Sunday, September 15, 2013

A day to remember

Today marks a very dark anniversary in the history of the financial markets and I would submit to my readers a very dark day in world history.  Most people don't realize that the planet sat on the precipice of financial Armageddon on Monday, September 15, 2008, when Lehman Brothers filed for Chapter 11 bankruptcy protection.  The chart below serves to place that event in the context of the market history of that time:

(click on chart for larger image)

The market received its "shot across the bow" when Bear Stearns, a highly leveraged player in the mortgage backed securities business, went out of business in March, 2008.

By September, the pressure on Lehman Brothers had become financially unbearable.  And, upon the bankruptcy filing, the prospect of Lehman's $4.3 billion in mortgage securities being liquidated sparked a sell off in the commercial mortgage backed securities market that started a chain reaction where hedge funds had to delever and money markets literally stopped answering phone calls from frantic investors scurrying to redeem their shares.  The panic quickly spread around the globe and the credit system essentially froze as a result.  The Dow Jones closed down just over 500 points (−4.4%) on September 15, 2008. This drop was subsequently exceeded by an even larger −7.0% plunge on September 29, 2008.

Lehman's collapse froze short-term money markets, making normal finance impossible. A run on money-market funds began when the Reserve Primary Fund, an industry pioneer, said it could no longer maintain the $1.00 net asset value that all money market funds traditionally maintain.  This was due to losses on Lehman paper.  Goldman Sachs and Morgan Stanley were about to fail because hedge funds and other prime brokerage customers began pulling their cash out in response to prime brokerage assets at Lehman's London branch being frozen.

Unlike the Bear Stearns episode, the Fed and the government initially stepped aside when Lehman came to them for assistance.  No doubt, they were testing the waters to see what might happen.  But as the crisis quickly unfolded, the prospect that Goldman Sachs and Morgan Stanley might collapse quickly awakened sane minds with the realization that a scenario was developing that would have made the 1929 market crash and Credit Anstalt's failure in 1931 seem like a picnic.

The federal government (including the Fed) had to eventually front trillions of dollars and guarantee more than $14 trillion to stop the panic.

I know some of my readers believe that there should have been no intervention; that we should have let the free market sort it all out.  And honestly, no one can accurately estimate the outcome of such a scenario.  But I don't think anyone can deny that Morgan Stanley and Goldman Sachs defaulting would not have had the most catastrophic effects on the global financial and political system.

I often say to others that if the government and Fed had not stepped in during those dark days we all would have been asking our wives that first winter which pieces of furniture they liked the least so we could burn them to heat our homes.  And maybe that statement is hyperbole.  But maybe it isn't.  I've laid out the historical facts.  You decide ...