Remembering Lehman Brothers: What Have We Learned?

Five years ago, at the five-year anniversary weekend remembering the collapse of Lehman Brothers, I wasn’t ready to deal with the bad memories of that terrible time.

Granted, what happened 10-years ago in financial markets was not like being in a war, a natural disaster, sick with a terrible disease or the victim of a terrible crime, but it was still upsetting to me (no doubt because I live in a cloistered bubble, outside of the real world, for which I am thankful).

Now, though, 10-years after the fact, I am ready to talk about it. I’ve read a lot of coverage recently about what we as a nation have or haven’t learned and I don’t have a lot to add here, except that borrowing too much and blowing up is part of the human condition – we’ll never learn (here’s a sobering look at debt today).

Rather than opine about all of humanity, I can tell you what we learned at Acropolis:

  1. Our buy-and-hold strategy works if you keep holding. We had no idea where the bottom would be, and, in fact, we won’t ‘celebrate’ that anniversary for another six months. Tried as we might to get people to stick with their portfolio, some people bailed out, and their returns suffered because they didn’t get back in quickly enough.
  2. Take the right amount of risk to meet your goals. I’m not aware of any clients that had to drastically change their lifestyle following the crisis. I know that some people changed during the crisis, which was a smart response, but they switched back within a relatively short period. I’m not aware of anyone who had to change their lifestyle permanently.
  3. Stocks are very risky. We didn’t even get the full lesson in 2008; it was just a reminder. The entire lesson came in the Great Depression when stocks lost 90 percent. In the 2008 crisis (which includes the end of 2007 and the beginning of 2009), we ‘only’ lost 55 percent. Stocks have enjoyed great returns despite these incredible drawdowns, but be careful!
  4. The right kind of bonds are safe. The Barclays Aggregate (then known as the Lehman Aggregate by the way), made five percent in 2008. The index is about 25 percent corporate/credit, and the rest is government in some form or fashion. You earn less yield with the government bonds, but when the bad times come, you generally make a positive return, which is often untrue with the higher yielding bonds.
  5. Preferred Stocks are more like stocks than bonds (maybe we should have known based on their name). We owned preferred stocks for a bunch for financial institutions, including Lehman Brothers and Bear Stearns. Fortunately, we sold almost all of them before the collapse of either one.

    Sadly, though, we owned the preferred stocks of Fannie Mae and Freddie Mac since we didn’t think the government would let them fail. The anniversary of their failure was three months ago, and I didn’t celebrate that one either.

    There are two big lessons learned here. First, keep the safe side of the portfolio safe. If we had considered preferred stocks part of the stock portfolio, it wouldn’t have been so bad, but the message that the bonds were failing alongside the stocks was tough to deliver. It would have been hard either way, but if I had to choose, I would do it differently.

    Second, there’s not much diversification with related entities. We should have figured that if Fannie went, so would Freddie. In retrospect, I can say that we had too much of each one of them independently, but we really had too much if you think of them jointly. We were well within all of the regulatory and our own self-imposed rules, but, in hindsight, I think we should have analyzed this differently.

All-in-all, we got far more right than we got wrong. Our relatively plain-vanilla and conservative approach meant that we all got through the crisis. Just as importantly, we also collectively reaped the benefits of the stock market bonanza that followed. Owning cash for the last 30-years felt good in 2008, but was a costly choice most of the time.

There is one lesson that I’m nervous we’ve learned, but shouldn’t have, which that stocks always recover quickly. After the S&P 500 bottomed in 2009, it was only four years before it was made new highs again in 2013.

To put that in perspective, the S&P 500 didn’t recover from the Great Depression until World War II, the MSCI EAFE index of developed stocks just got back to new highs at the end of last year from the 2008 crisis, and the Japanese are still a ways away from getting back to the 1989 high. Four years is quick.

Thinking about where we’ll be 10-years from now, I’m willing to bet that we’ll have gone through another bear market, though probably not like the 2008 financial crisis. I’m also willing to bet that the principles that I laid about above will get us all through the next one as well. ┬áIt won’t be Lehman, but it will be something – it’s part of the human condition.