The following is an archive of a series of 5 notes Keith shared with clients during the month of September 2018 reflecting back on the Financial Crisis, and specifically, the Month of September 2008 ten years after. These notes are inspired by and excerpts from a journal that Keith began during 2008, and has continued to this day. These notes concluded with the “Lessons From the Financial Crisis”, which is posted separately on The Exchange.
Part 1:
September 2008 was the most significant month in my career and is comparable only to October 1929 as one of the most pivotal months in the entire history of the capital markets. It was not the beginning or the end of the financial crisis but the crescendo of excesses in the financial markets quietly building for years, if not decades.
During that period of time, I began to journal my thoughts, in an effort to help me remember what was happening during that incredible historic period of time. My hope is to learn from the past so as to help guide our clients more effectively in the future. I hope this multi part series captured through my journal will captivate and perhaps even educate you as to the historical significance of the financial crisis now known as the “Great Recession”.
The story really began quietly in the late summer of 2007. The credit markets really began to break down and was the early precursor to the events of September 2008. August of 2007 brought tremors through the normally quiet tax-free municipal bond markets. I can remember as a firm we were scratching our heads as to why there was such an uncharacteristically negative move in this conservative asset class. The equity markets were still increasing and did not peak until October of 2007. Yet, behind the headlines of the day, the “shadowy” but LARGE world of the derivatives market and subprime mortgage markets were beginning to crack. Looking back, these were clearly the early tremors of the coming “earthquake” that would shake the U.S. financial markets to their very core.
History would provide a short respite, or the “calm before the storm” between late summer of 2007 until the first couple weeks of 2008. This proved to be the worst 2 weeks of the new year for the equity markets since the 1930’s. The equity markets were now sending a clear signal there was a category 5 Hurricane brewing in the near future.
February 13, 2008, is a day I will never forget. This is the date the financial crisis “hit home” for our firm. Auction Rate Preferred securities, historically a very low risk asset froze virtually overnight. Some $350 Billion dollars industry wide was completely frozen, as the lack of liquidity in the financial markets started to hit “Main Street” investors. I wrote in my journal a recap of a call to my wife, “We have a significant problem with one of our investments”, I remarked, and “I have no idea when I will be home.” Soon after, March 16, 2008, one of the oldest and largest investment banks in the world, Bear Stearns, was acquired by JP Morgan under the direction of the Federal Reserve for a mere $2 per share, effectively wiping out the historic company.
September 6, 2008, exactly 10 years ago from the date this article is written, is the day the U.S. government seized Fannie Mae and Freddie Mac. These were both publicly traded companies formed by an Act of Congress (1938 for Fannie Mae and 1970 for Freddie Mac), and the result was two government sponsored entities with the implicit backing of the U.S. Government. These two large corporations backed as much as $5 trillion dollars of mortgages and with the ongoing meltdown in the real estate markets underway Fannie and Freddie went into “conservatorship” in September. The equity holders, both common and preferred shares were effectively wiped out. This had ripple effects through many small to mid-size banks as they had significant capital exposed to these preferred equity assets. By September 6, things had come completely and totally off the rails. Ultimately, the realization that these investments were not safe, meant a whole lot of things were not as safe as we thought, and this chain reaction would move quickly. Markets opened Monday September 8, and commercial paper, money markets and the safest of the safe was now at risk. The month I will never forget was just beginning and nothing was going to slow down the chaos and panic to unfold in the next several weeks of September 2008.
This is the first of a series of articles attempting to chronicle the “Financial Crisis”, stay tuned.
Part 2:
As mentioned in Part 1, Bear Stearns collapsed back on March 16, 2018. Not long after this occurred, rumors began to swirl that Lehman Brothers may also not survive. This was seemingly impossible to imagine as the firm had grown into a global financial powerhouse since its humble beginnings in Montgomery, Alabama in 1844. Lehman had successfully navigated many challenges over the years—railroad bankruptcies in the 1800’s, the Great Depression of the 1930’s and two world wars just to name a few. However, the collapse of the U.S. housing markets and their headfirst dive into the pool of subprime mortgages proved to be the death blow.
Sunday night, September 14, 2008, was not a normal Sunday. I generally go to church every Sunday morning and our family has dinner Sunday night. But this Sunday was different, after church I was glued to the financial networks as the reports of Lehman’s Bankruptcy seemed now imminent and the next morning, September 15, Lehman Brothers filed for bankruptcy (the largest bankruptcy in U.S. history).
