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A decade on from 2008 – are we smarter?

A decade on from 2008 – are we smarter?

It feels like just yesterday I watched the financial panic of 2008 unfold.

I’d shuffle in the morning with a coffee, and analyse the action from the US market the night before, taking notes. Dow Jones down another 150 points. Aussie dollar up one cent to the greenback. Gold down to US$787 that’s a US$69 loss this week.

Day after day, my screen flashed red.

Sky news was on in the background.

Churning out the same old stories.

The thing is, at the time we didn’t know exactly what was wrong, just that things weren’t right.

And it went on like this for months.

More bad news. More defaults. More market falls.

And then one day the Dow dropped 500 points in one trading session.

The market crash was here.

Often when we hear people talk about the market crash of 2008, it’s neatly summed up to feel like something that played out over a number of weeks.

That’s not the case.

The events that set up the stock market crash began in early 2007. Eighteen months before the US market tumbled 500 points in one day.

When news got around that a London based subsidiary of insurance firm AIG defaulted on some credit swaps, the US stock market fell.

But the market sell-off didn’t last long.

Not long after AIG defaulted, US mortgage firm Freddie Mac said it would no longer buy subprime loans. They’d decided subprime debt was too risky suddenly.

Over the next five months, Bear Sterns hits the headlines for liquidating anything in their portfolio linked to subprime mortgage debt. Followed by another major mortgage provider in the US, American Home Mortgage Investment, filing for bankruptcy.

Several other small lending firms in the US filed for chapter 11. The international banking interest rate, the LIBOR, spiked to 6.7%, something not seen since the dot.com crash.

All of these events were signs of economic stress.

Yet the US stock market rallied.

The Dow Jones even set a new record, closing above 14,000 points for the first time ever in October that year.

The Federal Reserve Bank pumped US$41 billion into the financial system. Offering cheap lines of credit for the banks, all in a desperate attempt to keep the lending machines running.

Basically, the Fed knew how unstable the banking system was. So, they stepped in. The Fed knew if the banks weren’t able to lend money, there was an enormous risk the banking system could collapse.

For a month, it looked like the Fed’s actions worked.

In spite of major banks going broke in the US, the stock market was rather resilient. There was no crash. Perhaps it was just a price correction after all.

Nothing to fear.

At least, that’s what we thought at first.

4,000 points down in three weeks

Come the new year, it didn’t take long for the US bank defaults to start again.

In early March of 2008, the Fed stepped in once more.

This time, it was to personally guarantee some US$30 billion of investment banks Bear Sterns’ less liquid assets. Two weeks after this money guarantee from the Fed, Bear Sterns was sold to JP Morgan for $2 per share. Seven days earlier Bear Stern shares were worth $30 per share.

Over the months, several more subprime mortgage related businesses went broke.

Still, the US stock market ticked down. But it didn’t crash.

Then one day in mid September, what triggered the crash came out of nowhere.

America’s fourth largest investment bank, Lehman Brothers, filed for bankruptcy.

The Dow Jones closed down 500 points that day. 600 the next. Within three weeks, the Dow Jones was 3,600 points lower.

A decade on

This week marks the tenth anniversary since Lehman Brothers filed for bankruptcy. The event which nearly crippled the entire financial system.

Now, Lehman brothers didn’t cause the crash. Lehman Brothers was the breaking point for investors. It was the signal of the loss of faith in the financial system.

Here’s the thing.

Prior to the Dow Jones falling 500 points in one day, the financial system was showing signs of stress everywhere.

We just didn’t know what to do with that information.

It didn’t help that central banks and politicians confused the public. Reassuring us that things were under control.

Even though the market crash hadn’t happened yet, parents on the school run were uttering phrases normally only used on Wall Street. Suddenly everyone was using words like ‘subprime’ ‘CDOs’ and ‘credit default swaps’ into daily chit chat.

But the point is this: the signs of economic stress were visible earlier.

And a decade later, the financial markets are no safer.

The US may be done with lending to the subprime market for now. But there are growing pockets of turmoil in global markets.

There are several countries with worthless currencies, that are unlikely to pay their loans back. The US is raising interest rates and may trigger their own recession. Trump is waging a trade war on China through tariffs, which in turn is increasing the cost of goods for the US. If prices move too high for both countries, it could potentially reduce trade and lead to an economic slow down.

The signs of stress are building in the markets once again.

This time though, let’s remember the past.

So you as an investor don’t get caught out this time.

Kind regards,

Shae Russell Signature

Shae Russell,
Editor, The Daily Reckoning Australia