September 2018 marked the 10th anniversary of the collapse of Lehman and the beginning of the crisis that it heralded. At the time I was managing an investment fund focussed on the global financials sector, and together with my colleagues, we were in the thick of it.
Back in 2006 we had identified that something was not right in the US mortgage market. A worrying trend had emerged whereby new mortgage borrowers were defaulting within months of buying their new homes. Why anyone would do that puzzled us, yet for subprime mortgage lenders it appeared to be just a mild inconvenience. At an industry conference in Florida in November we witnessed executives of these mortgage lenders revelling in excess, confident that their boom could go on and on.
By the beginning of 2007 the cracks began to appear. New Century, a major subprime lender whose stock we had been short, warned it would not meet profit estimates. It subsequently ran out of liquidity and failed. In July two Bear Stearns hedge funds failed. After that the dominoes really began to fall. What’s more, they also fell outside of the US. Later that month German Bank IKB announced losses. It wasn’t just that subprime credit was being impaired — in May Ben Bernanke had said that subprime was contained — it was that there was a significant amount of leverage sitting behind it.
On 1 August 2007 I updated my status on Facebook: “Marc is worried that a global financial crisis is unfolding before us”.
Six weeks later the run on Northern Rock played out on international TV. This was another stock the fund was short. Discussing whether to retain the position earlier in the summer on the basis that the stock price had increasing support from its book value, a colleague remarked, “Book value is just assets minus liabilities.” The cost of Northern Rock’s liabilities ultimately overwhelmed its assets and soon it was gone.
Over the next few months we attempted to follow the money to see where weaknesses lay within the system. We met with Greg Lipmann, the Deutsche Bank trader featured in Michael Lewis’s book The Big Short (played on screen by Ryan Gosling). He didn’t bring Jenga blocks to the meeting, but he did bring a story of hidden and interlocking exposures. The crisis was emanating out from bank balance sheets, and bank balance sheets were what we studied for a living.
By 2008 things hadn’t calmed down. In March I attended a breakfast meeting with the CFO of Bear Stearns in London. Laying on a full English for all attendees, the CFO attempted to persuade us that Bear Stearns had enough cash to fund its balance sheet. A few days earlier it had rattled the market by putting out a press release stating that liquidity remained strong. It wasn’t convincing. That weekend I called off a home purchase, telling the Gloucestershire broker, “You may not have heard of Bear Stearns but by next week you will have, and its impact won’t be good”. The following week Bear Stearns was sold to JPMorgan for a fraction of its historic value.
For a while we wondered whether the lows were in. By now US banks at least were identifying their problem assets and beginning to raise fresh capital. But as quickly as they plugged holes in their balance sheets with capital, new holes emerged. Financial stocks were especially volatile in July as the market got excessively short and the news wasn’t quite bad enough — yet. A kind of truce was called in August 2008, when a veneer of calm descended as Wall Street emptied out.
And then Lehman happened. At the beginning of September I was in New York attending an industry conference hosted by none other than Lehman itself. As delegates like me scurried between meetings, our host’s balance sheet was collapsing around us. A conference call in which management unveiled its last-ditch plans for survival was broadcast around the breakfast hall. People winced.
By the following week, the financial crisis I had worried about one year earlier had become a reality. Developments that had previously been confined to my computer screen began to take shape in the real world. I remember the lurch in my stomach when I tried three different cashpoints along my local high street to find them all empty.
The fund performed well over the next few months as those banks that had taken their hits early began to recover, whilst those that had resisted the tide struggled. By now the trauma that had begun on banks’ balance sheets was spilling out into the general economy. Later it would spill into politics, which would require a completely different perspective that we were less well prepared for.
Ten years on it is natural to contemplate whether something similar could happen again. A very specific set of circumstances converged for it to happen at all back in 2007/08. Since then more people have learned to read banks’ balance sheets. Central banks and policymakers have made it a core part of their process. So something quite like it is unlikely to happen again in as unexpected a fashion. But the basic story of excess is an unchanging human one. Ten years ago my work required me to look in the right places at the right time. Next time, it will be different people looking in different places. It will pay to heed them.
Originally published at https://www.linkedin.com.