In May, Alan Greenspan, chairman of the board of governors of the Federal Reserve, offered a candid warning about the global financial system that provides an appropriate perspective for the recent market turmoil.
As reports paraphrased him, the world's financial experts don't know enough about how the global financial system works to prevent a catastrophe. He singled out the burgeoning market in over-the-counter derivatives. Only a financial crisis could test how vulnerable this largely unregulated market is.
His remarks can be extended to the markets generally and what makes them move abruptly. In the recent market turmoil, these OTC markets appear to have passed a test, declining without causing a cascade of financial failures.
Importantly, Mr. Greenspan didn't suggest tighter regulation. Instead, he suggested the market itself may be a better regulator than any government effort. When "it's your money at stake," he said, ". . . it's really wonderful how it focuses one's attention."
In fact, he suggested raising the cost of rescuing failing financial organizations. Expectations that monetary authorities will rescue failing financial institutions has encouraged excess risk taking and reckless financial practices.
Mr. Greenspan deserves support to put the price of prudence to the market participants themselves.
His speech offers investors a clue on how to look at the recent stock market turmoil. For many investors, late summer's market fall is the first severe correction they've had.
The volatility teaches lessons involving risk tolerance and prudent asset allocation. The lessons include patience, meaning a long vs. short investment horizon.
The most important lesson about the market is uncertainty.
Investors with well-thought-out investment policies and asset allocations can take the turmoil in stride, knowing they've prepared for such a scenario.