Three reasons for the mess and how to get out of it!

My undergrad was in History.
At that time, everyone would ask me if there was any practical use for studying the past.
I would fumble with an answer and say something like- "lessons from history are important for us to avoid mistakes in the future" or "those who forget the lessons of history are condemned to repeat it" etc etc- all platitudes that I myself didn't quite believe in.
The financial crisis currently plaguing the US and the broader world economy has brought back some memories- most recently of the irrational exuberance of the dotcom bubble in the 90's but more importantly that of the 1920's when the overvaluations led to the eventual crash of the stock market and the onset of the Great Depression that resulted in large scale government intervention, consolidation in industry and widespread unemployment, symptoms eerily close to what we are seeing now.

Why do such "crashes" happen? How can we avoid them? And will we?

Cutting through all the jargon, here are the three reasons for the mess.
One- incorrect valuation of assets based on faulty assumptions. So, the land prices will continue to go up and therefore dont worry about whether you can afford your mortgage because your house will be worth much more anyway and you will have equity in your home to cash out if you are trouble- thats faulty logic. To have "securities" based on those assumptions about mortgages is even worse as they go against the grain of what the word security means! Look at the inherent value of any asset, be conservative in predicting future cash flows and if there are positive surprises, good for everyone.

Second- affordability and that goes for both companies and individuals. Over-leverage is never good and so be careful about the materialistic streak you could enter if you spare cash. Rule of thumb- spend no more than 75% of your income and have a cash reserve equivalent to six month of expenses at the very least for a rainy day. For companies, cash is king too. See all these companies trying to get a piece of 700bn bailout- its all about the credit squeeze.

Third- remain emotionally stable and that goes for companies, markets and individuals. We have seen an incredible loss of confidence in the past three weeks, the Dow has plunged from a high of over 13,000 to under 9,000. Have companies suddenly become worthless? No. But have people have lost confidence? Yes. People like security and that comes in numbers. Panic has a cataclysmic effect too. Someone panics, some others join and before you know it, others are bailing on the market based not on their understanding of performance or objective data, but because some others think that values aren't good. This is the time to stay solid and not panic. If you have done a goof job of one and two above, you have nothing to worry about.

So there are the three lessons. Value appropriately, spend reasonably, and don't panic when crisis hits. The lessons are as important for companies and as they are for individuals.
And from all our lessons of history, we know that when we fail to live by these value, we are taught some painful lessons that make us come back on the right track.
History does repeat itself in uncanny ways, and I am glad to have that undergrad even if it was years ago....the lessons are still fresh in my mind!