The dominoes were beginning to fall in earnest and the “Financial Crisis” was already looking for its next victim. The financial markets were in a seemingly endless liquidity crisis.
As “luck would have it” I flew to Washington DC the evening of September 17, to meet with Adam Putnam and attend the Congressional Hearing on “auction rate securities” the next day. At the time he was one of the highest-ranking Republicans in the U.S. House of Representatives and was on the financial services committee that was leading a Congressional Hearing on the “Auction Rate Securities” crisis (referenced in part one). I arrived at his office early on the morning of September 18, with an appointment to discuss this issue face to face with him. The minutes turned into over an hour and he never arrived at his office. Adam’s staff let me know, he was tied up on another issue and he would meet me at the lunch recess for the hearing. He never arrived at the hearing which was chaired at that time by Barney Frank (a blast from the past). I was somewhere between disappointed and angry that we had not been able to get our schedules to work out. At lunch, I received a call from his office, I was told he would meet me in the U.S. Capital after the hearing and I would have only 5 minutes to speak with him. Finally, Adam walks down the capital hallway with several staffers corralling him towards me. I needed at least an hour to describe to him the dilemma for our clients and I had ONLY 5 minutes!!! For the first 4 minutes, I quickly describe our situation, but he was clearly not listening and completely distracted. As we were rapidly concluding the short 5-minute discussion, I asked him, “Adam, what is going on?” His answer is forever seared in my memory, “Keith, it’s bad, REAL bad!” and with that he was whisked off to another meeting and I was left to head to the airport to travel home.
What was happening that day was the Reserve Fund, a large money market had “broken the buck” and the value had fallen below the $1 price for a money market fund (virtually unthinkable previously). Money markets were widely considered one the of the safest places for an investor to hold dollars but now the crisis had claimed its next victim. Money market funds of all things……. Adam was part of the decision process with President George W. Bush, Treasury Secretary Hank Paulson, Tim Geithner and others to “guarantee” money markets. They feared a “run on the banks” like the 1930’s that could create extreme havoc throughout all facets of the financial world. The next day, September 19, 2008, the U.S. Treasury announced the establishment of a temporary guarantee program to protect shareholders of money market mutual funds with a goal to “calm down” down investors that would ultimately be in place for 1 full year. The Lehman bankruptcy was accelerating the downward spiral and in just a few days new victims would appear.
Of the 10 largest bankruptcies in U.S. history, six of them occurred in either 2008 or 2009. More bailouts and bankruptcies and government takeovers were soon to follow the Lehman collapse. Those days were long and burdensome as a financial advisor/planner, but lessons were beginning to emerge even though they were hard to see at the time.
This is the second of a series of articles attempting to chronicle the “Financial Crisis”, stay tuned.
Part 3:
he week of September 14 – 20, was a “week to forget”, yet I will never forget. From part 2, you will remember, Lehman Brothers was in bankruptcy talks the evening of Sept. 14th and would ultimately file the next morning. The very same day, the venerable firm, Merrill Lynch, was purchased by Bank of America for a fraction of the all-time high price. The controversy has remained over the years as to why the Federal Reserve let Lehman fail and saved or helped to save others as the crisis continued.
Merrill Lynch was referred to as “Mother Merrill” by our industry for decades and had created many of the trends on Wall Street, some good and some not so good. But this day, even Merrill Lynch was collapsing under the weight of the leverage created during thesubprime mortgage and housing collapse. The Fed clearly helped induce the transaction between Bank of America and Merrill this day to help stave off a continued contagion that would just not be stopped. The thought of the markets absorbing a bankrupt Lehman and Merrill on the same day could have been disastrous not only for the markets but the entire economy. The transaction between the two generated intense regulatory scrutiny and a deal Bank of America vehemently tried to get out of without success. Two iconic brands eliminated in one day and it is just Monday!!
