Lessons from Lehman – six investment managers reflect on 15 years since the bank’s collapse

by | Sep 18, 2023

emerging market investing

On 15 September 2008, 15 years ago last week, the collapse of US investment banking giant Lehman Brothers sent shockwaves through global financial markets.

While no saviour for the investment bank could be found over the infamous ‘Lehman Weekend’, the ripple effects from the bankruptcy resulted in unprecedented market interventions by global governments in the weeks and months to follow. 

A decade and a half on, six investors highlight some of the lessons learned as a result of Lehman Brothers and the global financial crisis, as well as discuss whether the consequences of this turbulent period are still being felt today.

Learning three key lessons

By Ken Wotton, manager of the Baronsmead VCTs

“The collapse of Lehman Brothers was the straw that broke the camel’s back, leading to the global financial crisis in 2008. The sense of fragility in the financial system and the huge policy response still reverberate in markets 15 years later. This seismic discontinuity relatively early in my fund management career taught me three critical lessons that inform my approach to investing to this day. 

Firstly, I seek to moderate exposure to large exogenous factors that can impact my investments more than the actions of a company’s own management team. Secondly, I avoid excessive financial leverage in investee companies. The adverse combination of these two factors was devastating for some businesses in the aftermath of Lehman Brothers. Thirdly, and more positively, I believe passionately in the power of great management teams. The best teams do not waste a crisis but instead use it to innovate, are agile enough to rapidly change course when necessary and can outcompete less nimble rivals to drive gains that can last many years. 

These lessons apply as much in 2023 as they did in 2008 and, as then, I expect some of the best investment opportunities to arise out of the uncertainty of the current market turmoil.”

Lehman influenced my approach

By Fatima Luis, senior portfolio manager at Mirabaud Asset Management

“As a fixed income investor, two core lessons were ingrained in me from the Lehman Brothers collapse that have influenced the way I invest: the mark-to-market concept and hidden leverage. 

Days before the collapse of Lehman, there was a lot of debate on whether it made sense to invest in a Lehman senior bond, which was set to mature within a couple of months. Market pricing suggested this particular asset had a high probability of a decent recovery – in a normal bankruptcy, there would be some priority in liquidation and senior debt holders would have a higher ranking in recovery. This was not to be the case and mark-to-market is only as good as the last trade. In this instance, losses would subsequently be exacerbated by the magnitude of leverage not only in Lehman – which was known for its aggressive culture – but throughout the entire banking industry. It made no difference if you held a AAA-rated Lehman sponsored bond or the equity.

Excessive leverage destroys diversification, tainting so many segments of the economy at the same time when things go wrong. Fortunately, lessons were learnt, as post-GFC reforms and regulatory oversight did prevent a systemic event with this year’s demise of Credit Suisse.”

Landscape very different today

By Quentin Fitzsimmons, portfolio manager of the T. Rowe Price Dynamic Global Bond Fund

“The financial landscape looks very different today than it did in 2008, when the collapse of Lehman Brothers almost brought down the entire financial system. We are now firmly past the peak of market liberalisation, with clear long-term deglobalisation trends now in place. Russia’s invasion of Ukraine and the Covid-19 pandemic have prompted many countries to look inward and re-localise their economies. This will be inflationary, as will be the unprecedented level of public and private spending likely required in the coming years to decarbonise economies. 

Some of this may be partially offset by technological developments that prove to be deflationary. Overall, however, inflation will probably settle at higher trend levels over the long term, which means central banks may find themselves under some political pressure to loosen targets in the future.

For central banks, the past 20 months have been in stark contrast to the decade that preceded them. Most notably, central banks have had to hike interest rates, which now appear close to their peak. Central banks have also moved from being the buyers of last resort in financial markets to being active sellers. This scaling back of support has had a profound impact on markets. Investors now face a more challenging landscape of tighter liquidity, more volatility, and higher interest rates – but one which is likely to offer compelling opportunities for those with an active approach.”

A bank run happening today

By Charles-Henry Monchau, chief investment officer at Bank Syz

“The US is currently enduring a bank run in slow motion, 15 years after Lehman. Adjusted for inflation, the three failed banks in 2023 – SVB, Signature and First Republic Bank – are bigger in size than the 25 that crumbled in 2008. 

While the Fed was prompt to put in place some mechanism to contain the crisis, total deposits keep flowing out of US banks. Since the start of the rate hike cycle, US banks have registered nearly $900bn outflows, by far the largest ever. This is basically the first bank run of the digital era. Deposits have been moving mainly into money market funds, a sign of savers losing confidence in banks. The loss of confidence is by the way not limited to the US – as seen with Crédit Suisse. 

The deposit outflow is creating funding issues, while at the same time, banks are facing large unrealised losses on bond portfolios. The usage of the Fed’s emergency bank funding facility keeps jumping and just hit a new record high of $108bn, even as ‘the regional bank crisis is over’, and the current rate banks are paying the Fed on these loans is an alarming 5.5%. In other words, the banks that almost collapsed a few months ago are now borrowing record levels of expensive debt from the Fed.”

Avoiding Lehman-style situations

By Robert Dishner, senior portfolio manager on the multi sector fixed income team at Neuberger Berman

“Over the past 15 years since the Lehman Brothers collapse, markets have focused on not having another similar event – either through regulations or reactions to a potential crisis. Whether they succeed is still to be determined. ‘Lehman shocks’ are usually incorporated into risk reviews – much like Russia’s default on its Long Term Capital Management debt, or the Enron and Worldcom scandals before the events in 2008. 

Regulation tends to be backward-looking, and there are always concerns surrounding unintended consequences and inadvertently creating different types of systemic risk. However, the recent banking issues in the US, where government agencies guaranteed deposits of certain banks, or in Switzerland, where the regulators arranged the merger of Credit Suisse and UBS, are two recent examples of different reactions. While this has come with less liquidity in certain parts of the market, we now have greater ‘solvability’ of crises.

The largest change over the past 15 years has been the increasing speed that events occur. Market participants are increasingly conscious of not being exposed to another Lehman situation, as we saw in the spring of this year.”

The importance of diversification

By Greg Eckel, manager at Canadian General Investments

“In Canada, our biggest concern was the potential collapse of the global financial system. This is where Canada and its banks really came to the fore on the global scene. The structure and regulation of Canadian banks gave some protection and serenity compared with other areas, and it came to be seen as a blueprint for remedial measures elsewhere. This was a big win for Canada, and these qualities remain. Due to this, Canada should be considered for investors as a good and safer place to invest in times of geopolitical unrest.

The Canadian market is somewhat concentrated by nature and is relatively smaller than most of its global peers, so it is somewhat disadvantaged in scale. Post-crisis, we gradually started to incorporate a greater allowance for investments in the US, which assisted in the liquidity discussion, but also addressed the concentration factor by opening up more opportunities.  

The collapse of Lehman Brothers and subsequent global financial crisis reinforced that market timing does not work, but diversification does. We believe it is best to remain fully invested, as you never know when a recovery may occur, and you never know where most of the damage or success may come from. We found it beneficial to move up the market cap spectrum to get more liquidity in our portfolio, which assisted in providing the potential for greater flexibility and relief in times of stress. This playbook is what we used in the early stages of the Covid-19 pandemic. We stayed fully invested and diversified, and the company rebounded strongly on a quick recovery.”

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