10 years later, Lehman’s real lessons for investors
By Ken Fisher
Saturday marks 10 years since Lehman Brothers failed, morphing a stock market correction into global financial panic. What should we learn from it?
We know that U.S. stocks plunged 45 percent from Sept. 12, 2008, to March 9, 2009. And that the accompanying recession destroyed 8 million jobs and $500 billion in U.S. GDP. Those disasters left folks fearing an endless depression. And yet stocks recovered, like they always have.
Remember this when things next get dark.
Bear markets like the last one feel horrendous. Paper losses are real-life painful. Yet if you’re long-term oriented, you can endure a bear without derailing your goals. The subsequent bull market repairs the damage sooner than you think, if you capture it.
That last financial crisis was America’s worst since the 1930s. Yet U.S. stocks, including dividends, hit new highs less than three-and-a-half years after the bottom. Capturing this upswing wasn’t comfortable, though. It meant owning stocks when you least wanted to. Not selling your stocks late in a bear is one of the hardest things to do. But also essential. The old cliché is true: It’s always darkest before the dawn.
While stocks recovered relatively quickly, investors didn’t — not emotionally at least. As I detailed two weeks ago, the panic scared folks for years. They feared “the next Lehman” lurking around every corner. Auto loans, student debt, Greece, Brexit, U.S. deficits — all became suspected Lehman repeats. Today, people fear European banks, debt loads and tariffs. Consider what actually happened a decade ago, and these comparisons ring hollow.
Legend has it that Lehman bloated itself on subprime debt and mortgage-backed securities, was insolvent and tanked the financial system. That’s wrong. Negative net worth didn’t kill Lehman. When it failed, its assets markedly exceeded its debt. It was simply cut off from normal, necessary short-term funding. It was illiquid, not insolvent. Big difference! The Fed and Treasury killed it.
Lehman’s MBSs weren’t toxic. Their interest obligations were paid regularly. Lehman wasn’t wanting to sell them. So market value wasn’t really relevant. But a new, wrongheaded accounting rule, FAS 157 – mark-to-market accounting – demanded banks recast all assets at “current market” value. Easy for readily traded securities. Hard for illiquid, rarely traded mortgage-backed securities.
Some banks and hedge funds sold mortgage-backed securities at fire-sale prices. That required Lehman to write down their mortgage-backed securities to match. The write-downs zapped its capital. And not just Lehman’s.
In his crisis history, “Senseless Panic,” the former head of the Federal Deposit Insurance Corporation (FDIC), William Isaac, estimated FAS 157 mushroomed several hundred billion in loan losses into nearly $2 trillion in write-downs. By my count, he conservatively underestimated.
After write-downs vaporized Lehman’s capital, it couldn’t get short-term funding for normal short-term obligations, like Bear Stearns six months earlier. But Bear didn’t go bankrupt. Instead, the Fed brokered a merger with JPMorgan Chase and absorbed Bear’s mortgage-backed securities. The Fed ultimately profited on them, proving them nontoxic.
The Fed refused that option for Lehman, denying funding to all interested buyers while rejecting Lehman emergency help, forcing its bankruptcy. This isn’t my speculation. Fed transcripts confirmed it.
At a September 16, 2008, meeting, policymakers congratulated themselves for denying help. They were clueless their arbitrary approach destroyed investors’ confidence. Lehman’s demise demonstrated that Uncle Sam determined who lived and died via crazy criteria. The U.S. saved Bear, killed Lehman, then nationalized insurance giant AIG. No consistency! Lenders won’t lend when the government’s rules change rapidly.
The widely bandied risks of today’s bull market don’t compare. Investors fight the last war psychologically. Markets don’t. The next bear will likely look more normal, starting amid investor euphoria.
Until then, fear of Lehman-like failures will keep this bull market rolling. Own stocks.