics it was stalling, but still fairly healthy. And the summer of 2008 is when things got really dicey.

Southwick: What happened then?

Housel: I think that's when consumers, themselves, and businesses really started seeing the writing on the wall. And a couple of events [like] Fannie and Freddie being seized. Bear Stearns basically failed and was taken over in March of 2008. Fannie and Freddie were in August of 2008. Just this confluence of events is when unemployment really started ticking up.

And it was almost like a tipping point that was not necessarily based on any one specific news story, but I think it just becomes obvious to most people in the economy where you look around and you say, "Well, shoot. This isn't good." And everyone at the same time, down to me. I probably started going to restaurants less often. And one year before I would have spent extra money on this, but now in 2008 I said, "I should hold back."

And you multiply that by 300 million Americans and it really happened so quickly. That on the consumer side and then the banking side, of course Lehman Brothers went bankrupt in September. Washington Mutual. Merrill Lynch. AIG. Everything just happened in a one-week period. And you put those two things together -- a financial crisis and then a slowdown and lack of optimism of consumers -- and those two things really drive each other, as well. But it really just came crashing down in a one-week period in September of 2008.

Southwick: So if so much of the stock market is based on optimism, does that make it often a trailing indicator of how bad things are going in the economy? Or is every market crash its own little unique snowflake?

Housel: I think it's unique. There are tons of periods, historically, where you can look back and say the stock market was looking in the rearview mirror and it hadn't really caught up. And then you can also find a lot of periods where it's obvious that the market was looking ahead at the next six months or the next year and saw a recovery before other people. So it's generally phrased as the market is looking six to 12 months ahead, but I think you can also look at periods like late 2007 where I think it was looking 12 months behind and really didn't see what was coming ahead.

Southwick: So we are in the second-longest bull market in history. How are we doing? I feel like we're good. We're fine, right? Have we forgotten the lessons of the Great Recession or no?

Housel: No, I think an important point, here, is that explains a lot of what's going on in America is that the last eight or nine years of recovery have been phenomenal for some people and nonexistent for others. And that, I think, explains a lot of the political dynamic in the United States over the last couple of years. With the exception of maybe the 1920s, it's hard to find another period in American history where things have been so bifurcated and one group [a pretty big group] doing great.

If you are college-educated, living in a city, and below, let's say, age 50, the last nine years have probably been pretty good for you. If you are living in a rural area without a college diploma and you're over the age of 50, the last nine years have probably been pretty tough. And it's usually not like that in the economy. It's usually been on broad terms [of course, it's never true for everyone] that most people move in the same direction at the same time. In the last couple of years it just hasn't been.

One statistic I remember is 2011, which is kind of the peak skew between groups. If you were a Caucasian female with a college education, the unemployment rate was 2%. If you were an African-American without a high school diploma, the unemployment rate was 48%. So when people ask how the economy is doing, well, who are you? It was completely different based on people's circumstances and that's held through today.

Southwick: So we'll just have to wait and see when the next market crash is and see what happens then and we'll have you back on to talk about it.

Housel: We'll come back to talk about the Greater Depression.

Southwick: Well, please come back then. Actually, you don't get to leave just yet because, of course, we have the last installment of your month-long Trivia game coming at you.

[...]

Southwick: Yet again it's time to break out the Trivia board and I have the categories in front of you: art and literature, sports and leisure, geography, history, science and tech, and entertainment. Morgan, as always as our guest, why don't you go first?

Housel: I'm starting with history again.

Southwick: And, of course, as you know that's the Time magazine Person of the Year.

Housel: All right.

Southwick: Time magazine got really creative in the 2000s and had a hard time deciding on just one Person of the Year more than once. While I can get behind recognizing the American soldiers in 2003 who were fighting in Iraq, the most eye-roll inducing recipient was in 2006 when, thanks to Web 2.0, Time announced who as the person of the year?

Housel: You!

Southwick: Aarggh! Wasn't it the worst?

Brokamp: Geeks!

Southwick: You and I. This is in Time's own words. Because you, you, all of us were being recognized for such brave acts as...