September 16, the “bailout” of AIG begins. After the close of the markets that day, The Federal Reserve announced they would “loan” (or government bailout some would say) a much needed $85 Billion dollars to the failing AIG. A global insurance brand founded in the early 20th century. The story around AIG is fairly complicated due to the “Credit Default Swaps” they had reaped profits from the past decade or so but now these “weapons of mass financial destruction” as Warren Buffett called them, were creating massive risk to the entire global financial system and this is when the U.S. Government began to see a very bad ending if AIG would collapse. This put many large institutions at risk: Goldman Sachs, Morgan Stanley, Barclays and many others. On a side note, I read a book years after the crisis called, “Good For The Money—My fight to pay back America” by Robert Benmosche. He retired as the successful CEO of MetLife Insurance and came out of retirement to lead AIG’s plan to pay back the entire loan from the government which they accomplished, and the US taxpayer made a return on the original $85 Billion-dollar bailout.
As mentioned in part 2, I was in Washington D.C. over the two-day period of September 17 and 18, 2008 and these 2 days are perhaps the most critical days for the global financial system since March of 1932 when Franklin Delano Roosevelt closed the banking system for a week to begin to restore confidence to the failing banking system during the Great Depression. This is what the Federal Reserve was trying to do during this week, somehow begin to restore the confidence of the system. The actions they took would prove to be instrumental in keeping the system “afloat”. However, if the financial system were to be described as a hospital patient, the patient was on “life support” and more intervention would still be needed in the months ahead……..stay tuned!
Part 4:
All of us have at one time or another had a loved one in the intensive care unit or on life support or both. It is unsettling to say the least. All of us differ as to what gets us through these periods. But one thing is sure for all of us, it is day to day or even a moment by moment experience, not knowing what the next 24 hours may bring. This is the only analogy that comes to mind to accurately describe the condition of the global financial system for this bizarre crisis.
The week of September 15, 2008 was the week “we peaked over the edge of the abyss” and extraordinary measures were going to be needed. The evidence was mounting as chronicled in the first 3 parts of this series and part 4 will bring more drama.
By mid-day, September 17, 2008 on the heels of Lehman Brothers bankruptcy, AIG emergency bailout and the Merrill Lynch saving moment, the discussions now turned towards Morgan Stanley and Goldman Sachs. Morgan Stanley stock was down nearly 25% for the day and Goldman was down nearly 15% as well. Discussions fervently involved survival for these two other storied financial firms. Both institutions were being hit by “short selling”. A process implemented by investors who believe a stock will decline in value. Short selling was a large part of the crisis and ultimately the SEC would issue a temporary ban on short sales of certain financial companies. Both companies survived in part by a timely sale of 20% of the company to Mitsubishi for Morgan Stanley and an infusion of capital by Warren Buffet’s Berkshire Hathaway for Goldman Sachs. The Federal Reserve was fully engaged in this process being led by Ben Bernanke at that time. He was a student of the Great Depression and in my opinion, our nation was extremely fortunate to have his educated leadership through this historic period. He and his team would ultimately roll out the proverbial “alphabet soup” of possible fixes to this extreme time. Remember the T.A.R.P. (Troubled Asset Relief Protection) and T.A.L.F. (Term Asset-backed Securities Loan Facility) just to name a couple. Mr. Bernanke knew history and it was his vision and courage that allowed our nation to “pull out all the stops” to avoid perhaps the second version of a Great Depression. Congress was weighing a $700 Billion bailout to keep us from collapse, it would cause much confusion and political wrangling but ultimately would pass Congress and begin the healing.
The crisis was still far from over, but the commitment made this week in history by Ben Bernanke, Hank Paulson, Tim Geithner and George W. Bush would prove to be the necessary life support the victim needed to make it through. Ultimately, the free market began to work, and the life support measures faded in necessity.
The week of October 6, 2008 was another emotional roller coaster and the crisis was once again striking “Main Street” and not just “Wall Street”. The stock market sold off hard all week and our firm and team were taking calls by the second. We could hardly take a breather to just grab a drink of water. My journal entries were most plentiful this week due in part to this volatile market sell off and the last day of the week, Oct. 10, 2008, was my 39th birthday. Our team was GLUED to our phones, making as many calls and call backs as humanly possible. Ginny Houghton, my now long-term partner, made me take a break at lunch and eat a burger in our conference room around 1 pm that day and they placed a candle in the bun and sang “Happy Birthday!” I will always remember their kindness. Additionally, my role of President of our firm at that time, added to the burden as our leadership team was spending every free moment working to keep all our employees energized as the days sometimes felt like months. By weeks’ end, the market had fallen 1,874 points or 18% which proved to be the worst weekly decline ever on both a point and percentage basis and was the culmination of 8 straight down days whereby the market had declined fully 22%. From the highs a little over one year earlier the S & P 500 had declined 43% as well. I must humbly admit, I was wondering if I was “cut out” for this business by the end of this week.
