10 years on since Lehman - what is the greatest market risk now?

Mark Appleton, SA Head of Multi Asset and Strategy at Ashburton Investments.

A new paradigm of fear and uncertainty was unleashed on the world with the demise of Lehmans on the 15 September 2008. And while markets have recovered, spectacularly in some cases, a lingering symptom of the crisis could be one of today’s biggest risks to buoyant stock markets.

Landing at Beijing airport on that day to attend a Chinese banking and property conference, co-incidentally co-hosted by Lehmans, and to be greeted with news of it’s demise was traumatic. Liquidity and credit, the very lifeblood of economies, had dried up and panic reigned. The world was staring into a precipice and financial markets plunged. There was nowhere to hide. Most asset classes, and even those that normally don’t move in the same direction started to correlate - in a bad way.

What went wrong 10 years ago?

In a nutshell it was a severe under- appreciation of risk. Investors, aggressively sought high yields in a low yield environment, turned their attention to the US house mortgage market. Lenders fell over themselves to supply this demand by bundling mortgages together, securitising them (after they were given high credit ratings by credit rating agencies) and selling them to investors.

Demand for these securities continued soared with the result that lenders dropped lending standards and lent more money to more people, many of whom were unemployed and couldn’t afford to service the loan, to buy houses. Easy access to funding fuelled demand for homes and prices rose in response. There was significant moral hazard where the originators of the loans were incentivised by profit but without being constrained by risk as this was simply being sold off to other investors. These securities found their way into money market funds, pension funds, insurers, you name it.

It was a house of cards. When defaults naturally started, investor appetite diminished. Lenders pulled back and house prices started to fall. This damaged collateral values and non- performing loans started to pile up. The Credit Default Swap market where defaults were insured proved to be an added complication in the crisis with insurers not having adequate capital to back them up. Bank capital was decimated. Lending came to a standstill.

Fortunately, synchronised action from global central banks and governments in providing spending and massive liquidity injections saved the day.

Since those panicked times, economies recovered and global equity markets have done well with the S&P 500 up over an impressive 11% per annum over the past decade.

Other markets, while not quite so buoyant, have also performed reasonably well with the FTSE 250 up over 8% per annum, the Dax (Germany) and the Topix ( Japan) up over 5% per annum - all in US Dollar terms. Regulation and transparency has also improved and banks have undergone stress tests to see whether they are adequately capitalised.

What lessons learned?

Firstly have a healthy appreciation for risk and price it accordingly. Secondly know where your money is going and know the what assets underpin your investments. Also, appreciate how interconnected the world has become.

What risks still lurk out there?

Ironically it is the exceptionally low level of interest rates themselves (courtesy of the Global Financial Crisis) that poses perhaps the greatest challenge. Lifting interest rates off this very low base together with still relatively high levels of debt could cause problems.