Lessons from Lehman

Posted by Liz Rees in Weekly musings category on 19 Sep 18


A whole decade has passed since the collapse of US investment bank Lehman Brothers on 15 Sept 2008, an event that deepened the Global Financial Crisis. It all started with defaults on sub-prime mortgages in the US which were handed out to first-time buyers with poor credit records and low affordability scores. Excessive risk taking, a decline in lending standards, complex investment vehicles and a lack of regulatory oversight contributed to the melt-down.

Consequently, the world economy experienced the worst recession since the Great Depression of 1929 which, one way or another, affected us all. Lehman was the biggest bankruptcy in history and in the following weeks global stock markets lost nearly $10 trillion of value. Equities continued to fall for a further six months, before bottoming out in March 2009. To address the issues, radical measures were undertaken by Central Banks. Quantitative Easing (QE) programmes, involving aggressive interest rate cuts and bond purchases, were successful in restoring liquidity and confidence in the financial system.

How do things look today? Certainly, the banking system is now in a far healthier state with increased capital requirements and leverage rules, regular stress testing, ring-fencing of assets and stricter governance. Off balance sheet activities, notably those sub-prime mortgages, have been restricted and brought into the regulatory framework. Moreover, the world economy has made steady progress, albeit with disappointing productivity growth which has held back real incomes.

For investors, the recovery has been remarkable. Much as it felt like doomsday at the time, looking back it seems but a blip on the chart. Those who did not panic and stayed invested had recouped all their losses by the end of 2010. Since then, all asset classes –whether equities, bonds or property– have made decent gains. As bond yields declined (due to QE pushing up prices) investors turned to equities for superior income which in turn has pushed up their prices. Consequently, an investment in the FTSE UK All Share index will have doubled your money while an average US Smaller Companies or Technology Fund will have gone up threefold.

The best performing region is the US, with Emerging Markets the laggards. At a sector level, technology has stood out while, unsurprisingly, Banks have been slower to recover. Smaller companies in all regions have outperformed their larger counterparts which is what we would expect in a recovery cycle. Homeowners, particularly of high-end London properties, have also been beneficiaries. Indeed, the Bank of England estimates that shares prices are 25% higher, and house prices 22% higher, as a result of QE.

Not everyone has been a winner though. Assets are generally owned by the better off in society and many ordinary people have faced austerity measures, along with falls in real incomes, as economies and tax receipts contracted. This produced widespread distrust of financial institutions and governments and brought a backlash against globalisation which no doubt contributed to Trumps’ victory, Brexit and the success of anti-EU parties in Italy and Sweden. We can’t predict how far this trend will go but there are early indications that wage growth may finally be picking up.

Record global debt levels, following a decade of low interest rates, are another concern. This was behind the recent sell-off in Emerging Markets, where dollar strength makes it harder to service dollar-denominated loans. However, companies have learnt from the past and try to borrow in currencies where they have revenues. Moreover, in developed nations the signs are that the corporate sector overall is behaving in a more prudent fashion.

Admittedly, there are pockets of consumer debt, such as PCP car loans and unregulated peer to peer lending (P2P), which need to be monitored. A decade ago most financial risk was held by financial institutions whereas today it is spread more widely across the population. For example, P2P lending has expanded rapidly but has no government protection against losses. Even more risky is the rise of cryptocurrencies such as bitcoin which sky-rocketed before crashing back to earth.

So what is the outlook from here? Central Banks are starting to raise interest rates and shrink their balance sheets; otherwise they will have no scope to take action when the next slowdown occurs. They have taken care to adopt a gradual approach, for fear of dampening the recovery which, aside from the US, is muted.

One thing the Financial Crisis taught us is the importance of taking a long-term view and remaining invested through difficult times. We’ve come a long way but now is not the time for complacency; valuations in most markets are high relative to history although to date this has been supported by strong earnings growth. Some stock markets have hit all time highs, yet sentiment remains subdued and it has been dubbed ‘the most unloved bull market of all time’.

For me, the main learning from the crisis is that things break, they get fixed, we try not to make the same mistakes again. Of course, fixing one problem doesn’t mean another won’t occur. There will undoubtedly be further challenges in the future, possibly due to factors we are not yet aware of! To quote Mark Twain, ‘History doesn’t repeat itself but it often rhymes’.

Investing in equities always carries risk but for long-term investors the rewards are clearly visible. Looking ahead, exciting new opportunities are appearing due to transformative new technologies such as artificial intelligence, robotics and electric cars. Experience tells us to be well diversified, keep calm and carry on investing.

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