Have We Learned Anything From Lehman’s Collapse?

On September 15, 2008, Lehman Brothers, the U.S. investment bank collapsed. It sent shockwaves throughout the financial markets and remains the single largest bankruptcy filing in U.S. history. This was just the tip of the iceberg. The whole financial system was on the brink of collapse. Why?

The failing U.S. housing market, and particularly the sub-prime mortgage market was about to implode. Clever investment bankers had packaged the sub-prime mortgages with traditional mortgages and sold the bonds to generally unsuspecting investors. Unfortunately, the unsustainable housing market was turning south. And what turned to be clever instruments – CDOs, MBS and others – were now becoming toxic. The world was on the precipice of a dramatic systemic collapse.

Only unprecedented actions by policymakers changed the financial Armageddon. Although the catalyst was the downward spiral of the U.S. housing market, its root cause may probably lie in cheap money, lax standards and irrational exuberance.

A decade on, we have spiralling debt, growing tariffs and rising interest rates providing fresh impetus or ingredients for a perfect storm. Global debt is now USD247 trillion or 318% of GDP, according to the Institute of International Finance. Tariff wars have only just begun and interest rate rises from 1.75% to 2.0% in 2018 to 2.5% - 2.75% by mid-2019 (by the Federal Reserve) are envisaged in due course.

There are lessons to be learnt from the Lehman collapse including never resort to extreme leverage; never invest borrowed money in equity markets; never panic and cash out in a falling market. Nevertheless, be prepared for a 40% drop (in the Dow) if there is a crash in either 2019 or 2020. That’s the average drop (40%) before and in a recession.

References

1. Lehman Brothers Collapse: Key Lessons https://www.foxbusiness.com

2. Two Lessons from Lehman Brothers Collapse https://www.marketwatch.com