On 15 September 2008, investment bank Lehman Brothers filed for the largest bankruptcy in US history and was blamed for bringing the world economy to its knees. A pivotal moment in the global financial crisis (GFC), few can forget the images of Lehman’s employees leaving offices carrying their belongings.
However, culpability goes much wider. Ten years on, we reflect on what led to the crisis and the lessons learned.
The first stage of the crisis began more than a year before Lehman collapsed, when a bubble in the US housing market started to burst. Low interest rates in the US had been encouraging consumers to spend, and banks were becoming less scrupulous in their lending standards. People with poor credit were now able to access loans and mortgages. This supported demand for houses, keeping prices high. Despite the risks of default, banks kept offering these mortgages, believing that even if customers did default, the bank would still own a highly valued house it could sell on.
To reduce their risks, some banks began to bundle together these poorer-quality ‘sub-prime’ mortgages into a form of corporate bond which they sold to other institutions. And there were plenty of willing buyers, as long as house prices stayed high. Some of these bundled securities were so complex and opaque, that no one really understood what they owned. But that didn’t matter: banks took fees, borrowers got mortgages, investors bought what they thought were ‘safe as houses’ investments, and the boom continued…until it didn’t.
Over time, many of these sub-prime mortgage holders found they couldn’t afford the repayments and defaulted on their loans. Swathes of foreclosures or repossessions followed. The banks needed to sell these homes, but with the market becoming flooded, house prices declined. Many financial institutions were left holding worthless properties and ‘toxic’ debt that was impossible to get rid of.
As the sub-prime mortgages had been sold on through a web of opaque transactions, no single bank knew exactly how exposed any other bank was to the crisis. This made banks wary of lending to each other, which led to rising borrowing costs and a reduction in lending.
In September 2008, Lehman became a victim of this lack of credit and was the first major bank to collapse. It had invested heavily in the sub-prime market during the boom, acquiring several smaller mortgage providers and bundling up billions of dollars of housing loans to sell on. Its failure sent shockwaves around the global financial system. Fear took hold and a climate of distrust ensued, causing credit markets to seize up completely and stock markets to plummet.
Similar dramas were unfolding across Europe, not least the onset of its own sovereign debt crisis. This began with the collapse of the Greek economy and its banks, but spread to Italy, Spain, Ireland and Portugal. At its centre was a dangerous link between the fate of some sovereign nations and their domestic banks. The borrowing costs of weak countries and their weak banks moved upwards in tandem, dragging both down towards insolvency. As one of the poorest and most indebted nations, Greece was hardest hit.
As the world plunged into recession, central banks began slashing interest rates to spur growth. However, by 2009, rates in some countries were close to zero, leaving little room to manoeuvre. The authorities had to turn to more unconventional measures including the large-scale buying of assets such as government bonds (quantitative easing or QE) to boost the economy.
The US Federal Reserve, the Bank of Japan, the Bank of England and the European Central Bank have all engaged in QE to varying degrees.
The actions taken in the difficult years after the crisis have borne fruit; the return of global growth, declining unemployment, and higher corporate profits.
The US stock market finally reached its lowest point in March 2009. Since then, it has risen three fold and is experiencing its longest ever continuously rising market. In the same period, the UK’s FTSE 100 Index has more than doubled.
Some observers are now questioning when the current economic cycle will end and what that might bring.
So what lesson have we learned? The crisis exposed problems in the way that certain companies at the heart of the financial system were run and this has made investors much more aware of good corporate governance.
Regulatory intervention was also crucial in averting a far worse crisis, and financial companies now abide by much tougher rules. Global banks generally have stronger financial reserves and excessive risk taking has been replaced by prudence.
But the GFC still casts a long shadow. Most notably, it undermined the system of trust that was at the centre of western market economies. The glue that binds the capitalist system is the idea that finance works in the interest of the people, but the GFC strained that relationship to breaking point. The biggest lesson is that trust, once lost, is hard to regain. While time may be a great healer, this is a challenge that many financial institutions still face.
Forecasts of future performance are not a reliable guide to actual results in the future, neither is past performance a reliable guide to future performance. The value of investments, and the income from them, may fall as well as rise and cannot be guaranteed. Any views expressed are our in-house views at September 2018. Investment markets and conditions can change rapidly and the views expressed should not be taken as statements of fact nor relied upon when making investment decisions. This information may not be used, copied, quoted, circulated or otherwise disclosed (in whole or in part) without our prior written consent.
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