Ten years ago the world ended. Only it didn’t.
On Monday, September 15, 2008, Lehman Brothers, founded in 1844, shocked the world by filing for Chapter 11 bankruptcy protection.
Over a frantic weekend of negotiations, the U.S. Treasury and Federal Reserve had failed to come up with either a rescue package or a buyer, so the fourth largest firm on Wall Street, with 25,000 employees, simply disappeared.
In the following weeks, the Fed and Treasury reversed course and bailed out insurer AIG and mortgage giants Fannie Mae and Freddie Mac, with help from a panicked Congress, which authorized $700 billion to purchase toxic mortgages securities from financial institutions under the Troubled Asset Relief Program (TARP).
To say those were scary days is a huge understatement. During the 1987 stock market crash, we worried it would be a repeat of 1929. Turned out the 1987 crash was the only bear market not followed by a recession since World War II. But 2008 was the real deal—a stock market crash, financial crisis, and a recession that was the biggest since the Great Depression.
What did investors learn from this near-death experience—or what should they have learned?
- Giant financial crises are rare events. There have been dozens of local or regional banking crises over the past 40 years. Only this crisis and the Depression were truly global, cataclysmic events.
- You can make money if you don’t panic. This bull market and the one that ran from 1932-37 both showed gains of about 325%. Of course, back in the 1930s, nobody had any money to invest, but this time people who held on did just fine.
- Not all bubbles are created equal. You could see the housing bubble from a mile away. The same is true for the dotcom bubble in the late 1990s and the cryptocurrency bubble last year. But others aren’t so easy to spot (have we been in a bond bubble?). The point is, when you see gigantic moves in any asset class and, especially, investor complacency, it’s time to take some money off the table.
- We may not be so lucky the next time. The Dodd-Frank banking reform act gave regulators more tools to unwind failing institutions, required big banks to hold more capital against risky assets and stepped up oversight of systemically important institutions. But there remain gaps in the regulatory framework, lowering interest rates won’t be as potent a policy next time as it was then, and there may be zero public support for bailing out big banks. That could add a huge element of uncertainty and make the next big crisis as scary as the last one.