Lessons learned, lessons lost from the 2008 financial crisis


Graham Smith - Market Commentator

12 September 2018

This week marks the collapse in 2008 of the investment bank Lehman Brothers, widely regarded as the most critical moment of the US subprime and soon to be global financial crisis. The US government had, the previous week, stepped in to rescue Fannie Mae and Freddie Mac – America’s main guarantors of mortgage debt.

In the UK, HBOS was rescued by Lloyds TSB later the same month, as the aftershocks of the Lehman event rippled around the globe. In October, Lloyds and RBS effectively fell into government hands by accepting taxpayers’ money.

Yet just a few months after that, the financial instruments based on subprime mortgages that had sunk Lehman Brothers and threatened to do the same to other large banks had, perhaps unbelievably, begun to make a comeback.

By the following spring, hedge funds were snapping them up and some lower grade securities that had traded at just a few cents on the dollar during the dark days of the crisis were drawing the buyers in1.

Opinions at the time became polarised, between those that saw the low prices of riskier mortgage backed securities as an opportunity of a lifetime; and those that vowed never to go near anything other than straightforward equities and bonds ever again.

Today such polarisation still exists, only this time the lines of demarcation are more likely to have been drawn between those attracted to new assets like cryptocurrencies and the rest.

The recent rise of bitcoin and its plethora of young siblings will be seen by some as a lesson lost from the 2008 financial crisis.

Yet many things have changed. In the lessons learned column are the high levels of scrutiny now widely applied to banks. They’re now required to back up their loans with more assets than ever before, providing them with a greater ability to withstand shocks. Lending requirements have also been tightened.

In the UK, the regulation of banks was returned to the Bank of England and a new body – the Financial Conduct Authority – in 2013.

There has also been a stark change in attitudes towards mortgage backed securities without government guarantees. Since 2008, the once thriving new issues market in the US for securities like these has virtually disappeared2.

Partly that’s down to low mortgage interest rates which have rendered mortgage based products less interesting to investors. However, those securities that have risen from the ashes lately have been of a considerably higher quality than those flooding markets in 20083.

We also woke up to the fact that markets are highly interconnected and there needs to be robust global cooperation to police risks. What started out looking like a local area problem in American banks turned out to be anything but that.

The downside to all this greater understanding and another lesson possibly lost is that genuine investment opportunities might sometimes get unfairly kicked by the wayside due to over-caution.

The poor performance of European banking stocks so far this year probably has much to do with concerns that future risks – trade wars, outflows from emerging markets or Brexit – will damage earnings.

So while the profits of European financials comfortably bettered expectations in the second quarter and continued growth across the eurozone provided yet more scope to strengthen balance sheets, the prices of European bank stocks have remained locked in a downtrend4.

Over the past ten years, some investors will have lost faith and, just at the wrong moment, been propelled into cash yielding close to zero.

For some the real damage caused by the financial crisis was not the loss that may have been inflicted in the immediate aftermath but an expensive interruption or, worse, suspension of long term investment plans.

There’s also good reason to believe that the response to the crisis by governments and central banks made inequalities of wealth and power more extreme. Quantitative easing pushed up the prices of assets the poor simply do not own.

This reality or perception of reality continues to drive a rise in populism to this day, while playing into the hands of anti-globalists and helping to deliver a narrative supporting trade tariffs and protectionism in America.

Ultimately for investors, the lessons to be learnt from the financial crisis were far from unique. Over the past 30 years – which just about covers my financial experience – every crisis inflicted pain on overextended strategies and forced some investors to change tack.

For longer term investors with sensibly worked-out portfolios, from the stock market crash of 1987 through a debt crisis in Asia ten years later, the dotcom bubble, 9/11 and Greece’s debt crisis, these events ultimately became little more than temporary setbacks.

Three powerful investor tools would have helped in each case. Diversification is key because it presents the possibility of owning assets that do relatively well while others are not. Always having cash on the sidelines to add to a portfolio when the fear in markets is great is another sensible measure to take.

Finally, and never to be underestimated, is the power of saving regularly in stock market funds or shares. Since markets neither move up or down in straight lines, they provide plenty of opportunities for investors committing the same sum of money each month to buy most when prices are low and buy less when prices are high.

At a stroke, that takes out the risk of either getting swept up in overly exuberant markets or completely missing out through being too cautious when markets bottom out. It also reduces an investor’s average buying price per unit or share over time with no aforethought.

More on principles for good investing


1 Housingwire, 02.03.09
2 Wall Street Journal, 28.07.14
3 CNBC, 20.03.17
4 STOXX, 09.09.18 and Thomson Reuters I/B/E/S, 04.09.18

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