Six years ago this month, the venerable, 158-year-old investment banker Lehman Brothers collapsed and the world was plunged into the worst financial crisis since the Great Depression. As the sixth anniversary of the crash approaches, some investors are worried another one could already be around the corner. So just how have capital markets changed since then, and what have we learned?
In some ways, the market has fundamentally changed, not unlike after the Great Depression of the 1930s when a generation became frightened of investing in stock markets. Though currently North American stock markets have been setting record highs as credit markets touched record low yields.
The 2008 crisis prompted the U.S. Federal Reserve to pump massive stimulus dollars into the economy. That move pushed bond yields to their lowest point in 75 years. This forced investors to seek income from “bond-surrogate” investments such as high-dividend-paying stocks, high-yield bonds, levered loans and real estate.
The proliferation of these products and strategies has brought different risks to investors, including liquidity issues, expensive valuations and regulatory changes. Governments have introduced much tougher capital rules on U.S. and international banks to reduce the chance of future bank failures. This has led banks to use far less of their own capital in global markets, which, in turn, has reduced secondary market liquidity for many securities and removed some of the more credit-worthy bank counterparties in these markets.
Here are four lessons from 2008 that investors can apply today:
1. Be skeptical of the next new product or approach to investing. The crisis in 2008 was presaged by a record set of innovations in credit markets. Sub-prime asset-backed securities, collateralized debt obligations and increased leverage magnified what might have been a contained real estate correction to a broader financial collapse. Today, we see many new alternative strategies, asset classes and products, all with their own risks.
