The Day Lehman Died – The 10th Anniversary of the Financial Crisis of 2008

The Day Lehman Died – The 10th Anniversary of the Financial Crisis of 2008

The month of September has some chilling reminders that the world is not immune to global catastrophe.  We took time this week to remember the fallen from the cowardly terror attacks on September 11, 2001.  That day, much like Pearl Harbor, will always be a day of infamy in American and world history.  The “Global War on Terror,” continues to this day and wartime operations continue in Afghanistan, making it the longest war in US history.

But September also is the month of the most momentous economic calamity of this century, and perhaps second only to the Great Depression.  We have described the events leading up to the “Financial Crisis of 2008” in previous blogs in July and August, and they reflected a rolling crisis over an extended period dating back to the 4th quarter of 2007. However, the grand tsunami of financial catastrophe can be traced to the bankruptcy filing of Lehman Brothers on September 15, 2008.

The Day Lehman Died – The 10th Anniversary of the Financial Crisis of 2008

 Lehman Brothers had been an American banking icon on Wall Street since 1850.  It is hard to understate its role in American finance. They were involved in some of the most important and most lucrative deals in US history!  Just consider Lehman’s history:

The History of Lehman Brothers included some of the biggest moments in global finance:

  1. It issued the stock for some of America’s most iconic brand names: W. Woolworth Company, Macy’s, Gimbel Brothers, Inc., The Studebaker Corporation, B.F. Goodrich Co., RCA, Compaq Computers, among many others.
  2. Lehman arranged the first financing for major oil companies often in the news such as Kerr-McGee and Halliburton.
  3. Famous merger in 1983-1990 with Shearson/American Express in 1984 and then Shearson/Lehman merged with EF Hutton in 1988 (“When EF Hutton talks, people listen.”)

The Day Lehman Died – The 10th Anniversary of the Financial Crisis of 2008

  1. Lehman backed the take-over bid by the management team of F. Ross Johnson and RJR Nabisco, ultimately losing the bid to Kohlberg Kravis Roberts in what was then one of the largest “leveraged buyouts” in Wall Street history. It was dramatized in popular culture by the famous book and then movie – “Barbarians at the Gate.”

The Day Lehman Died – The 10th Anniversary of the Financial Crisis of 2008 

Lehman was in the same category as Salomon Brothers, Goldman Sachs, KKR, during Wall Street’s hey-day.  They were among the giants of Wall Street.  Their movement into mortgage origination in 1997 would become the most profitable department within the bank.  By 2006, mortgage loans and mortgage backed securities were generating almost $250 million a month in revenue.

Lehman, however, was exposed to – and some would say helped create – the contagion of sub-prime mortgages.  The government’s reduction of lending standards, requirements to lend into poor credit neighborhoods, and the government’s willingness to underwrite the paper on many sub-standard loan packages, led to a collapse in credit quality and underwriting standards.  We created an over-sized market of bad credit debt.  When adjustable rates adjusted upwards, people stopped paying.  Foreclosures commenced, the value of the mortgages dropped, the values could not be priced as they all dropped at the same time.  In the first quarter of 2008, Lehman was sitting on $680 billion of mortgage notes, and only $22.5 billion in firm capital to back it up.

 

The Timeline of the Lehman Brothers collapse:

