The Voluntary Blindness of Modern Finance

Why Conventional Models That Guide Policy and Capital Allocation Fail When Outcomes Matter Most

“This will interest you…in this world where people have all these algorithms, and computer science, and fancy math, and so forth. Neither Warren nor I have ever used fancy math in business—and neither did Ben Graham, who taught Warren. Everything I’ve ever done in business could be done with the simplest algebra and geometry, and addition, and multiplication, and so forth. I never used calculus for any practical work in my whole damn life.”¹

—CHARLIE MUNGER, late vice chairman of Berkshire Hathaway

On April 21, 2026, I published an article on SSRN, entitled “Applied Financial History: Expanding the Vision of Modern Finance.” The thesis is that the field of finance has come to rely too heavily on quantitative models, which restricts accepted truth to a narrow band of observations that can be proven at a high level of statistical significance. As a result, academics, policymakers, regulators, and many practitioners voluntarily blind themselves to simple, time-tested principles.

This entrenched bias toward quantification would be less concerning if conventional models were merely incomplete. The problem, however, is that their very design makes them likely to fail during the rarest and most impactful events that shape economic and market cycles. This is because the data on which they depend function primarily as lagging indicators. It is repetitive financial structures and hard-wired human behaviors that are visible in advance.

The paper concludes that financial history offers a practical remedy by surfacing long-forgotten patterns of behavior. It then demonstrates how policymakers and investors could have used financial history to make better decisions over the prior six years. Importantly, it is not merely an exercise in hindsight. It includes multiple time-stamped articles, newsletters, and conference presentations showing that costly errors in monetary policy, private markets, and institutional consulting practices were not only foreseeable, but in many cases avoidable. Several of the most significant examples are summarized in this newsletter, as they continue to present some of the more pressing financial risks today.

Inflation and Monetary Policy Errors

“A new era hardly renders the Great Inflation irrelevant. To the contrary, its history holds important lessons for the future. The simplest is this: Inflation, if it reemerges, ought to be nipped in the bud; the longer we wait, the harder it gets to rein it in.”²

—ROBERT J. SAMUELSON, author of The Great Inflation and Its Aftermath

In March 2023, I completed the manuscript of Investing in U.S. Financial History. At the time, the Federal Reserve was in the midst of an aggressive monetary tightening campaign to extinguish post-COVID inflation. I assumed that Chair Jerome Powell and the leadership of the FOMC would follow through on their commitment, even at the cost of weakening labor markets. That judgment was based on a belief that Powell had likely internalized a critical lesson from the Great Inflation of 1965-1982. The lesson was that inflation must be confronted quickly and decisively, because failure risks allowing it to reemerge and erode the Fed’s credibility.

Unfortunately, the subsequent three years proved my assumption was incorrect. Instead, the Fed clung to its familiar framework of “data dependency,” signaling greater confidence in complex models derived from the preceding four decades rather than the simple principle derived from a historical episode that was far more relevant. As inflation approached the long-term target of 2% in the summer of 2024, officials began signaling their intent to pivot toward easing. Chair Powell formalized that shift on August 23, 2024, announcing that the time had come for monetary policy accommodation.

On August 27, 2024, I published a newsletter, entitled “The Fed Leadership Believes This Time is Different,” which explained why the experience of the Great Inflation suggested the pivot was premature and constituted a policy error. My criticism sharpened as the Fed cut rates by a total of 100 basis points in late 2024 and an additional 50 basis points in late 2025.³

As Figure 1 indicates, history, rather than data dependency, proved the more reliable guide. As of April 2026, inflation has remained well above the Fed’s target for an additional 18 months. Moreover, the Fed’s credibility has weakened and political pressure from a new presidential administration has intensified.

Figure 1: Federal Funds Rate (Minimum) and Trailing 12-Month CPI-U
(April 1, 2021 - March 31, 2026)

Sources: Board of Governors of the Federal Reserve System. “The Fed Explained: Accessible Version.” Accessed April 13, 2026; U.S. Bureau of Labor Statistics. “Consumer Price Index Historical Tables for U.S. City Average.” Accessed April 13, 2026.

