Lessons from Lehmans

by Ed Bowsher on 14 September 2009  |  0 comments
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It's a year since Lehman Brothers collapsed....

 I'll never forget the day that Lehmans collapsed. At the time I was Editor of The Motley Fool in the UK and the next couple of weeks were the most challenging of my professional life.

But I couldn't truly enjoy the challenge. The fear factor put paid to that....

Anyway, one year on, I thought I'd write jot down a few lessons from the crisis. This is not a comprehensive list:

1.       Don't ignore Libor

I was aware of Libor prior to September 2008 but it wasn't something I watched closely. That all changed a year ago.

Libor measures the rates banks are charging each other when they lend between themselves. Normally, the banks are happy to lend to each other at a rate somewhere close to the Bank of England's base rate so you'd expect to see a close relationship between Libor and the base rate.

But that relationship completely broke down last year as banks became very reluctant to lend to each other. (They were worried that the borrower bank might go bust and not be able to repay the interbank loan.) At times the difference between the two rates was as much as 1.3%.

3-month sterling Libor has now fallen to 0.63%, not much higher than the base rate at 0.5%. That's the kind of difference you might expect in normal times, so that's an encouraging sign.

2.       If something looks too good to be true, it's too good to be true

Two words: Bernie Madoff

3.       When Neil Woodford or Anthony Bolton say something, listen

These two are probably the UK's top fund managers of the last 20 years.

Back in late 2007, Woodford said he wasn't investing in bank shares at all. This was in spite of the fact that Woodford likes to buy shares that are paying higher than average dividends which the UK banks were doing at that time. Woodford, however, was canny enough to realise that the banks' balance sheets were a mess and best avoided.

Last October, Anthony Bolton said it was a good time to buy UK shares, and share prices have risen by more than 20% since then.

4.       Derivatives are dangerous

I watched a documentary on Channel Four in the early noughties that said derivatives were dangerous, and I confess I didn't really believe it. I know I was wrong now.

It's the derivatives that allowed banks and investors to borrow so massively. That over-borrowing was a primary cause of the crisis.

Things I got right, one thing I got wrong

Whilst researching this post, I looked at some of the articles I wrote at the height of the crisis. It was interesting to see what I got right and what I got wrong.

I made one big mistake. I supported Hank Paulson's decision to let Lehman Brothers go to the wall. I cringe when I look at the headline: Lehman collapse was right move.

I argued that bankers needed to learn that they wouldn't always be bailed out by governments. That was a reasonable argument, but the scale of the carnage was too large a price to pay for teaching that lesson to bankers. (And anyway, did they really learn it? All the other banks were bailed out, so it's pretty much inevitable that banks will start taking stupid risks again at some point.)

But I got some things right too:

• On the day Lehmans collapsed I said: Don't Panic!' We'll get through this crisis in the end. If you can focus on the long term, now is probably a good time to drip money into the stock market.

That was good advice, and the majority of people have come through relatively unscathed by it all.

• In the same article, I said that the one area of the stock market I'd avoid was banks. That was pretty good advice as even now Royal Bank of Scotland is trading at 54p whereas back then it was at 212p. That said, Barclays is now slightly higher than on September 15th, 2008. Of course, Barclays has turned out to be a big winner from the financial crisis as it was able to pick Lehman Brothers' US investment banking business at an ultra-low price.

• A couple of weeks later, I said it was a good time to switch your savings into a fixed rate bond. Back then you could get 7% on a one-year bond. That proved to be an excellent deal as savings rates tumbled over the last year. These days, the best one-year bonds are paying little more than 3%.

So have you learned much from the last year? Let me know in the comments box below.....