  1. “August 2007 – closure of sub-prime office BNC Mortgage”: Twelve-hundred positions and 23 branch offices were all eliminated due to “deterioration” in the mortgage market.  Lehman would continue underwriting mortgage backed securities.
  2. “September 2007 – the last gasp of profitability”: The stock price jumped 46% on a report that Lehman would still conclude its 55th straight quarter of profitability.  The moves out of sub-prime were being rewarded by the market.
  3. “June 9, 2008 – the days appear numbered”: Reporting a substantial loss for the first time in years, major staff shake-ups were announced.  CEO Richard Fuld, who had been with the company since starting in the basement as an intern, remained in his position, but was isolated from other management staff.  The stock got a bump in August when reports of the Korean Development Bank (KDB) were considering buying into the company.  But when talks broke off in September, there were signs of storm clouds closing in, as KDB officials were quoted in the Wall Street Journal as saying they “….could not properly price the firm’s capital holdings, and therefore could not make an informed decision on an offer sheet.”
  4. “September 9, 2008 – KDB is out, stock plunges”: When the news hit the public, Lehman’s stock price collapsed, dropping 45% in one day and driving the S&P down 3.4%.  It was clear that Lehman’s size would have a direct and proximate impact on the overall marketplace…. the original “Too Big to Fail” bank.
  5. “9/11 – Down Goes Lehman”: A very sad day indeed.  Lehman Brothers had occupied several floors in the Twin Towers 7 years earlier when the terrorist attacks occurred.  Hundreds of employees lost their lives.   9/11 would be another dark day in Lehman’s history, as the stock price dropped 40%, and the Federal Government announced they would not bail out the company.
  6. “9/13 – Paulson, Geithner, steal Lehman’s deal”: In an emergency meeting at the New York Federal Reserve offices, a deal was negotiated to save Lehman through a merger/acquisition by Barclay’s Bank in England and Bank of America.  The Brits, however, after agreeing in principle, backed out, under pressure from their own government.  Bank of America, fearful of taking on a deal they could not underwrite, went to the Hank Paulson, the US Treasury Secretary, and Timothy Geithner, Chairman of the New York fed, asking for a bailout, or another partner.  Fearing problems with Morgan Stanley, the Feds let the BOA withdraw, leaving Lehman without a bailout savior.
  7. “9/15 – The Board votes to liquidate”: Infuriated that the Feds would not grant a bailout, despite doing so in the past (Bear Stearns, Long Term Capital Management), and blaming Paulson and Geithner for not keeping Bank of America at the table, the Board of Directors for Lehman voted at 1 AM, on September 15th, to put the company in bankruptcy.  The collapse of real estate prices had destroyed the value of the mortgage securities market, and Lehman did not have the capital to support what it owed.  Thousands of employees would be laid off the next morning.Lehman Board votes to liquidate
  8. “September 2008 and what followed – The Financial Fallout”: The bankruptcy filing announcement precipitated the worst intra-day drop in the stock market’s history (over 1000 points) and finished down 554 points.   While the volatility continued with up and down days through the remainder of the year, the downward trend and sense of dread in the larger economy was a constant feeling.  The market would drop again 449 points on 9/17 … again dropping 774 points on 9/29 … the Dow would end up down 13% by the end of October.

Lehman’s employees were immediately let go on the day of the bankruptcy filing.  Scenes of employees leaving with personal items in boxes was an indelible portrait of the fearful times which followed.  Although the stock market would continue to decline until reaching bottom in March 2009 (Closing at 6443, a 50% drop since October 2007), the hinge-point in the Financial Crisis was the Lehman Brothers collapse.  The Feds – so willing to bail out banks and everyone else on Wall Street after Lehman – most likely could have prevented the entire crisis by saving Lehman Brothers that September 2008. 

 Since then, Congress enacted a great deal of regulation to help prevent the next crisis from occurring.  But most analysts will tell you – big banks are bigger than ever, they are too big to fail, and the next crisis we may not be able to bail ourselves out of.  The public will not be in the mood to bail out anyone, and much of our political division comes from the Financial Crisis:  bankers were bailed out by Main Street – the taxpayer.  Now, the same people are richer than ever, but Main Street lost their homes, their savings – no one bailed them out.

Our financial system is the greatest system of wealth creation ever conceived by mankind.  But that does not prevent the system from malfunctioning thanks to government intervention.  Policies that force banks to lend to poor credit quality note-holders was doomed to fail, and it did.

Capitalism and the free market are the only systems that work for a free society, but what goes up will come down.  We have been in a 9-year bull market, super-charged by the pro-economy policies of the current Administration.  History, and common sense, suggest we are due for a correction.  Is your money protected? We may be able to help. Give us a call at (877) 912-1919 or visit TyJYoung.net.

Great Week of News…With a Few Warning Signs- Trade Deal

Great Week of News…With a Few Warning Signs

The country lost a war hero this week.  Senator John McCain finally succumbed to the brain cancer he was fighting for some time.  He suffered unimaginable torment at the hands of the communists during the Vietnam War.  His bravery and heroism during that time is representative of the legendary greatness exhibited by the American war fighter, and we are all grateful for his service and what he went through on behalf of all of us.

