Top Lessons from the 2008 Financial Crisis - Introduction
We are at an inflection point in the financial market. The stock market is an all-time high. The global instability is increasing from the threat of ISIS and North Korea. There is also a threat of protectionism especially with Trump’s America First policy and Brexit. The United States is going through a period of deregulation, larger than what happened during the Reagan years. For sure, this has played a big role in pushing the market higher. However, there are huge risks that we need to look at. In this article, I will go back to the 2008 financial crisis and look at what we can learn from it.
The 2008 crisis was caused by a combination of factors. In the period of George Bush as president, he removed many financial regulations. As a result, banks had a frenzy. They created financial instruments known as CDOs (collateralized debt obligations) and MBS (mortgage backed securities). These instruments allowed people, even those who had a bad credit history to take mortgages. In 2008, the house prices started coming down and people started defaulting on their obligations. Banks like Lehman Brothers, Merrill Lynch, and Bear Sterns were the most affected. They had given out so much loans. When the crisis started to unfold, Bear Sterns was bought for pennies while Lehman Brothers collapsed.
These banks were insured by AIG, then, the biggest insurance company in the world. When the banks collapsed, the company also suffered but it was saved by the taxpayers. At the end, many Americans and many money managers went bankrupt. People like Ken Griffin and David Einhorn lost billions of dollars.
The first lesson is that nothing is permanent. This is I believe one of the most important lesson anyone needs to learn from the crisis. Lehman Brothers was once one of the largest banks in the United States with more than 20,000 employees. It had iconic buildings and prestige. However, at the final day, the company collapsed with international media watching. We watched its employee pack their belongings and go home jobless. As a trader and as a human, you need to realize that nothing you own or a situation you are at is permanent. You might be doing so well but one day, you might be at a loss. Therefore, live your life knowing that.
The second lesson is on the bullish and bearish markets. As a trader, you need to realize that bear and bullish markets never last forever. They come and go. Before the crisis, the market was on an uptrend with records being shattered every month. As a result, most investors decided to put their money on the long trades. Then, when the crash came, they lost money. A good look at investors who made money during that time shows that none of them were long-only investors. A person like Jim Simmons of Renaissance made more than 70%. He made his money because of his long-short strategy where he buys undervalued companies while shorting those he believes are highly valued.
The third lesson is on who you listen to. There are many investment analysts today; the so-called sell-side analysts. Before the crisis, many were interviewed by financial media and supported the financial organizations. Jim Cramer, a person who is highly respected promoted Lehman Brothers, a week before its collapse. Therefore, as a trader, I recommend that you only use your research before you buy and sell financial instruments.