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Lehman Brothers’ Collapse: Did the Markets Learn Any Lesson?


After surviving two world wars and 1930’s Great Depression, Lehman Brothers had filed for bankruptcy on Sep 15, 2008. The collapse of the leading investment bank not only affected its employees or investors but also led to a global financial crisis.

It took years for nations like the United States to regain financial stability through measures like massive quantitative easing programs. In Twitter, Trump congratulated America after Wall Street saw its longest bull run last month.

Regulators have been keeping a close watch on big institutions to lower the possibility of another such crisis. However, the market still has more lessons to learn from the decade-old financial crisis.

Lehman Bankruptcy

That time in the United States, Lehman was the fourth-largest investment bank with global employee-base of more than 20,000. Notably, it was the biggest bankruptcy in history as Lehman had assets worth $639 billion along with $619 billion debt, per Investopedia.

The financial crisis was induced by the widespread default on subprime mortgages, which made Lehman the biggest victim. The demise of Lehman acted as a catalyst and worsened the crisis, leading to the erosion of trillions of dollars in terms of market capitalization.

Following the meltdown, the global market witnessed a phase of “credit crunch”. In fact, the United States alone saw a fall in credit supply of trillions of dollars. Also, governments employed austerity measures for controlling debt. Central banks started employing quantitative easing — a monetary policy to boost market liquidity by purchasing government securities.

'Too Big to Fail' Banks Under Scrutiny

The meltdown of systematic banking could again hit the global economy. In fact, from 1970 to 2007, there were 124 such crises reported by International Monetary Fund. Although it is not possible to completely avoid such downturns, the target should be to reduce the impact.

Among the measures taken after the Lehman incident, banks are required to hold more equity capital than funding themselves with additional debt. This might be safer as banks are not liable to pay shareholders a specific amount of money. After clearing all obligations, banks are supposed to pay stockholders the leftovers, if any.

Banks are required to report assets that are more liquid and are under constant scrutiny by regulators. Meanwhile, banking systems in Europe are healthier. Especially, the organizations included in the 'too big to fail' list are under inspection.

More Lessons to Learn

Most regulatory bodies across the globe want banks to lend capital for properties, taking the focus away from other prospective businesses. Through Fannie Mae and Freddie Mac, the U.S. government provides guarantee to mortgage debt, thus encouraging loans for properties.

Mortgages from banks are purchased by Fannie Mae and Freddie Mac in secondary markets. Both the government sponsored enterprises pooled the mortgages to create mortgage-backed securities (MBS). Fannie Mae and Freddie Mac provide guarantee to buyers of MBS for both interest and principal payments. Thus, by purchasing loans from banks, Fannie Mae and Freddie Mac are providing liquidity that encourages banks to lend more capital.

It seems that the market has not learnt enough from the bankruptcy of Lehman. Regulators are still encouraging banks to lend money for property purchases despite knowing that Lehman had collapsed following losses from high-risk loans associated to properties in the United Sates.

On top of that, in their financial statement, banks in the eurozone are free to report sovereign bonds at historic price without the need for capital requirements. In fact, banks have the liberty to hold as many sovereign bonds as they want to. However, if the price of sovereign bonds declines significantly, the value of the bank’s asset will also fall considerably.

The liberty to hold government bonds without capital requirement signifies that sovereign bonds carry no risks. However, the scenario seems different now as the euro zone economy is slowing down. Moreover, given that the European Central Bank has decided to wind down its massive quantitative easing through the end of 2018, there are chances for the price of government bond to plunge.

Most Important Investment Lesson Learnt

Warren Buffett once said, “Be Fearful When Others Are Greedy and Greedy When Others Are Fearful.”

Lehman’s bankruptcy had created a panic among investors which led them to withdraw funds from equity. However, a few who held on to or bought stocks pocketed massive gains, as evident from the 10-year price chart of S&P 500.

S&P 500: 10-Year Price Chart

Hence, the price investors pay for a stock matters. Given that Wall Street is overvalued, investors should buy less pricey stocks with upside potential.

Employing our proprietary Stock Screener, we are picking stocks that are undervalued as compared to the S&P 500 index. All the stocks flaunt a Zacks Rank #1 (Strong Buy) or 2 (Buy) along with a solid VGM Score. You can see the complete list of today’s Zacks #1 Rank stocks here.

Here, V stands for Value, G for Growth and M for Momentum, and the score is a weighted combination of these three scores. Such a score allows you to eliminate the negative aspects of stocks and select winners. However, it is important to keep in mind that each Style Score will carry a different weight while arriving at a VGM Score.

Headquartered in Deerfield, IL, Caterpillar Inc. CAT is the world’s leading manufacturer of machinery equipment.

With a VGM Score of B, the company has a TTM P/E ratio of 14.7, lower than the S&P 500’s 19.99. The stock is also trading below its 10-year median ratio of 15.45 and has significant upside potential with a 10-year high ratio of 31.39.

Presently, the company carries a Zacks Rank #1.

International Paper Company IP, headquartered in Memphis, TN, is among the leading producer of containerboard.

The Zacks #2 Ranked firm with a VGM Score of B has a TTM P/E ratio of 11.77, below its 10-year median ratio of 14.74. With a 10-year high ratio of 33.68, the stock has substantial upside potential.

Headquartered in New York, MetLife, Inc. MET is among the world’s leading financial services firms.

The #2 Ranked firm with a VGM Score of B has a TTM P/E ratio of 9.37, lower than its 10-year median ratio of 9.39. The less pricey stock has significant potential for upside with a 10-year high ratio of 18.29.

Based in San Jose, CA, Broadcom Limited AVGO is engaged in distributing diverse semiconductor devices.

The Zacks #2 Ranked firm with a VGM Score of B has a TTM P/E ratio of 13.35. With a 10-year high ratio of 73.88, the stock has substantial upside potential.

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