I remember where I was when Lehman Brothers collapsed: boarding a flight from Los Angeles to London to return to university after the summer break. In the days leading up to that fateful day on 15 September 2008, there was already a tangible feeling that America was losing its stranglehold on economic dominance. Fear was in the air as I watched the events unfold on CNBC from a large flat screen television in the airport bar.
Back in Australia, portfolio manager Tamar Hamlyn was busy preparing for the launch of Ardea Investment Management.
“Our timing was challenging to say the least, but it all worked out well in the end and we will reach our own 10-year anniversary in November,” Ms Hamlyn told Investor Daily.
“Everyone has their own story of late-cycle excess, but one unsubstantiated rumour doing the rounds was that executives at a certain company had paid exorbitantly to commandeer an elevator for their exclusive use. I guess their time was so valuable it was worth saving a few extra seconds by travelling express.”
On the weekend prior to Lehman’s default, Kapstream managing director Steve Goldman flew back to New York from Sydney where he was visiting Kapstream, discussing his long-term plans to move to Australia.
“I returned to New York City just past midnight on that early Monday morning, decided I was hungry and went to find something to eat,” he recalls.
“I was living next to the New York Federal Reserve and as I walked out of my apartment I saw heads of the big banks walking out of the Federal Reserve building. There were no reporters, cameras or crowds to see their dejected look as they walked into the street.”
When asked by this reporter to share his experience of the financial crisis, Australian mortgage lending veteran and securitisation guru Kym Dalton quoted Hemingway’s novella Fiesta, sometimes known as The Sun Also Rises: “How did you go bankrupt? Slowly at first, then all of a sudden.”
Today, Mr Dalton is the chief operation officer of neo-lender Australian Mortgage Marketplace (AMM).
“My AMM co-founder, Graham Andersen, called me in 2006 after HSBC’s US housing unit suffered a multibillion dollar write down on their sub-prime loan portfolio saying, ‘this could be the start of something big!’,” he recalls.
“But then we had Hank Paulson, the US Treasury Secretary announcing in mid-2007, that the sub-prime crisis would be contained and wouldn’t impact the wider economy, so we all relaxed a little.
“After an escalating set of unfortunate events in US subprime through to early 2008, it became abundantly clear that there indeed was a genuine crisis. Graham Andersen and I were involved in a project to bring wall street investment bank, Bear Stearns, to Australia to consolidate the small non-bank and securitisation sector. What could possibly go wrong?”
A lot, as it transpired.
“Practically overnight, Bear became insolvent, being rescued by a merger with JP Morgan Chase on 16 March 2008. That was not a good day,” Mr Dalton said.
In the US, household names such as Countrywide, WAMU and Merrill Lynch were acquired or failed, culminating in the ‘big bang’ – the insolvency of Lehman Brothers.
“It was clear that this was a tipping point and life as we knew it in Australia was bound to change,” Mr Dalton said. “Which it did. There were a number of notable failures, including highly leveraged finance houses such as Allco and Babcock and Brown, there was a capital and liquidity ‘strike’ meaning, among other things, that RMBS markets became dysfunctional and uneconomic, leading to the only buyer left in the market – you guessed it, the Australian Treasury.
“The government guarantee of bank deposits and a perceived ‘flight to quality’ entrenched the market power of the big banks – a situation that is only being unwound at this time, 10 years later.”
AMP Capital chief economist Shane Oliver said the events around the the failure of Lehman Brothers and the GFC have been “done to death”. But he can offer a few words of wisdom for investors.
Shane Oliver’s 7 lessons from the GFC
1. There is always a cycle. Talk of a “great moderation” was all the rage prior to the GFC but the GFC reminded us that long periods of good growth, low inflation and great returns are invariably followed by something going wrong. If returns are too good to be sustainable they probably are.
2. While each boom bust cycle is different, markets are pushed to extremes, with the asset at the centre of the upswing overvalued and over-loved at the top and undervalued and under-loved at the bottom, which for credit investments and shares was in first half 2009. This provides opportunities for patient contrarian investors to profit from.
3. High returns come with higher risk. While risk may not be apparent for years, at some point when everyone is totally relaxed it turns up with a vengeance as seen in the GFC. Backward-looking measures of volatility are no better than attempting to drive while just looking at the rear-view mirror.
4. Be sceptical of financial engineering or hard-to-understand products. The biggest losses for investors in the GFC were generally in products that relied heavily on financial alchemy purporting to turn junk into AAA investments that no one understood.
5. Avoid too much gearing and gearing or the wrong sort. Gearing is fine when all is well. But it magnifies losses when things reverse and can force the closure of positions at a loss when the lenders lose their confidence and refuse to roll over maturing debt or when a margin call occurs forcing an investor to sell just when they should be buying.
6. The importance of true diversification. While listed property trusts and hedge funds were popular alternatives to low-yielding government bonds prior to the GFC, through the crisis they ran into big trouble (in fact Australian Real Estate Investment Trusts (REITs) fell 79 per cent), whereas government bonds were the star performers. In a crisis, “correlations go to one” – except for true safe havens.
7. The importance of asset allocation. The GFC reminded us that what matters most for your investments is your asset mix – shares, bonds, cash, property, etc. Exposure to particular shares or fund managers is second order.
