Lehman Brothers, 10 years on: seven lessons for investors
Interestingly, long-term investors in Ireland have not fared badly over the last decade
An employee of Lehman Brothers carries a box out of the company’s HQ building (background) while dodging the media assembled outside on September 15th, 2008, in New York. Photograph: Chris Hondros/Getty Images
This Saturday, September 15th, marks the 10th anniversary of the collapse of Lehman Brothers. The biggest corporate bankruptcy in history, Lehman’s failure caused mayhem in financial markets, exacerbating the worst global financial crisis since the 1930s. Ten years on, its effects are still being felt. For investors, here are seven pointers to reflect upon.
Sit tight in times of panic
The months following Lehman’s collapse were traumatic for investors. The S&P 500, which had been falling steadily all year, lost more than a quarter of its value over the following month. By late November, it had fallen 40 per cent.
The pain wasn’t over: rallies quickly fizzled out and stocks didn’t bottom until March 2009, by which time they had almost halved from pre-Lehman levels. Anyone who bought at October 2007’s bull market peak would have seen the value of their investment crater by 57 per cent – the worst bear market since the 1930s depression. In a New York Times op-ed in October, at the height of the crisis, Warren Buffett appealed to long-term investors to hold tough and resist the temptation to sell. Buffett admitted he hadn’t the “faintest idea as to whether stocks will be higher or lower a month – or a year – from now”, but that equities would “almost certainly outperform cash over the next decade, probably by a substantial degree”.
He was right. Anyone who bought stocks the day before Lehman went bust has done just fine, with the S&P 500 registering annualised gains of 11.1 per cent over the last decade.
Don’t wait until the coast is clear
Investors are often tempted to hold off on buying in times of crisis, to wait until the coast is clear. That’s understandable. As already noted, those who bought when there was blood in the streets in the weeks following Lehman’s collapse subsequently endured nerve-racking declines. However, in Buffett’s aforementioned op-ed, he warned that “if you wait for the robins, spring will be over”. During the 1930s depression, stocks had already bounced 30 per cent by the time economic conditions stopped deteriorating. During the second World War, Buffett noted, markets bottomed in April 1942, “well before Allied fortunes turned”. In the early 1980s, he added, the time to buy stocks was when inflation was raging and the economy was “in the tank”. It was no different in 2008/09. By the time the US recession officially ended in June 2009, the S&P 500 had already rebounded by more than 40 per cent.
Many individual stocks never recover, just as many national markets can spend years – even decades – in the doldrums
“The market does not turn when it sees light at the end of the tunnel,” as GMO founder Jeremy Grantham aptly noted at the market bottom in March 2009. “It turns when all looks black, but just a subtle shade less black than the day before.”
Diversify, diversify, diversify
Although stocks have enjoyed a strong recovery over the last decade, the gains have not been distributed equally. European markets have badly lagged US indices. Italy’s Mib index remains well shy of pre-Lehman levels, while Greek equity investors have endured a particularly dreadful decade. Contrary to popular belief, long-term investors in Ireland haven’t fared badly over the last decade. The Iseq’s Total Return Index, which includes dividends, has more than doubled since Lehman’s fall.
However, anyone who took a punt on Irish bank stocks lived to regret it.
“We invested in what we believed were blue-chip stocks – AIB, Bank of Ireland, Anglo – and all of that has been wiped out,” Gay Byrne admitted in 2011. Financial investors in Europe and the US suffered a similar fate, with investors discovering supposedly safe blue-chip giants like AIG, Lehman, Citigroup, Freddie Mac, Fannie Mae, HBOS and RBS weren’t so safe after all. The “stocks for the long run” argument refers to a diversified basket of stocks, not to all stocks. Many individual stocks never recover, just as many national markets can spend years – even decades – in the doldrums. The fall of Lehman Brothers and a host of other financial titans in 2008 was a painful reminder that undiversified investors are asking for trouble.
“Many people now say they knew a financial crisis was coming, but they didn’t really,” says behavioural finance guru and Nobel laureate Daniel Kahneman. “After a crisis, we tell ourselves we understand why it happened and maintain the illusion that the world is understandable.” Now, many people – like George Soros, economist Nouriel Roubini and the aforementioned Jeremy Grantham – did envisage trouble. However, Soros admitted in November 2008 he “did not actually anticipate that it would get as bad as it did”, saying it had “gone beyond my wildest imagination”.
We are not sure people remember everything they need to remember
Months earlier, Grantham said he “underestimated in almost every way how badly economic and financial fundamentals would turn out”, saying he was now “officially scared”. As for Roubini, he had been predicting global recession since 2004, arguing (wrongly) that high US deficits would cause global investors to take fright and abandon the dollar. Many commentators were “right for the wrong reason”, to quote former financial columnist Morgan Housel, now a partner at the New York-based Collaborative Fund. Many others agreed there was a housing bubble, but thought the damage would be contained. You might remember things differently, but ask yourself: if you really “knew” what was going to happen, then why didn’t you sell your house, invest the proceeds by shorting the hell out of bank stocks and retire to a life in the sun?
Companies and investors can get away with excessive risk-taking and all kinds of questionable behaviour in a bull market; you only find out who is swimming naked when the tide goes out, as Warren Buffett famously put it. Think of Sean Quinn, who went from billionaire to bankrupt after betting the farm on Anglo Irish Bank, or Bernie Madoff, who for decades got away with the greatest financial fraud of all time before the tide finally went out in the months following Lehman’s collapse.
A culture of caution
The magnitude of the financial crisis scarred investors around the world, many of whom remain cautious today. Almost one in three US millennials sees cash as the best place to invest money they won’t need for the next 10 years, according to a Bankrate.com survey in July. A separate American Association of Individual Investors (AAII) survey found 68 per cent said their financial decisions today are either somewhat or strongly influenced by the global financial crisis.
Almost a quarter of respondents said they are holding more cash to protect themselves from the next downturn; another 17 per cent said they had reduced their stock holdings or are holding less volatile stocks; 11 per cent are investing more in bonds to protect against another crash.
Forgetting the lessons?
While many investors remain cautious, there is concern that US policymakers are in danger of forgetting the lessons of the 2008 financial crisis. Donald Trump has signed legislation rolling back key parts of the 2010 Dodd-Frank Act regulating financial practices. The tighter restrictions placed on banks deemed too big to fail will now only apply to institutions with over $250 billion in assets – five times the previous threshold of $50 billion.
In July, former Federal Reserve chairman Ben Bernanke and former US treasury secretaries Hank Paulson and Tim Geithner warned that policymakers must remember the lessons of 2008. Loose regulation of financial institutions “made the system very fragile and vulnerable to panic” in 2008, cautioned Geithner.
That was echoed by his Republican predecessor, Hank Paulson. “It is important that people focus on the lessons”, said Paulson. “We are not sure people remember everything they need to remember”. One investor who is unlikely to be surprised is Jeremy Grantham. At the height of the post-Lehman panic in October 2008, he was asked what people would learn from the turmoil.
“We will learn an enormous amount in a very short time, quite a bit in the medium term and absolutely nothing in the long term”, Grantham replied. “That would be the historical precedent.”