Some economists argue that it was unclear whether the Fed’s decision to ease monetary policy would reignite inflationary pressures. They also point to complicating factors such as tariffs and energy shocks stemming from the recent outbreak of war in the Middle East. That uncertainty was real. But the asymmetric risk of a premature pivot was also real. The potential costs of reigniting inflation in terms of the impact on household purchasing power and institutional credibility were both known and materially greater than the risk of maintaining restrictive policy for too long.

The failure to recognize this asymmetry was also a defining error of the Great Inflation. Under the leadership of William McChesney Martin, Jr. and Arthur Burns, the Fed learned that when inflation reemerges, their credibility eroded and political constraints intensified, making effective policy responses progressively more difficult. This principle was articulated clearly in Arthur Burns’s famous speech, entitled “The Anguish of Central Banking.”⁴

Outlook for 2026 and Beyond

The Federal Reserve has repeated the same error and now operates in a much more challenging policy environment. Their credibility is weakened; political pressure has intensified; inflationary pressures appear to be rising; and a spike in energy prices linked to the conflict in the Middle East adds further complication.

In May 2026, Kevin Warsh is set to assume the role of Federal Reserve Chair. Whether he can resist pressure to continue easing monetary policy before inflation is fully contained remains uncertain. It is also conceivable—although it seems far less likely—that inflation naturally subsides. But even in that scenario, meaningful damage has already been done. Household purchasing power has been further impaired, and institutional credibility has eroded. If policy easing continues prematurely, the risk of a relapse increases, raising the likelihood that future stabilization will require more aggressive intervention.

The FOMC under the leadership of Chair Powell discounted a simple lesson of the Great Inflation and placed its faith in models designed for a different era. In doing so, it failed to recognize that the credibility it inherited was not a permanent asset—it was earned through the resolve of prior leadership, most notably Paul Volcker. That credibility is now diminished and must be rebuilt under more difficult conditions.

A Speculative Episode in Private Markets

“Ben Graham used to say, ‘It’s not the bad investment ideas that fail; it’s the good ideas that get pushed to excess.”⁵

—CHARLIE MUNGER, late vice chairman of Berkshire Hathaway

One of the more striking patterns that emerges from studying repeated speculative episodes over several centuries is the conviction with which participants embrace narratives that appear sensible prior to a reckoning, but then are quickly relabeled absurdities soon after. Such warning signs are visible in language, unintended optics, and narratives that become increasingly detached from observable reality. A few memorable statements that preceded major speculative episodes in the U.S. are captured in Figure 2. The final quote by Marc Pinto, global managing director of private credit at Moody’s, is a leading candidate to capture the hubris that defines the speculative episode which currently appears to be entering the final stage.

Figure 2: The Familiar Language of Speculative Episodes

Sources: Alistair Roberts, America’s First Great Depression: Economic Crisis and Political Disorder after the Panic of 1837 (Ithaca, NY: Cornell University Press, 2012); “Fisher Says Prices of Stocks Are Low,” New York Times, October 16, 1929; Jim Cramer, “The Winners of the New World,” Speech at 6th Annual Internet and Electronic Commerce Conference and Exposition, TheStreet, February 29, 2000; Holden Lewis, “Experts: No Real-Estate Bubble Burst,” Chicago Sun-Times, September 10, 2004; “Moody’s Says the Banking System, Private Credit Markets Are Sound Despite Worries Over Bad Loans,” CNBC, October 17, 2025.

Warning Signs in Private Markets

Over the past year, I have written multiple newsletters, articles, and LinkedIn posts warning about the many red flags in private markets. Much like the inflation dynamics in 2024, many are undetectable in conventional data favored by investors, regulators, journalists, and academics. Commonly cited metrics, such as IRRs, default rates, and reported volatility, are lagging indicators. The more compelling evidence derives from simple principles governing how speculative cycles form, advance, and eventually collapse. They typically proceed in the phases described below.

