13 September, 2013 10:04

Lehman Lessons (Part 3)

What are the lessons of Lehman’s failure?

It’s important to look at the failure in context–in the context of the economy at that time, and also in relation to other financial institutions. Bear Stearns had been bought by JP Morgan in a Fed-engineered takeover in March; mortgage giants Fannie Mae and Freddie Mac were put into a Federal conservatorship the week before. On Friday, September 12th, 2008 many market participants thought the same fate awaited Lehman. The stock might be wiped out, but the bondholders would be made whole.

But that’s not what happened. The next Monday the company filed for Chapter 11, its senior bonds traded down to 30 cents on the dollar, and a financial panic ensued, with the market falling over 30% within a few weeks. How did otherwise free-market advocates come to expect federal intervention and support?

One culprit is the culture of bailouts that had been growing since the early ’90s. Mexico received US support in ’94; Long Term Capital was taken over in a Fed-supported bailout in ’98; investors had been discussing the "Greenspan Put" for years: the belief that if the market traded down, the Fed would lower interest rates to support asset prices. The expectation of government support led to widespread moral hazard–where firms take on risk believing that if it works out they make money, but if the venture fails, they’ll get government support. This didn’t happen with Lehman; try as they might, Federal officials couldn’t find an excuse–or deep-pocketed partner–to bail them out.

Government support can make a crisis worse when it leads them to take risks they otherwise would leave alone. In 2008, what should have been a moderate recession almost became another Great Depression because financial intermediaries doubled down. Instead of reducing risk, the entire financial system became more fragile.

There are not atheists in foxholes, and no conservatives when bailouts are at hand. Beware of governments bearing gifts.

Douglas R. Tengdin, CFA

Chief Investment Officer

By |2013-09-13T10:04:56+00:00September 13th, 2013|Global Market Update|0 Comments

About the Author:

Mr. Tengdin is the Chief Investment Officer at Charter Trust Company and author of “The Global Market Update”. The audio version of each post can be heard on radio stations throughout New England every weekday. Mr. Tengdin graduated from Dartmouth College, Magna Cum Laude. He received his Master of Arts from Trinity Divinity School, Magna Cum Laude and received his Chartered Financial Analyst (CFA) designation in 1992. Mr. Tengdin has been managing investment portfolios for over 30 years, working for Bank of Boston, State Street Global Advisors, Citibank – Tunisia, and Banknorth Group. Throughout his career, Mr. Tengdin has emphasized helping clients manage their financial risks in difficult environments where they can profit from investing in diverse assets in diverse settings. - Leave a comment if you have any questions—I read them all! - And Follow me on Twitter @GlobalMarketUpd

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