The 2008 Global Financial Crisis; Was it caused by some Dick [Fuld]?!

In 2008 the world saw its largest economic depression since world war II, with an estimated figure of $700bn lost from the three largest stock exchanges.

So who is to blame?

After watching the “Love of money: the bank that bust the world” documentary, there is a clear message that suggests the sole perpetrator of the crisis of 2008 are the banks, and in particular the Lehman Brothers. It is remarkable that Lehman went from being a bank with assets of $639bn to an insolvent wreck. It did not require much to make Lehman go up in smoke. At the end of its last financial year, it was so highly leveraged that its assets had only to fall in value by 3.6 per cent for the bank to be wiped out (Ft.com, 2016).

The management team led by Dick Fuld ignored the fundamental economic concept that you do not finance long-term investments with short-term money, and this is what led to their downfall. They had a leverage ratio of 44:1, and so when the housing bubble eventually collapsed, they were in a position of insolvency as they didn’t have enough cash to pay their debts as they fell.

 

Lehman brothers share price 2004- 2009 graph

 

 

 

 

 

 

 

 

 

 

It is evident from the historical share price graph that Lehman brother’s strategy was initially shareholder value creation but when the housing market collapsed in 2007 their strategy became value destroying for the shareholder.

Although a lot of blame was directed towards the Lehman Brother’s, there were also a number of other factors which played a role in the global financial crisis. The turner review, a report compiled by the FSA, criticises the regulatory approaches that were in place at the time of the crisis. These approaches were created based upon intellectual assumptions, mainly being the theory of efficient and rational markets. Below is a brief summary of their 4 key criticisms of the theory of stock market pricing:

• Market Efficiency doesn’t imply market rationality
• Individual rationality doesn’t ensure collective rationality
• Individual behaviour  is not entirely rational
• Empirical evidence illustrates large scale herd effects and market overshoots

 

Financial Times,. (2016). ‘Lehman Brothers: A crisis of value’ by Oonagh McDonald - FT.com. Retrieved 19 February 2016, from http://www.ft.com/cms/s/0/d6099910-b3c2-11e5-b147-e5e5bba42e51.html?ftcamp=engage/capi/widget/client/openft/b2b#axzz40dQ6XZ4m