His politics were quite combative with his own party, and to a significant degree with President Trump.  That conflict headlined some of the news media this week, along with the convictions of former Presidential campaign Chair Paul Manafort and Trump attorney Michael Cohen.

But if you search deep into the Google pages, or watch a number of cable news shows, then you can find some very positive and quite intriguing news stories that are good for the country and for the economy!

 I. Top 5 news headlines for this week:

5.“Deregulation leads to expansion of energy access and rare-earth minerals”:  It should be well-known now that the energy industry, coal mining, fracking, and much more has been deregulated.  These industries are required through numerous laws and regulation to be protective of the environment, but the regulatory regime had led to restrictions in market access and profitability.  The Administration’s deregulation initiative has spurred economic growth, jobs and innovation.  In addition, restrictions on the mining of rare-earth materials have been lifted.  Everything from clean energy batteries to advanced weaponry that the Pentagon relies upon were being imported from sources abroad because mining for them in the US had been restricted.  This upside-down, dangerous threat to national security has finally been lifted.   This is a win for capitalism, and a win for national security.

4.“Mexico and the United States agree in principal on a new trade deal to replace NAFTA”:  Much of our political unrest can be attributed to many factors.  Most agree social media has exacerbated or even served as the root cause.  But the primary reason has been economic:  free trade and globalization has driven corporations to search for cheap labor, and that has negatively impacted blue collar employment in the US over the last 25 years.  The free market was only working in one direction:  if you pursue cheap labor across state lines, then you cannot have protected markets or the theft of intellectual property, or you get trade that is neither free nor fair.  The result is a populist revolt.  President Trump rode that wave and his primary target – going back to the early 90s – was NAFTA.  The trade deal between Mexico and the US this week probably means the end of NAFTA as we knew it, and that drove the market surge this week.

3.“Canada rushes to get a deal before its too late”:  Sound and fury, signifying…nothing.  Europe, Mexico, now Canada…everyone wanted to stick their chest out and say how they weren’t going to let the Americans dictate terms – and then we dictated the terms.  The Canadian Foreign Minister literally got on a plane to come to Washington after the President and Mexico announced their new trade agreement.  Simply put – apparently lost on the establishment and the elites of the last 26 years – no one can afford to NOT have a trade relationship with the country that has the largest economy, the freest economy, the most innovative economy, the fairest rule of law (although weakened), the largest multi-national banks, and the deepest capital markets.  Simply put – apparently lost on the establishment and the elites of the last 26 years – pursuing a strategy of economic confrontation with the United States has always been suicidal and self-defeating.  Canadian Prime Minister Justin Trudeau will be on TV claiming they prefer no deal to a bad deal…and shortly will sign a good deal for everyone that puts the American worker first.

2.“Nasdaq 8000”:  For the first time in the tech-index’s history, it broke 8000 on the big board.  While previous tech high’s scare investors – such as the dot.com bubble – the technology market has matured since that time, with larger and a more diverse set of companies which drive valuations.

1.“Growth revised upward”:  Not 4.1%, but actually 4.2% GDP growth in quarter number two.  This growth is predicated on actual deregulation, tax reform, and strong dollar policies.  It is based upon wage growth (2.8% year-over-year, first time since 2007) and actual economic activity as opposed to printing money or zero interest rates.  What goes up must come down, but the growth we are seeing is positive business expansion, it represents a healthy economy.

Not everything is rosy or hunky dory – the Mueller investigation never ends….China shows no signs of relenting in this trade war…Russian warships are back in the Mediterranean for the first time since 1990…the Congress remains incapable of addressing our debt problems nor even passing a regular budget…hopes for a deal in North Korea are waning…and, we are due for a market correction.

But America’s economic vitality and strength, and our role as the “indispensable nation,” is allowing the capitalist engine to power on as we near the end of 2018.

Part II: Ten Years Ago, The World Changed

Part II – Ten Years Ago, the World Changed

This is part II in our three-part series remembering the 10th Anniversary of the 2008 Financial Crisis (view part I of the series here).  This week, we look at the month of August of that year and the big events which represented the closing days of the real estate boom.

