Lessons from Lehman's Collapse 10 Years After Failing
Stock-Markets / Credit Crisis 2008 Sep 25, 2018 - 11:09 AM GMTBy: Michael_Pento
Global financial services firm Lehman Brother’s stock was in free-fall during the first week of September 2008. After making huge bets in the mortgage securities space, Lehman’s President Dick Fuld feared bankruptcy and frantically sought out a buyer. The company was hopeful to strike a weekend deal with either Barclays PLC or Bank of America.
Nevertheless, Lehman’s outsized investments in the mortgage market ultimately proved them too risky a partner for anyone; and the giant investment bank went belly-up on September 15th. Prior to this event, Lehman had reported record earnings every year from 2005 to 2007. The Street believed the company to be infallible. Analysts held on to hope until the bitter end. Their mantra went something like this, “nothing to see here, this is a small correction in a small section of the housing market that has little effect on the overall economy.”
But it wasn’t the first time that year that analysts got it wrong. The Wall Street perma-bulls also missed the eleventh-hour fire sale of Bear Sterns to JP Morgan for $2 a share. Five days before the sale, a CNBC host who loves to play with buttons fervently advised a viewer to leave his money in the firm, insisting it would be silly to make a sale at current values. However, less than a week later it lost $60 per share!
The Lehman case became the largest bankruptcy filing in history, surpassing other bankrupt giants such as WorldCom and Enron. Markets were panicked. The following day, September 16th, AIG called then-Fed Chairman Ben Bernanke asking for an $85 billion dollar bailout. For years AIG had collected premiums on Credit Default Swaps (CDS), which are basically insurance policies on debt. All three credit rating agencies, which had rubber stamped all new debt issuances as AAA for years, finally downgraded AIG to AA-, immediately triggering a collateral call of $32 billion dollars. In just one day AIG was basically insolvent. AIG had written CDS contracts on $500 billion in assets, $78 billion of these were on residential and commercial mortgages and home equity loans. Remember, the same types of loans Wall Street and the Fed assured investors were rock solid.
And this was Tuesday; the week had just begun…
September of 2008 was perhaps the most eventful month in Wall Street’s history. On September 21st Goldman Sachs and Morgan Stanley, the last two independent investment banks, become bank holding companies, so they could compete for deposits with commercial banks and better ensure their solvency.
On September 25th a group of Washington Mutual Bank executives boarded a plane to Seattle. Upon de-boarded, they discovered that the Fed had seized their bank assets and sold them to JPMorgan Chase; marking it the biggest U.S. bank failure in history.
And then, of course, Congress got in on the fun rejecting a $700 billion Wall Street financial rescue package known as the Troubled Asset Relief Program, or TARP, on September 29th ; before accepting it on October 3rd.
Also occurring in that infamous month of September 2008 was the placing into conservatorship of both Fannie Mae and Freddie Mac; those two giant government sponsored enterprises that would have gone bankrupt without a taxpayer bailout.
The problems didn’t end with September. October saw Wells Fargo, the biggest U.S. bank on the West Coast, squeeze out Citi Group to buy floundering Wachovia for about $14.8 billion dollars. And it was a good thing Citi wasn’t successful in their acquisition because in November the Treasury Department, Federal Reserve, and Federal Deposit Insurance Corp., all had to come up with a plan to rescue Citigroup. Citi issued preferred shares to the Treasury and FDIC in exchange for protection against losses on $306 billion of securities it held.
When the dust settled, the government exited the mergers and acquisitions business and did what it does best--namely, create a scheme to monetize debt and re-inflate asset prices. The first round of Quantitative Easing--a form of government-sponsored counterfeiting--was announced on November 25, 2008.
It’s important to remember that while this major crisis was brewing the Fed saw nothing on the horizon. Then Fed Chair Ben Bernanke saw no bubbles or risk for the broader economy, even as subprime mortgages started to collapse. Janet Yellen, Bernanke’s successor as Fed Chair, made this infamous quote regarding the real estate sector in September 2006, “Of course, housing is a relatively small sector of the economy, and its decline should be self-correcting.”
Fast forward to today, Wall Street and the Fed are busy assuring us there are no bubbles out there at all. And, even if one does exists, it poses no threat to the overall economy whatsoever. They want you to ignore the doubing of the National Debt since Lehman failed. Don’t worry about an annual deficit of $1 trillion either; which is projected to only surge “big league” from its current level of over 5% of GDP. Never mind stock prices that are 1.5x the underlying economy—a valuation so high that it has never been witnessed before. A doubling of corporate debt to a record 45% of GDP isn’t a concern either—even when considering the quality of that debt is at a record low. And, having trillions of dollars worth of sovereing debt with a negative yield is just par for the course…or so they insist.
At least that is their public spin. However, the Fed recently found it necessary to telegraph to certain insiders within the Main Stream Financial Media what it would do during the next financial crisis. Here is the plan: It has pledged to act early and forcefully once the next crisis becomes manifest. The Fed will also publicly promise to do whatever it takes to fight deflation and tumbling asset prices and rising unemployment rates immediately—there will be no scaling into the next fight. Finally, our government will not delay or tinker around the edges when it comes to passing the next fiscal stimulus. It seems both parties have agreed that a massive tax cutting and infrastructure package would need to be enacted very quickly once the next recession arrives.
Of course, our government will have to recognize a crisis exists in the first place, which given the historical record, won’t be until the markets are in absolute free fall. But assuming they do eventually arrive on the scene, those are the things it would try to do “better”. This is crucial to understand if you want to make the most prudent investment decisions going forward. This is because the changes to economic growth and with the inflation/deflation dynamic are going to be unprecedented in scope and in magnitude. If investors are not modeling those changes they will be blindsided. Prepare now while you still have a chance!
Michael Pento produces the weekly podcast “The Mid-week Reality Check”, is the President and Founder of Pento Portfolio Strategies and Author of the book “The Coming Bond Market Collapse.”
Respectfully,
Michael Pento
President
Pento Portfolio Strategies
www.pentoport.com
mpento@pentoport.com
(O) 732-203-1333
(M) 732- 213-1295
Michael Pento is the President and Founder of Pento Portfolio Strategies (PPS). PPS is a Registered Investment Advisory Firm that provides money management services and research for individual and institutional clients.
Michael is a well-established specialist in markets and economics and a regular guest on CNBC, CNN, Bloomberg, FOX Business News and other international media outlets. His market analysis can also be read in most major financial publications, including the Wall Street Journal. He also acts as a Financial Columnist for Forbes, Contributor to thestreet.com and is a blogger at the Huffington Post.Prior to starting PPS, Michael served as a senior economist and vice president of the managed products division of Euro Pacific Capital. There, he also led an external sales division that marketed their managed products to outside broker-dealers and registered investment advisors.
Additionally, Michael has worked at an investment advisory firm where he helped create ETFs and UITs that were sold throughout Wall Street. Earlier in his career he spent two years on the floor of the New York Stock Exchange. He has carried series 7, 63, 65, 55 and Life and Health Insurance www.earthoflight.caLicenses. Michael Pento graduated from Rowan University in 1991.
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Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.
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