This weekend marks the tenth anniversary of one of the most significant days in our lifetimes: the collapse of Lehman Brothers investment banking firm on September 15, 2008.
It is not as infamous as 9-11, but the sudden collapse of Lehman Brothers nearly brought down the entire global financial system and created the country's worst economic events since the stock market crash of 1929.
Like our grandparents who never forgot the scars of the Great Depression, the "Great Recession" adversely changed the fortunes of many homeowners and retirees. Moreover, the unprecedented actions taken by the government to stem the cascading crisis that started in 2008 remain controversial today.
By 2008, storm clouds had formed from concerns about a housing market bubble and sub-prime mortgages. In retrospect, wild and loose mortgage lending begat a US housing bubble of epic proportions, one of the worst in human history.
As aptly described in the great movie, The Big Short, Wall Street firms like Bear Stearns, Lehman Brothers, Merrill Lynch and others were packaging junk mortgage loans into investment pools called mortgage backed securities ("MBS") and selling them as safe investments to lemming investors around the globe. And firms like AIG were selling exotic financial insurance products call credit default swaps to help shield investors against MBS credit risk.
Cracks in the sub-prime mortgage lending market first appeared in 2007 and in March 2008, the first domino fell. The venerable Wall Street firm (and leading MBS peddler) Bear Stearns nearly filed for bankruptcy, but the federal government quickly jumped in to arrange a bail out, "encouraging" JP Morgan to purchase the company to calm jittery global financial markets.
The calm didn't last for long. In early September 2008, the federal government was forced to take control of the two gigantic mortgage loan federal agencies – FNMA and Freddie Mac – because they were insolvent due to the mounting pile of delinquent residential mortgages they had guaranteed.
And then, all hell broke loose with the Lehman bankruptcy. In the days prior to the filing, frantic efforts to find a buyer failed and, in the end, the government opted not to bail out Lehman and let it go under.
With over $600 billion in assets and twenty-five thousand employees, Lehman remains the largest bankruptcy in history. The startling event sent financial shockwaves around the world, the effects of which are still being felt.
And the government's decision to arrange bail out for Bear Stearns but not Lehman Brothers remains a hotly controversial decision, even today.
Lehman was a leading perpetrator of the sub-prime MBS investment scheme, using debt to fund its largesse. At the time of its bankruptcy, it debt was a staggering 32 times its equity capital.
Merrill Lynch was insolvent due to its own MBS troubles and was hastily sold to Bank of America arranged by the government; the deal was announced on September 15th.
And on September 16th, the fed government was forced to extend a $85 billion (!) loan to AIG to keep it from folding from the weight of the credit insurance it sold on trillions of dollars of junk mortgages.
And then came the crowning government meddle: the $700 billion dollar Troubled Asset Relief Program bill – TARP - to inject cash equity into the largest financial institutions to keep the US financial system from buckling.
While the bankers were getting bailed out, nearly eight million Americans lost their homes due to foreclosure, many more were beset for years with negative home equity.
As Bruce Springsteen sang in 2012: "On banker's hill the party's still going strong, the rest of us are shackled and drawn".
The US economy soon crashed and the US unemployment rate eventually rose to double digits. Not surprisingly, the US stock market panicked; its peak-to-trough drawn down ending in March 2009 was a breathtaking 57%. Many retirees never fully recovered.
Prior to 2008, the notion of the US government injecting billions of dollars of debt and equity capital in the country largest bank (Citigroup) and largest automobile manufacturer (General Motors) to keep them afloat was laughable, yet it happened.
That's not all: From 2008 to 2014, the Fed Reserve pumped almost $5 trillion of cash into the US economy to shock it out of its coma. In turn, the federal government spiked the US national debt by trillions of dollars endeavoring to do the same thing, both with mixed results.
All of this reads like weird fiction, but it happened and the question whether a similar financial meltdown could bring us to our knees again has not been answered.
As I reflect on the sobering Lehman anniversary, here's my take:
· Due to bailouts and new regulations, we now have a serious moral hazard problem. A concentration of US financial assets are held by a small cadre of mega-sized financial institutions, which means they are now truly "too big to fail". So they can take financial risk and keep the gains while taxpayers subsidize future losses – not good.
· US national debt has doubled since 2008 due to misguided stimulus spending that was largely pork and politically motivated tax cuts. Both political parties share the blame.
· There are asset bubbles all around, including stocks, bonds and real estate, due to the Fed's financial engineering. The Fed has no clue how to seamlessly unwind $5 trillion of cash printed since 2008 without causing economic discomfort. At least the Fed stopped printing money in 2014, the European Central Bank is still printing Euros.
· The massive Dodd Frank financial regulation bill did not solve the too-big-too-fail dilemma, but it did make home mortgage lending overly complicated, concentrated the nation's banking assets, stifled small banks and choked lending. Outside of that, it was a home run.
To summarize, we can't yet write the final history on the Great Recession because it has not fully played out yet. I fear that unpleasant unintended consequences of all the government intervention in world capital markets lie ahead for investors.
Until next time, be well…..Tim
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