It was real estate, and the government’s intervention into that market, that drove the collapse of the banks in that year.  It was not too little government, but too MUCH!  President Jimmy Carter signed, and President Clinton extended, a law known as the Community Reinvestment Act (CRA).  This law required banks to loan sub-prime into communities which had bad credit, eliminating the bank’s risk calculus and making the government liable for the debt when Fannie and Freddie bought the paper, or in general, as banks have FDIC insurance to cover accounts.   Failure to loan into bad credit neighborhoods, and the government could revoke your bank charter.  With implicit government guarantees on the debt, the banks happily extended loans to people who would not be able to repay them.

This, by itself, was just one of many issues that had deformed the real estate and bank lending markets.    The one regulation which may have helped – Glass-Steagall – had been repealed by Clinton with Republican support in 1999.  This allowed bank traders to use regular bank depositor funds to trade in the stock market.  Resourceful capitalists that they are – Wall Street began bundling bad credit loans, known as subprime, with good loans in what was known by few as “mortgage backed securities” (MBS Bonds).

When the bad credit loans’ adjustable rate mortgage adjusted upward in the early to mid-2000’s, these people stopped paying.  The bad debt was mixed with the good debt in the bonds as stated above, and Wall Street began to sell them….rapidly.  Those holding the notes – banks and the government – began to see massive losses.  Those who insured the bonds began to receive massive claims they could not cover……you remember what happens next, we cover it in the final Part III next month.

So how did markets and money look in August 2008 – not pretty:

The 4 BIG events in August 2008 which headlined the ongoing financial crisis of that year:

4. “Global Banking Giant HSBC announces 28% drop in profits”: As earnings reports were released that first week of August, HSBC was hemorrhaging money and suggested in a note to clients that the economy was projecting to be the “…worst we have seen in decades.”

3. “Another global bank announces a suspension of withdrawals”: August 10th BNP Paribas announces in a press release that they were suspending all account withdrawals “…because it cannot value the assets in them, owing to a complete evaporation of liquidity…” in the market.  While the biggest shoe to drop to date – the first withdrawal suspension of the crisis – the markets were rather melancholy in response.  They would trade in a 200 point range the remainder of the month.

2. “Geo-political crises are rampant across the globe”: Russia has invaded Georgia … President Musharraf resigns in Pakistan, setting off protests in the streets … the Baltic States – Latvia, Estonia and Lithuania – enter a steep recession which begins migrating through eastern Europe … Al Qaeda launches simultaneous attacks in Afghanistan and Iraq … the financial crisis was one of many that were striking at the confidence of Western society.

1. “Nationwide Insurance reports real estate prices slid 10% just in the month of August”: In one of the steepest declines of the on-going crisis, Nationwide reported a 10% drop on August 28th.  It appeared to be what would force the water over the dam, and it was one of the many factors that would – on 8/28 we were less than two weeks from the Lehman Bros. collapse.

America’s Democratic party would nominate Barack Obama as their nominee this month 10 years ago, and the American team was on their way to winning another overall medal count at the Summer Olympics in China.  The economy was struggling, but we were completely unaware of what was coming soon.

Or were we?

As has been well documented, many traders had been forecasting doom for over a year – Michael Bury, Gregg Lippman, Steve Eisman and Ben Hockett were preaching for well in advance that the system was corrupted and the banks were over-extended.  They were ably portrayed in the hit 2015 movie titled “The Big Short,” based upon the book of the same title.  They were not the only ones – our firm’s “safety first” clients experienced ZERO losses, and started the climb back up with their portfolio 50% ahead of those who remained in risk associated assets.

New clients in the months that followed were often represented by the money manager in the home being dragged into the office by the ear, and when asked if they were ready to get into a principal protection product, they would offer some resistance – the remnants of the “I know better” mentality of the easy money era, only to receive an immediate “Shhh!” from the other spouse.  This was the classic spousal refrain you could see in each couple sitting at the table in the days and months that followed the collapse:  “…You screwed things up listening to Wall Street, now I am making sure we don’t lose the rest of it.”

 August 2008 had some precarious moments, but was really the calm before the storm.  Part III will follow in September with our examination of what would become the biggest financial crisis in recorded history.