1. Disruptive Event — A genuine opportunity emerges, often in response to a prior crisis or introduction of a new technological innovation.

   Recommended Reading: The Panic of 1819, Silicon Valley Bank, and the Danger of Bank Runs

2. Early Success of Pioneering Financiers — Pioneering capital providers generate strong returns, attracting broader attention to the opportunity.

   Recommended Reading: A Whale of a Tale: The History of Venture Investing in the United States

3. Imitation-Driven Growth — Capital floods into the strategy as imitators seek to replicate the results of pioneers.
   Recommended Reading: A 45-Year Flood: The History of Alternative Asset Classes

4. Formation of a Speculative Supply Chain — Intermediaries, such as investment consultants, institutional allocators, fund managers, and wealth advisors, form a segmented supply chain around the opportunity.

   Recommended Reading: Incentives Are Dangerously Aligned in Private Markets
   

5. Convergence of Participant Incentives — Participants across the system become aligned toward asset growth, eroding investment discipline. Self-interest of supply chain participants gradually comes to dominate decision-making.

   Recommended Reading: Incentives Are Dangerously Aligned in Private Markets

6. Breakdown — The underlying economics inevitably deteriorate, and are revealed abruptly when inflows slow or reverse.

   Recommended Reading: The Music Has Stopped in Private Markets

The Language of Last Resort in Private Markets

“Every banker knows that if he has to prove that he is worthy of credit, however good may be his arguments, in fact his credit is gone.”⁶

—WALTER BAGEHOT, author of Lombard Street

The dynamics in private credit and private equity markets appear to be hovering between stages five and six of the cycle outlined above. A speculative supply chain has been operating at full capacity for many years, and capital deployment decisions are increasingly optimized around the self-interest of participants rather than underlying fundamentals.

An early signal that the system was approaching a breaking point appeared on February 18, 2026, when Blue Owl suspended quarterly redemptions in its OBDC II private credit fund. Wary of the risk of facing similar restrictions, investors submitted a wave of redemption requests across many semi-liquid private credit funds offered by Blackstone, BlackRock, Cliffwater, Morgan Stanley, Ares, and others.

In June 2025, I had a conversation with a tenured professor of finance at a top-ranked European business school. His research focuses on private debt and private equity. I outlined my concerns about the multi-decade influx of capital into private markets, combined with the inherently unstable structure of semi-liquid funds. I walked through the mechanics, including the widespread use of one-day gains, bank-like liquidity promises, and the historical tendency for such structures to fail under stress. The following exchange concluded our conversation:

Professor: “If you can show me the data that proves it, I’ll believe it.”

My response: “By the time the data proves it, it will be too late.”

This interaction captures a widening divide between the practice of finance and the academic quest to quantify it. Practitioners are often forced to act on incomplete information, responding to patterns before they are fully visible in the data. Academic frameworks, by contrast, frequently require empirical confirmation before being approved for use. In stable environments, academics are applauded for their rigor. In late-stage cycles, they are dismissed for their irrelevance.

In its most extreme form, this bias can lead academics to relinquish responsibility for warning investors about potentially dangerous market conditions. By the time the evidence becomes statistically undeniable, the damage has often already occurred. The subsequent collapse is then reframed as an unforeseeable event rather than the culmination of risks that were visible structurally and behaviorally long before they appeared cleanly in the data.

Investment Consultants: Shadow Architects of Speculation in Private Markets

“Can you imagine an investment consultant telling clients, year after year, to keep adding to an index fund replicating the S&P 500? That would be career suicide. Large fees flow to these hyper-helpers, however, if they recommend small managerial shifts every year or so.”⁷

—WARREN BUFFETT, former CEO of Berkshire Hathaway

Investment consulting firms play a central role in guiding the investment decisions of many of the world’s largest institutional investment plans, including public pensions, insurance companies, foundations, and endowments. They are typically regarded as independent and objective advisors—a reputation earned in the 1970s and 1980s when their primary function was independent performance reporting.

