It doesn't have a catchy name like "Black Friday" and the losses during the trading session weren't historic, but Monday September 15, 2008 was the day all hope was lost in containing the Financial Crisis. It was just after midnight on the morning of the 15th that Lehman Brothers was forced to file bankruptcy, putting 26,000 employees out of work and ending 158 years of operations.
The bankruptcy had become fait accompli the prior day when the UK regulators had refused to backstop a deal for Barclays (BCS) to acquire Lehman, ending any hope for a White Knight to save the day. The U.S. government, already on the hook for Fannie Mae and Freddie Mac, had little legal authority or desire got involved further in non-government sponsored entities like Lehman.
Though CEO Dick Fuld's hubris and lack of common sense is now legendary, it wasn't entirely irrational at the time. The government had been extending similar lifelines for months.
Bear Stearns had faced related problems in March of 2008. Ultimately the government pushed for a shotgun marriage between Bear and JPMorgan (JPM). Bear was taken out for $10 a share, well below its 52-week high in the $130s but better than a wholesale liquidation. Fuld maintains to this day that he was right to hold out for more than $17.50 a share in exchange for control of the bank less than a month prior to its total collapse. According to then-Secretary of the Treasury Hank Paulson, Dick Fuld had "been in denial for a long time" over the ultimate fate of the bank, unable to accept that the company he was overseeing could be so toxic.
"The truth of the matter is the moral hazard got set up with the Bear Stearns deal several months before," says Jay Richards, the author Infiltrated: How to Stop the Insiders and Activists Who are Exploiting The Financial Crisis to Control Our Lives and Our Fortunes.Regardless of what the government should have done, it became apparent that there was no safety net beneath the teetering financial system. The U.S. was effectively making up rules as it went along as banking officials tried to plug an endless series of leaks. Once Lehman went down liquidity seized for all institutions.
A day later, on September 16th the Federal Reserve bailed out American International Group (AIG), backstopping it with $85 billion of taxpayer money in exchange for nearly 80% of AIG's equity thus sparing its CDS partners from their own collapse.
By the end of the week there was chaos. At an obvious loss of what to do the government decided to suspect the free market by banning short selling on the stocks of 799 financial institutions on September 19th. The move works for exactly one day. The Select Sector SPDR Financial ETF (XLF) closed at $22.38 on the 19th, 15% higher than where it is today.
Exactly two weeks after Lehman filed for bankruptcy, September 29th, the house rejected the Bush administration's $700 billion bailout plan, triggering a 777 point loss in the Dow. To this day it's the largest point loss in history. The following day the Dow recorded it's third largest one-day point GAIN on hopes that a different version may be passed. Over the next five months the Dow would lose more than 30% of its value, finally bottoming in early March of 2009.
When Lehman went down interbank lending simply ceased. Financial institutions knew they were holding toxic garbage on their books but there was the distinct possibility their potential trading partners were in worse shape. Lehman introduced the notion that failure was actually possible, which caused a virtual seizure in the system.
Bad laws are better than anarchy. As Richards maintains, if the government had simply let Bear Stearns, fail Dick Fuld and other bank heads wouldn't have so blithely continued levering themselves to the hilt right up until the system collapsed. To Fuld's point, saving Lehman would have involved escalated moral hazard but at least it would have been predictably lunacy. When the government started rescuing some banks and letting others collapse all bets were off. Wall Street is always a casino but at least the gamblers know the rules.
September 15, 2008 marked the day it became obvious that the house was making things up as it went along, plunging the entire system into chaos.
Patient investors outside of the bank stocks were rewarded handsomely if they had the courage to hang on. It took more than two years for the Dow to close higher than where it was at the start of September 2009, but if you bought and held at the end of this month in 2008 you've made than 40% on your investment so far. In terms of a basic trust in the fairness of the financial system it's debatable as to whether or not such a thing is possible.
More from Breakout:
- Lehman Brothers
- Bear Stearns