September 15, 2008 is a date that will forever be ingrained in Wall Street’s memory, as this day marked the pivotal turning point of what would eventually become the worst financial crisis the U.S. has seen since the Great Depression. Though the dire state of the U.S. financial system had already become apparent to many in the industry, the fall of Lehman Brothers ultimately sealed the country’s fate, setting off a chain of events that affected everyone from Wall Street to Main Street. Though five years have passed since the 158-year-old investment bank filed for bankruptcy, the aftermath of the “Great Recession” can still be felt to this day [see ETFs That Lost 50% In a Single Year].
Even today, many still try to play the blame game and point fingers, but the ultimate demise of the system was undoubtedly caused by fiscally irresponsible financial institutions. These mega banks–which later became coined “too big to fail”—took on astronomical risks, filling the system with toxic subprime mortgages neatly packaged into seemingly attractive securities. As a result of these not-so-innovative financial innovations, the country plunged into recession, forcing a staggering 473 banks to close their doors, 15 million people to lose their jobs, and millions of foreclosures.
Despite the substantial coverage of the recession, the size and scope of this crisis is still somewhat difficult to grasp, but a look at where the financial industry is now may bring some better perspective:
Too Big To Fail Gets Bigger
Prior to the collapse, banking stocks made up roughly 9% of the S&P 500 (based on total stock market value), according to CNN Money; now, however, banks account for more than 17% of the famed index. And though Wall Street saw several financial titans fall, many of their assets were acquired by other mega banks–namely JP Morgan (JPM) and Wells Fargo (WFC)–making these institutions even larger than before [see The Best (And Worst) Performing ETFs For Every Quarter].
And while these banks continue to become even larger, Washington is still dragging its feet, unable to come to a consensus on banking regulations. As a result, these banks continue to take on excess risks to try to make up for lost profits – JP Morgan’s infamous “London whale” incident, where the bank lost more than $6 billion in complex derivative trading, is just one example of such irresponsibility.
Putting aside these incidents, however, it is difficult to argue that without the leadership of bankers like Jamie Dimon, these banks would likely have never been able to emerge from the ashes. Ruthless or not, these individuals were able to essentially capitalize on the crisis, benefiting their bank, their shareholders, and of course, themselves [see How To Take Profits And Cut Losses When Trading ETFs].
From Lehman’s filing on September 15, 2008, here is a look at where the U.S.’s biggest banks are now (Please note that all of the charts below are based on monthly returns, using adjusted closing prices, starting from 9/15/2008 up until 9/03/13):
Since the crisis, three out of the five largest banks in the country have been able to recover from losses seen after Lehman’s bankruptcy. JP Morgan (JPM), Wells Fargo (WFC), and Morgan Stanley (MS), have all managed to gain over 20% over the trailing 5-year period. Bank of America (BAC) and Citigroup (C), however, have struggled to gain traction and make up for the tremendous losses seen in 2008 and 2009.
Financial ETFs Finally Seeing the Light of Day
Though certain banks have been able to bounce back from 2008, financial ETFs have struggled to erase losses. It was not until this year that popular funds like the U.S. Financial Services ETF (IYG, B+) and the Financial Select Sector SPDR ETF (XLF, A) were able to climb back above lows seen in 2009 [see also Select Sector SPDR ETFs Head-To-Head]:
Over the trailing 5-year period, these ETFs have gained only about 6.5%; year-to-date, however, IYG and XLF have gained 27% and 23%, respectively. PowerShares’ KBW Bank Portfolio (KBWB, B), which launched in November of 2011, has also performed well, gaining over 30% over the trailing 1-year period.
The Bottom Line
While the U.S. financial industry has recovered fairly well since Lehman’s bankruptcy, investors should always remain cautious about this corner of the market, regardless of how well these institutions have been able to bounce back and generate profits. And even if Washington is able to pass stricter banking reforms, these titans will likely still find ways–primarily through financial innovations–to boost their bottom lines. Last, but certainly not least, investors must always realize that the next crisis is always different from the last, making the game that is Wall Street even harder to play.
Follow me on Twitter @DPylypczak.
Disclosure: No positions at time of writing.
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