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Investing Lessons of 2008: Trust, but Verify

By Morgan Housel - Updated Apr 5, 2017 at 7:52PM

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It all seems so obvious in hindsight.

2008 was a crazy year and nobody knows for sure what 2009 will bring. We’ve spent the past month reflecting on 2008 and making predictions for 2009. Be sure to check out all of our coverage, including more Investing Lessons of 2008.

The biggest lesson I learned in 2008 was actually just a reminder of a Ronald Reagan-ism: "Trust, but verify."

Yes, this article is the epitome of "20-20 hindsight" and "Monday-morning quarterbacking." It's easy to piece together what happened after things implode. No one got an award for screaming "iceberg" after the Titanic sank. But the lessons, not the details, of what happened are still important going forward.

Real estate's a good example. Homeowners saddled with mortgages they can't afford, who claim they "didn't understand how it works," are a sad sight for two reasons. First, because they're losing their homes, and second, because they felt it was OK to take out a massive loan using something they admittedly never understood. Mortgage fraud is one thing, but unwavering trust without verification is another. That same blind conviction causes financial bubbles to boil out of control and decimate investors' portfolios.

Smoke & mirrors, meet Wall Street
Take Bear Stearns. Its 2006 annual report starts off with a gloating letter from the CEO that states in part, "The strict risk discipline imposed on our trading desks is reinforced by the strong sense of ownership that permeates the culture of the corporation."

At first glace, it's easy to take comfort knowing that the CEO is doing everything possible to manage risk. He said so himself! Why take the time to verify the hieroglyphic financial data of the annual report, when a man in an Italian suit who's paid ungodly sums says everything's A-OK? Trust? Check.

Scroll down a hundred or so pages, and you'll see why: Bear relied on $12 billion of equity to support $1.9 trillion in counterparty guarantees related to derivatives. No sense of ownership would ever allow that sort of risk-taking. Fast-forward to 2008, and the only one with a "strong sense of ownership" is Bear's new owner, JPMorgan Chase (NYSE:JPM). Verification? Fail.

Washington Mutual is another good example. Its 2005 annual report boasts how it planned on juicing profits, mentioning, "In Home Loans, we will focus on originating higher-margin products, such as subprime loans."

Fair enough. If one of the largest banks in the country was bullish on subprime, why should we think otherwise?

The answer could be found in its annual 10-K report from the same year, where WaMu warned in its section on risks related to subprime lending: "If unemployment were to rise or either a slowdown in housing price appreciation or outright declines in housing prices were to occur, subprime borrowers ... may be unable to repay their loans ... with a potential adverse effect on [WaMu's] earnings."

Yikes. Now take a look at this long-term chart of national real estate prices derived from Robert Schiller's book, Irrational Exuberance, and ask yourself whether a "slowdown in housing price appreciation or outright declines" should have been treated as an "if" or a "when" issue. Same goes for Wachovia (NYSE:WB), whose 2006 top-dollar purchase of mortgage sorcerer GoldenWest Financial eventually forced the bank into Wells Fargo's (NYSE:WFC) arms.

Two kinds of trust
Yes, all of those examples are completely cherry-picked. Furthermore, companies like Sirius XM Radio (NASDAQ:SIRI), General Motors (NYSE:GM), Ford (NYSE:F), and Cemex (NYSE:CX) have been hammered by some of the same credit-market reverberations roiling the finance industry, even though they had nothing to do with shoddy lending practices.

In truth, you'll never be able to spot every hidden danger. But you'll undoubtedly make far better investment decisions by replacing blind faith in CEOs, hot stock tips, investment advisors, and market pundits with faith in your own homework and analysis.

Think about it: Investors were eager to invest in a company merely because a stranger told them they should. Homeowners took out loans because bankers told them they should. Bankers thought real estate always went up because someone told them so. The opinions of real-estate agents paid solely on commission were treated as absolute fact. Nothing good can come out of that.

Yes, CEOs must be held accountable for their actions, but investors themselves are accountable for where they invest their money in the first place. If you're lucky enough to have money to invest, it's your responsibility to make sure you do so correctly.

That's one of the biggest lessons -- and eye-openers -- I learned in 2008: There's a tremendous difference between trust and blind trust. You always have to read the fine print.

Do your own due diligence. Read annual reports. Think for yourself before investing your own money. It's the only way you can ensure long-term investing success, and it's one of the main reasons The Motley Fool has dedicated its 2008 Foolanthropy campaign to promoting financial literacy.

Thankfully, 2008 is almost behind us. Here's to a better, smarter, 2009.

For related Foolishness:

Fool contributor Morgan Housel doesn't own shares in any of the companies mentioned in this article. Cemex is both a Motley Fool Global Gains and a Stock Advisor recommendation and the Fool owns shares. JPMorgan is an Income Investor selection. The Fool's disclosure policy would never be a Monday-night quarterback.

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Stocks Mentioned

Sirius XM Holdings Inc. Stock Quote
Sirius XM Holdings Inc.
$6.79 (1.12%) $0.07
Ford Motor Company Stock Quote
Ford Motor Company
$15.42 (2.55%) $0.38
JPMorgan Chase & Co. Stock Quote
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Wells Fargo & Company Stock Quote
Wells Fargo & Company
$44.62 (2.81%) $1.22
General Motors Company Stock Quote
General Motors Company
$37.95 (3.62%) $1.32
CEMEX, S.A.B. de C.V. Stock Quote
CEMEX, S.A.B. de C.V.
$4.53 (5.59%) $0.24

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