Investors were at wits end and in complete capitulation mode. Scores of financial advisors were leaving the business, but the COMMITMENT the Federal Reserve was making and ultimately Congress would join in, would provide confidence and the medicine needed to get the patient off life support in the months ahead. Once again……. the crisis was still in full swing, but it is always darkest before the dawn…..in the next part we will see the most crucial final turning point (in my opinion) and will conclude with the final part of this series —-the lessons learned (the ultimate reason for this series).
Part 5:
Under Ben Bernanke, the Federal Reserve made the commitment to pull out all the stops to stabilize the system as discussed in Part 4. Some of the decisions helped and some did not, but they were determined to get the economy out of the “critical care unit”.
The title of the series is, “The Month I will never forget”, which we now find ourselves in the late part of September. Major Wall Street firms were crumbling seemingly overnight, but “Main Street” had yet to feel the brunt of the hurricane we were experiencing. This was all about to change. The largest bank would fail on September 26, Washington Mutual then Wachovia Bank on Oct. 3 and before the entire crisis period ended, approximately 450 banks would fail (according to the USA Today). The Dow Jones would fall 58% by March of 2009, unemployment would peak at nearly 10%, the average home price fell by 33% and roughly 7 million Americans lost their homes (according to Credit.com article 4/24/15). On a side note, Bernard Madoff was arrested in December of 2008 and charged with the largest Ponzi scheme in history and he still remains in jail. The month I will never forget came to be known as “The Great Recession” which arguably started in the summer of 2007 and ended in March of 2009. Ralph Allen, my long-time mentor, business partner and friend has told me many times, “They don’t ring a bell at the top or the bottom of the market!” This period of time was a perfect example. NO ONE, I repeat NO ONE, knew in March of 2009 we were at the end, but history shows that was the turning point. What Happened????
An obscure accounting change was made in November 2007. This rule is helpful for investors to know the “fair value” of the assets of an institution on any given day. The assets must be priced at fair value or “marked to market”. This is quite technical. In normal conditions, it is a very understandable practice, but in a crisis, it does not work properly since asset values could be temporarily as low as zero. The accounting rule, “Mark to Market” (MTM for short) had caused trouble in the past, and as historians will tell us, “if you don’t study history, you are doomed to repeat it.” FDR outlawed mark to market accounting in 1938, which had been the law of the land for much of the Great Depression. Brian Wesbury writes of this in his book, “It’s Not as Bad as You Think”, where he describes after 1938 we experienced no crisis or threats of depression, yet after Nov. 2007 and the reinstatement, we had a crisis on our hands.
For the past 30 years, Allen & Company has hosted The Lakeland Chamber of Commerce Annual Economic Forecast Breakfast every January. Brian Wesbury was giving the national forecast to approximately 600 people on a cold January 2008 morning and he was beginning to describe this particular issue around MTM accounting. He stated he did not know if or when, the Mark to Market regulation would change, but he did know that Ben Bernanke and Tim Geithner knew of the damage it was causing and suspected they would make a change “sooner rather than later”. In March of 2009, the Financial Accounting Standards Board (FASB) proposed new rules to ease the burden financial institutions valued their assets and in early April the new rules were adopted.
History now shows the following: the stock market bottomed in mid-March 2009, the Great Recession ended by mid-year 2009, our country had no financial crisis between 1938 and 2007 without mark to market accounting rules in effect, and we began to heal in March of 2009. Some may want to call it a coincidence, and it certainly does not get any press from the media and politicians in our government but this simple, yet profound change made the most significant difference in the recovery. It was not Government intervention, but LESS intervention and the capital markets began the healing process.
Now, I must get back to my day job of guiding our clients along their financial journeys. However, this series of articles was my feeble attempt at a historical look through my eyes and my journal. Hope you have enjoyed reading even half as much as I have enjoyed writing. My last and FINAL article will be the joint work of my team to present to you…….LESSONS LEARNED…….
October 2018
**Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly. No strategy assures a profit or protects against loss. Investing involves risk including loss of principal.**
