The filing for Chapter 11 bankruptcy protection by Lehman Brothers on September 15, 2008, sent shockwaves that reverberated around the world. The investment bank had become so deeply involved in mortgage origination that it had effectively become a real estate hedge fund. So, when the subprime mortgage crisis hit home, Lehman turned turtle.
Many of you would remember Lehman’s bankruptcy news triggered a one-day drop in the Dow Jones Industrial Average of 4.5%, the largest decline in the benchmark since the September 2001 attacks. As we leave a decade, marked by economic uncertainties, it may be time to get some lessons from Lehman Brothers’ bankruptcy. These learnings are to do with your personal finance. Read on.
1. Forgetting your core – Lehman was one of the first Wall Street firms to move into the business of mortgage origination. Soon, Lehman had morphed into a real estate hedge fund, which was far from its core business of investment bank. As it happened, Lehman forgot its bread and butter business. Often, investors do the same. In the mad rush for returns or safety, they take their eyes off their goals. All personal finance journeys have a destination. No matter what you do, never forget why you started investing. Stick to your goal. Always.
2. Overleveraged, too little liquidity – By 2008, Lehman had assets of over $650 billion. However, this was supported by only $22 billion of firm capital. Just think about it: so little capital! Purely from an equity position, Lehman’s risky commercial real estate holdings were thirty times greater than its capital. In such a highly leveraged structure, a small decline in real estate values would wipe away all its capital. Something similar happened. This tells us that we should not take too much debt in form of assets. Debt is not an asset. Also, keep requisite liquid money with you if you take loans. Your debt position should never be more than 5-6 years of annual income.
3. Don’t panic when markets tremble – When Lehman Brothers news was out, the Sensex crashed by 3.5% on a single day. Over the next fortnight, Indian markets corrected another 7%. Subsequently, in the next seven days, markets dropped by 7% more. The story became scary. Investors were selling equities lock, stock, and barrel. Domestic-oriented businesses were looked at with the same suspicion as exporter companies. A high-quality company with rock-solid finances was given the same valuation as a poorly run debt-laden enterprise. In essence, the market had too many mispricing opportunities. When smart and nimble investors realized the same, they started building positions. This is why after dropping 52% in 2008, markets staged a biblical comeback: up 81% in 2009. The rest is history. This tells us that panicking does not help. Be calm in the face of adversity, and you will be rewarded.