Over the subsequent four decades, competitive pressures transformed their role. Investment consultants expanded into asset allocation, manager selection, and private markets implementation. In doing so, their business models became increasingly tied to the construction and maintenance of complex portfolios. This evolution created a structural incentive that can encourage greater portfolio complexity, irrespective of whether it consistently improves outcomes.

Modern Portfolio Theory in Practice

In 1990, Harry Markowitz received a Nobel Prize in Economics for his pioneering work on portfolio construction. His framework, termed Modern Portfolio Theory (MPT), demonstrated how diversification across assets with imperfect correlations could improve risk-adjusted returns. This insight was operationalized through mean-variance optimization (MVO) models, which use assumptions about expected returns, volatility, and correlations to construct “optimal” portfolios.

The rise of MVO coincided with the transformation of investment consultants from performance reporters to portfolio architects. The model became the primary tool used to recommend allocations, but its effectiveness depends entirely on the quality of the inputs. Those inputs—expected returns, volatility, and correlations—are not objective truths. They are assumptions that, in practice, can be influenced by institutional incentives as well as underlying economics.

Pro-cyclical Assumptions in Private Credit

In May 2025, I delivered a presentation at the CFA Live conference in Chicago on whether private credit markets were experiencing an oversupply of capital. I argued that numerous warning signs suggested they were—and that if the market was not yet in a bubble, it was moving in that direction.

One of the more interesting discoveries was the peculiar behavior of investment consulting firm return assumptions. Despite massive inflows of capital into private credit in the 2020s, the median real return assumption had increased. Two of the largest allocators during the two quarters preceding the conference, RVK and Meketa, published assumptions that tracked this trend. The real return assumptions of Meketa seemed especially elevated relative to historical expectations.

Figure 3: Horizon Actuarial Survey Results of Private Credit Assumptions and Capital Flows

Figure 4: Meketa and RVK Private Credit Return Assumptions and Capital Flows

Source: CFA Institute Research Foundation, “Private Credit Panel: Is There an Oversupply of Capital?,” YouTube video, posted August 1, 2025.

Basic supply-and-demand principles, reinforced by centuries of history, suggest that expected returns should decline as capital floods a finite opportunity set. Instead, they moved in the opposite direction. This divergence is difficult to reconcile with traditional supply-and-demand expectations.

This trend was concerning in and of itself, but what followed over the subsequent nine months was even more revealing. As stress began to emerge in private credit markets, those same assumptions were subsequently revised downward by both firms. In early 2026, Meketa reduced its long-term return expectation by 90 basis points, while RVK lowered its assumption by 25 basis points.⁸⁹

The Paradox of Academic Precision

The widespread use of MVO models among institutional investment consultants highlights a deeper blindspot that impairs the vision of academia. Modern Portfolio Theory assumes that MVO models are used to optimize portfolio outcomes, but it does not account for how the inputs are created.

In practice, return, volatility, and correlation assumptions are not immune to bias. They are susceptible to influence from the incentives of the consultants who produce them and allocators using them. Both groups operate within systems that reward portfolio complexity, increased allocations to private markets, and the appearance of academic-level rigor.

This speaks to a bigger problem. Many academics fail to anticipate how their work could be affected by the same market forces and incentives that shape the environments they are studying. In the case of Modern Portfolio Theory, the result is a costly paradox. A Nobel-prize-winning framework that academics laud for its citations can be used by practitioners to launder self interest using the language of scholarship.

Restoring the Vision of Modern Finance

“People calculate too much and think too little.”¹⁰

—CHARLIE MUNGER, late vice chairman of Berkshire Hathaway

The use of financial history offers a complementary analytical framework that addresses the voluntary blindness afflicting modern finance across multiple domains. By granting serious consideration to qualitative lessons from financial history, it provides a framework for identifying risks that are systematically underrepresented in conventional models. It prioritizes structural pattern recognition and directional insight in environments where statistical precision is inherently limited.

