One year later, what have we learned from the credit crisis
September 13, 2009 by admin
The collapse of Lehman Brothers is credited with creating one of the worst economic recessions since the great depression. Lehman Brothers, was only one of hundreds of companies that were poorly regulated and overleveraged, creating a credit system that was built on a house of cards and doomed to fail. The anniversary of the collapse of Lehman Brothers has been marked with ups and downs in the stock market, millions more job losses and a growing sentiment that the worst is over.
The main reason we study history is because it proves to be invaluable in teaching lessons and helping us learn from our mistakes. The collapse of the credit markets around the world can teach us many valuable lessons as we create finance markets in the future. The collapse of the current system can be traced in two major categories, lack of oversight and too much leverage in the systems. Banks and lenders have historically operated under a principle of lending on margin. These companies have the luxury of collecting capital (money) and utilizing this capital to lend to individuals or businesses, historically at ratios of ten to one or less. Essentially for every dollar they collect in capital, they lend this out ten times, increasing there ability to earn a profit on their borrowed funds. The downfall during the credit collapse was the lack of oversight in managing the leverage which banks and other financial related companies were participating in to try and increase their profitability. Companies such as AIG, took the concept of leverage to new extremes, by offering to insure companies who were leveraging assets known as derivative securities. These securities, often leveraged at ratios of 100 to 1, became insolvent as borrowers began to default on their mortgage loans, greatly diminishing the value of the assets and forcing these companies to increase their required capital to stay within guidelines. As the system began to collapse, the entire credit system froze as the collateral and cash required to lend money forced companies out of business or on life support through loans from the government. The lack of oversight in allowing these companies to create a casino like market to gamble for record profits can clearly be blamed as one of the root causes for the credit collapse and recession. Governments create regulations for the financial markets to protect individuals and consumers who can not protect their own interest due to a lack of understanding or knowledge of the intricacies of the market. The lack of oversight that allowed these companies to post record profits in the early part of the decade, fueled by a housing market that was growing to fast are the root cause for the crisis of today’s economy.
Today, the reality is that no one truly knows where the economy is heading over the next twelve months; optimism abounds in the stock market, up over forty percent since the low point of March. The labor markets have shed over three million jobs in the past year, and the national unemployment rate is fast approaching ten percent. The housing market is showing signs of life, thanks in part to historically low mortgage rates. Consumers though, remain cautious and it could take years to rebuild the wealth lost over the last twelve months for millions of Americans. The lack of employers committed to hiring remains the red flag in the future of the economy. The credit and lending markets are beginning to return to normal, but the damage has certainly been done and we can only hope that history does not repeat itself.