A long shadow
The demise of Lehman Brothers exemplifies the great financial crisis. Understanding the different stages of the crisis can provide important lessons for investors.
The first stage of the crisis actually began more than a year before Lehman collapsed, when a bubble in the US housing market started to burst, fear commenced its grip on investors and credit markets seized up.
September 2008 marked the next stage, when Lehman became the first of the major banks to collapse. It was the moment when problems in the banking sector became too much to bear, panic broke out and the entire financial system was taken to the brink of collapse. Pessimism, even depression, were indeed the watchword amongst investors.
The recovery stage began when politicians scrambled to find solutions to the calamity as the drama in financial markets filtered through to economies. The US stock market did bottom out in March 2009, with some confidence returning after the G20 Summit that April set out a recovery plan.
Many elements of this recovery stage of the crisis and the intervening years have been positive, including the response of regulators. Banks are generally much better capitalised than they were. The business model that got banks into the crisis, of relying on short term funding and producing products that no one understood, has largely disappeared.
There are also welcome signs that cultures in banking have changed. Excessive risk taking is frowned upon; prudence is in. Banks are now much more likely to define their purpose as supporting the economy through responsible lending. The provisions that global regulators have put in place mean that banks are certainly more able to withstand the kind of crisis that we experienced a decade ago.
Bull markets grow on scepticism and mature on optimism. The global economic recovery was delayed again by the European Monetary Union crisis, which itself has long-lasting implications for the likes of Greece and Italy.
However, the actions taken in the difficult years after the crisis have borne fruit in global growth, a steady decline in unemployment and higher company profits. The US stock market has risen three fold since March 2009 while the FTSE100 index has more than doubled.
Some aspects of those events of 10 years ago sill cast a shadow over us all to this day though. Most notably, the crisis undermined the system of trust that was at the centre of liberal western market economies. We have lived through a period when banks appeared to some to be rewarded for their impropriety, with taxpayer-funded bailouts right through to fiscal austerity, declining wage growth and the financial imbalances that quantitative easing has exacerbated.
The financial crisis strained that relationship close to breaking point because people no longer felt that they could trust capitalism to provide a positive future for them
The glue that binds the capitalist system is the idea that finance works in the interests of all the people. The financial crisis strained that relationship close to breaking point because people no longer felt that they could trust capitalism to provide a positive future for them.
What can we learn?
The different stages of the crisis reminded me of three core lessons. The first stage of the crisis emphasised that knee jerk reactions are the worst kind of reaction. Each day during that early period of the crisis brought worse news, more panic, and new stock market lows. It was incredibly hard to fight the urge to go against the herd and buy when others were selling. Those that did handsomely rewarded the clients that entrusted them with their money.
The second lesson is that trust, once lost, is very hard to recover. Regaining the trust that financial institutions lost in the crisis is a daunting task that will take years, perhaps decades. The asset management community might seem like a small part in this bigger, systemic debate. But, as the custodians of people’s savings who are responsible for their financial futures, we have a vital role to play.
Another lesson is to join the dots. In August 2008, when UK listed Royal Bank of Scotland unveiled half year results – including a £5.9 billion write down owing to exposures to a US mortgage market in meltdown - its share price rallied on optimism that the worst was behind it. The bank was nationalised 66 days later.
The fact that many investors missed the warning signs of the extent of the crisis should keep us humble. It is an important reminder that assumptions should always be tested and hard questions asked. No investment process can capture all risks all of the time but clients should be reassured that they are as robust as they can be.
The crisis also exposed problems in the way that certain companies at the heart of the financial system were run. It left some investors questioning why corporate governance failings were missed. In truth, many of the governance failings were spotted but clearly necessary changes were not made and warnings not heeded.
It is a worthy reminder that asset managers’ reputation as custodians of other people’s money relies on us taking a hard and vocal line on companies that are not acting in the interests of our clients.
We are ultimately responsible for helping provide a financial future for people. This simple duty to do right by our clients should be at the core of everything that we do. If we want to play our part in rebuilding trust, that must be our focus.
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