Had the Fed considered the lessons from the Great Inflation, post-COVID inflation may have already concluded. Had investors considered the fundamental dynamics of speculative episodes, the flood of excess capital into private markets may have subsided. Had academics considered the role of incentives in shaping the inputs into the models on which the allocation of trillions of dollars depend, the cost of malinvestment in private markets could have been mitigated.

But the deepest truth revealed by the study of financial history is that many financial crises repeat not because they’re undetectable, but rather because individuals who have strong incentives to preserve the status quo cannot tolerate the psychological discomfort that accompanies detection.

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Disclaimer: This is a personal newsletter written by Mark J. Higgins, CFA, CFP, in his individual capacity. The views expressed herein are solely those of the author and do not necessarily reflect the views, opinions, or practices of IFA or any other organization or entity with which the author is affiliated. This content is intended for informational and educational purposes only; it does not constitute professional investment advice, an offer, solicitation, or endorsement of any specific financial strategy, product, or service. The discussion contains the author’s opinions based on publicly available information and should not be interpreted as factual or predictive of future events.

Nothing in this newsletter should be construed as a guarantee of investment results, nor should past performance discussed herein be taken as indicative of future outcomes. Investing involves risks, including the potential loss of principal, and investors should consult their financial adviser or other qualified professional before making investment decisions. Additionally, every effort has been made to ensure an accurate portrayal of market practices and conditions, but the author disclaims responsibility for errors, oversimplifications, or omissions. By publishing this newsletter, the author aims to foster dialogue and education and does not intend to disparage any individual, organization, or investment strategy. Readers are encouraged to consider differing viewpoints and conduct their own research before forming opinions or investment strategies.

Any references to future economic or monetary outcomes in this newsletter are speculative and based on historical analysis and public information. Comparisons to past events, like the Great Inflation or post–World War I inflation, are meant to provide context, not predict the future. Readers should view these discussions as hypothetical and not rely on them for financial decisions. Always consult a qualified professional for advice.

1. Charlie Munger, “A Conversation with Charlie Munger and Michigan Ross – 2017,” YouTube video, 55:39, posted by Ross School of Business, November 30, 2017.

2. Samuelson, Robert J. The Great Inflation and Its Aftermath: The Past and Future of American Affluence. New York: Random House, 2008.

3. In 2024 and 2025, I published a series of newsletters that were increasingly critical of Federal Reserve policies and increased political pressure from the Trump administration. Links to those newsletters can be accessed here:

The Forsaken Playbooks of the Federal Reserve - October 14, 2025

A Dark Comedy of Errors in Washington - April 15, 2025

Inflation Persisted Because the Fed Relented - December 20, 2024

The Fed’s Pivot Violated the Rule That Matters Most - October 10, 2024

4. Arthur F. Burns, The Anguish of Central Banking (Washington, DC: Board of Governors of the Federal Reserve System, 1987).

5. Poor Charlie’s Almanack. Edited by Peter D. Kaufman. Virginia Beach, VA: Donning Company Publishers, 2005.

6. Walter Bagehot, Lombard Street: A Description of the Money Market (London: Henry S. King & Co., 1873).

7. Berkshire Hathaway, 2016 Annual Report (Omaha, NE: Berkshire Hathaway Inc., 2017), https://www.berkshirehathaway.com/2016ar/2016ar.pdf

8. East Bay Municipal Utility District, Revised Online Packet: Regular Board Meeting, March 19, 2026 (Oakland, CA: East Bay Municipal Utility District, 2026), https://www.ebmud.com/application/files/3117/7456/7706/REVISED_Online_Packet_RB_Meeting_3-19-26.pdf; RVK, Inc., RVK Insights: 2026 Capital Market Assumptions (February 2026), https://www.rvkinc.com/pdf/RVK%20Insights%20-%202026-02.pdf.

9. The two firms profiled are not the only ones demonstrating this trend. These dynamics reflect the broader incentive structures embedded across institutional investment processes.

10. Poor Charlie’s Almanack. Edited by Peter D. Kaufman. Virginia Beach, VA: Donning Company Publishers, 2005.