'A period of fear and greed' - The Lehman crash remembered

It's the end of a giant as Lehman memorabilia goes up for auction in London. Photo / Getty Images

"It was a frightening time ... a period of fear and greed," says Rickey Ward, NZ equity manager at JBWere.

Unlike the 1987 crash, which hit out of the blue, the global financial crisis began more like a slow motion train wreck.

But that changed on September 15, 2008 when the Lehman Brothers bank collapsed and panic set in around the world.

Ward – then working with Tyndall Investments - was one of a handful of local fund managers who had been feeling uneasy about the market's bullishness and the heady valuations of some companies.

"I recall struggling to justify company valuations," he says. "Ironically, a similar story to what many see today."

The credit crisis that blew up in mid-2007 launched the New Zealand market on a two-year roller-coaster ride. From a peak in May 2007, it suffered a significant correction as the ramifications of rising credit risk sank in.

But by October 2007 the NZX50 index had recovered all the lost ground as investors bet, optimistically, that the crisis would be contained.

It wasn't.

In the US, the property market was tanking and it took with it a whole new class of investments – collateralised debt obligations (CDOs) - derivatives sold off the back of bundles of low grade - "subprime" - mortgage debt.

Ward made an early call to take a defensive stance.

"I suffered a period of significant underperformance (due to selling shares and holding cash), so much so that clients kept questioning my stance," he says.

"It wasn't pleasant and second guessing became part of daily life, well up until all hell broke loose in 2008."

It broke loose alright. On the weekend of September 13 and 14, 2008 Lehman Brothers, the fourth biggest investment bank on Wall St, with assets of US$640 billion, waved the white flag.

Sunk by its over-enthusiasm for those complex subprime mortgage-backed derivatives and a failure to recognise the scale of the property slump, it called on the US Government to bail it out.

After a series of high powered crisis meetings, Lehman's fate was sealed.

Despite having bailed out rival Wall St bank Bear Stearns in March, the US Administration decided to draw a line.

The bankruptcy of Lehman Brothers – still the largest in history - was announced ahead of US markets opening on September 15.

"It [Lehman] was the moment most people realised we had a crisis on our hands," says Sir Michael Cullen, who was Finance Minister at the time. "But we'd been aware of that for some time. It had been building and there had been various events going on in various places that made it clear that there was a high probability of a financial crisis."

After Lehman there was a sense that all bets were off.

"If one systemic bank goes, the chances are it's going to flow on because they're all so interconnected in the way they structure their borrowings," Cullen says.

"It was a question of who went down first and what was going to be the reaction from the major national and international institutions.

"The IMF, the US Fed and so on: what would their response be? I think looking back, we were pretty staggered by the scale of the response that eventually happened."

That response – largely from central banks - saw interest rates slashed to near zero in most major economies.

Using a trick called "quantitative easing", but colloquially dubbed printing money, more than US$15 trillion has been injected into the global financial system since 2008.

The cure for the crisis has itself changed the course of history.

Low interest rates fuelled property bubbles and an equity market boom that is still running strong. Debt levels have ballooned - topping US$250 trillion globally this year .

Social inequalities grew as people with capital took advantage of new opportunities.

Those without were condemned to watch housing costs rocket while wages stagnated.

The case has been made that the subsequent public disillusion drove political upheaval in the US and Britain in 2016.

Ten years on, we are only now dealing with the risks associated with a return to normal central bank settings.

Still, it's important to remember just how dire things were in the days after Lehman and why drastic action was required.

Liquidity dried up overnight as trust and confidence deserted the market.

Even in Australia and New Zealand – where banks had largely steered clear of the derivatives causing the crisis – our governments were forced to guarantee retail bank deposits to ensure stability.

When insurance giant AIG collapsed just a day after Lehman, it became clear that the financial wheels that drive everyday life were seizing up.

For example, without AIG's insurance planes would not fly, trucks would not deliver.

The US Federal Reserve had no choice but to step in with a $US85b bailout for the insurance giant.

While local banks were robust, it was still a hair-raising time for anyone in the thick of a business transaction.

In Auckland, Andrew Kelleher – who had been watching events unfold in an equities role for ASB – was in the middle of buying into wealth manager JMI (now JMIS).

"We had been concerned about the CDOs and collateralised instruments for quite some time and we'd taken them off the approved list at ASB," Kelleher says.

"So we were already getting worried," he says. "That being said, that weekend – when liquidity disappeared – it really did take everyone by surprise and I don't think we realised until months after just how critical that liquidity issue had become."

Kelleher recalls the trepidation he felt after Lehman, having made the decision to buy into a wealth management business and seeing "how bad the macro environment for those businesses had become."

But he was also faced with a more immediate problem.

"I did require some funding and the attitude to the financiers towards buying into wealth management changed - rapidly, shall we say."

"We went from looking at a relatively straightforward funding exercise to buy into a wealth management business, to one that involved us being hit with 17-and-a-half per cent interest rates."

Ward also recalls the way sentiment turned after Lehman.

"Apart from the collapse in share prices and utter fear that wafted in the air, it was the change in corporate behaviour towards investors," he says. "Initially, information was difficult to obtain but eventually behind-closed-door meetings were commonplace. Investment bankers were all vying for a deal for various companies in desperate need of capital."

Thankfully, cooler heads ultimately prevailed in New Zealand compared to some other markets, Kelleher says.

"Generally, I don't think there was the kind of fear and panic that you would associate with something like 1987 when it was a lot more raw and immediate."

The NZX had the dubious honour of being the first major exchange to open after Lehman's collapse.

On Monday the 15th in New Zealand (still Sunday the 14th in the US) the local market dropped 2.77 per cent.

It was a moderate fall compared to the 15 per cent crash on October 20, 1987.

But there was more damage to come. By the end of the week the local market had lost 6.8 per cent. By the end of the year, 18 per cent.

In total, across 17 months from a peak in October 2007 to a low in March 2009, the NZX50 shed 44 per cent.

"The difference between 1987 and 2008 is that '87 was the purest point of non- intervention," says Cullen, referring to the hands-off economic policies of the 1980s.

"But also government debt-to-GDP ratios were much bigger then than they'd become by 2008. New Zealand, and Australia even more, were in a much better position to weather it."

As to how we are placed now, Cullen does see risks on the horizon.

"The big central banks have got enormous amounts of assets on the books, you've got enormous indebtedness," he says. "It's an open question whether the central banks have the capacity to do the same trick they did post-GFC.

"I don't think you can claim we're really back to normal."

Doug Pearce, now a director of the NZ Super Fund, was chief executive of British Columbia Investment Management in 2008 - managing US$75b in assets.

In a long career in investment, he has dealt with the high inflation era of the 1970s, the 1987 crash, the Asian crisis of 1997, the tech wreck in 2000 and the GFC.

He believes we may be better placed to avoid a systemic failure now, but that we will inevitably see another correction.

"One of things you have to look at is the length of the bull market and the valuations. Pretty well across the board, it seems high, it seems fully priced," he says.

"I think there'll be a correction again at some point - hopefully not a crash."

Some progress was made to improve the system, he says.

"The banks are in much better shape, the regulation has improved, the stress testing has improved."

But debt remains a concern, he says.

"I believe debt levels are excessive. There are storm clouds out there for sure.

"It's just human nature that we forget things."

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