Housel: I actually have it on my resume.

Southwick: We made Facebook profiles, Second Life avatars, and reviewed books on Amazon. And recorded podcasts. We blogged about our candidates losing and wrote songs about getting dumped. So brave. Way to go, you!

Housel: I'm shaking my head.

Southwick: That was the worst. All right, Bro. Your turn.

Richard Engdahl: Everybody got a trophy.

Brokamp: Everyone gets a trophy. Let's go with science and tech.

Southwick: Science and tech. Polaroid stopped making their cameras in 2008 and in 2009 Kodak stopped producing Kodachrome, the first mass-marketed color film. Well, they have taken your Kodachrome away, but photography lived on. First released in 2010, what app climbed to more than 100 million users in just two years and shocked everyone when it was later sold to Facebook in 2012 for $1 billion?

Brokamp: Instagram.

Southwick: Yay!

Brokamp: Duh duh!

Southwick: You got it right.

Brokamp: I got the easy one.

Southwick: It now has 700 million users and according to a 2017 study in Britain of kids aged 14 to 24; Instagram is the social media app most likely to make people feel depressed.

Housel: All right!

Brokamp: That's nice.

Southwick: Snapchat came in second and Facebook third.

Housel: Good for them.

Southwick: Morgan, your turn.

Housel: Let's go geography.

Southwick: All right. Geography. What was the title of Al Gore's Academy Award-winning documentary on climate change that came out in 2006?

Housel: How is that geography? I mean, the answer is An Inconvenient Truth, but that's not really geography.

Southwick: Well, this wasn't that long ago, so it's not like a lot of lines have been drawn. It's not like Siam is now... So yes, An Inconvenient Truth. An Inconvenient sequel just came out in July, so there you go. All right, Bro, your turn.

Brokamp: Let's go with entertainment.

Southwick: Entertainment. In 2006, iTunes announced the one-billionth song downloaded. It was the Speed of Sound by this very 2000s band from Britain.

Brokamp: Oh, man. I'm not going to know that one. I'll say Chumbawamba.

Housel: Coldplay.

Southwick: Morgan got it. Morgan with the steal. Yes, Coldplay. It was purchased as part of Coldplay's X&Y album by a guy in West Bloomfield, Michigan. Apple hit 25 billion downloads roughly seven years later by a man in Germany who, because Germany is not known for their good taste in music, [downloaded] the song Monkey Drums [Goksel Vancin Remix]. So we all remember that.

Brokamp: But of course.

Housel: Right.

Southwick: All right, Bro. Your turn.

Brokamp: No, I did that one. He stole it.

Southwick: Oh, sorry. No, Morgan.

Housel: Sports and leisure.

Southwick: In 2004, Janet Jackson had a wardrobe malfunction on live television during the Super Bowl halftime show. It was actually the day I met my husband. While it sparked major controversy, according to ESPN it also sparked inspiration in the mind of a 25-year-old Silicon Valley whiz kid, Jawed Karim. He created what website?

Housel: I don't know. I have no idea.

Brokamp: WardrobeMalfunction.com.

Southwick: Uh, do you want to think another second about what it could be?

Housel: No, I have no idea.

Southwick: YouTube!

Brokamp: What?

Southwick: He decided he wanted to make it easier to find the Jackson clip and other in-demand videos.

Housel: All right!

Southwick: Because everyone went online to try and see the replay.

Housel: Do you think that's a true story, or is that like the PEZ dispensers which is not a true story?

Southwick: I don't know. It was in ESPN magazine.

Housel: So let's just go for it.

Brokamp: I thought you were going to ask who played in the game. Who played in that game?

Housel: I don't know.

Southwick: So a year later he and a couple of friends founded YouTube. It was also a really big moment that put TiVo on the map. They enrolled 35,000 new customers in the aftermath of Nipplegate. Worst name ever. The final one. Art and literature. Bro, does that go to you?

Brokamp: Sure, I guess.

Southwick: The final book in this series was published in 2007, but it almost never happened, as the author was rejected by over 12 publishers before finally getting a book deal by an eight-year-old girl.

Brokamp: Harry Potter.

Southwick: Yeah.

Brokamp: Yeah. I've never read any of the books, by the way. I just know the phenomena.

Southwick: The final book in the series was published in 2007 but almost never happened as the author was rejected by over 12 publishers before finally getting a book deal when the CEO, the head of Bloomsbury Publishing, gave the first chapter to his eight-year-old daughter and she wanted to read more. So according to Scholastic, who publishes the series in the U.S., the Harry Potter books have now gone on to sell more than 400 million copies in more than 68 languages.

Brokamp: Amazing.

Southwick: It is amazing.

Housel: All right.

Southwick: Ah! Well, you tied today.

Brokamp: Duh duh duh!

Housel: Next time.

Southwick: Oh, it's nice to end on a note like that. All right, that's the show. Morgan, thank you again for joining us this whole month. This has been a really fascinating trip down History Lane and we appreciate all the context that you're providing so that we will be better in the next market crash.

Housel: I've actually been here all month long recording this. It's been a really long episode.

Brokamp: Sitting here in the room.

Housel: I'm so ready to go home.

Brokamp: All by himself.

Southwick: Fine! You can go home!

Housel: Thanks for having me!

[...]

Southwick: Well, that's the show. Aargh! We had so much fun.

Brokamp: As we always do.

Southwick: This has been a good month. I mean, we were talking about horrible things, but it's important to learn about these things and gain context so that you'll be prepared when the next horrible thing comes along.

Brokamp: And it will.

Southwick: It will. Oh, sorry. Spoiler!

Brokamp: The market is full of terrors.

Southwick: Oh! Only we think that Game of Throne references are that funny.

Brokamp: We're all Game of Thrones fans, here.

Southwick: There you go. So again. Thank you, Morgan, so much for taking the time to do this with us. Of course if you, our listeners, want to get more Morgan, you can go to the Collaborative Fund's website. He writes for them among other things. You can get all of his insights at CollaborativeFund.com/blog. Yeah, just go there. Read him. I do. And then I tell him to come on our show and he does.

Engdahl: Follow him on Twitter, too.

Southwick: Oh, yeah. Follow him on Twitter. He also says smart things on Twitter.

Brokamp: He's a big tweeterer, or whatever you call that thing. What is it? Tweetering?

Engdahl: He's got a blue check.

Southwick: I do, too. I'm verified.

Engdahl: What?

Brokamp: What's the blue check?

Southwick: Like that's my phrase. "What?" Like you don't get to steal my phrase. That's why I'm verified, because I've got the sweet catchphrases like that. That's how you get it. No, you can go to a link on Twitter and say, "Hey, here's who I am. I'm kind of a big deal," and then they say, "OK, cool," and then you get the blue check.

Brokamp: And why would you bother?

Southwick: Because it's kind of a big deal when you get the big check. When you're verified. Do you want me to help you with this?

Engdahl: It's like being the Starbelly Sneetch.

Southwick: Oh. We've got Stars on Mars.

Brokamp: Yeah, we know how it worked out for the sneetches, though.

Southwick: Well, we knew how it worked out for the person who was selling and removing the stars, anyway.

Brokamp: Monkey McBean.

Engdahl: Sylvester.

Southwick: Sylvester Met Monkey McBean? A little longer than that?

Engdahl: With his Star Off Machine.

Southwick: Oh. Ah! We're just in the home stretch. Literally there's only one more thing I need to say. The show is edited brickilly by Rick Engdahl. Our email is Answers@Fool.com. For Robert Brokamp, I'm Alison Southwick. Stay Foolish, everybody!

John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Alison Southwick has no position in any of the stocks mentioned. Morgan Housel has no position in any of the stocks mentioned. Robert Brokamp, CFP owns shares of Facebook. The Motley Fool owns shares of and recommends Amazon, Apple, Facebook, and Twitter. The Motley Fool has the following options: long January 2020 $150 calls on Apple and short January 2020 $155 calls on Apple. The Motley Fool has a disclosure policy.