I think we need to develop a detailed understanding of what exactly happened in the 2007-2008 financial crisis that goes beyond and superficial timeline of cause-effect relationships and events but looks into systematic vulnerabilities in the banking system at the time and consequences for different industries.
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It sounds good, I have recently been studying the 2008 crisis (in my free time), and would be interesting to develop it into something that goes much deeper.
Ok cool. I just wrote something about it as well and will merge it into this topic.
(Msg originally written in response to @Magaly in Volkswagen Scenarios)
I have to admit i am not 100% aware of all the details of the 2007-2008 financial crisis.
As an example, i just had to look up why different banks failed.
Apparently, Bear Sterns , Lehman brothers, Citibank, Merrill Lynch and others collateralized mortgage-backed securities with collateralized debt obligations, while AIG sold a lot of credit default swaps.
Similarly, I am not aware of the magnitude of balance sheets from different players and the impact of the failure of different players on the financial system.
Therefore it’s hard for me to say if there has been a sudden shock to the financial system but my assumption is that financial markets completely collapsed in mid-September 2008 at the time when Lehman went bankrupt and large support measures like a 138billion advance to Lehman Brothers by J.P Morgan or a 700billion capital injection program of the treasury had been taken.
Given that the treasury recovered all its money it appears that the fundamental situation of most u.s. banks has been alright even as they suffered large losses from mortgage-backed securities and a potential shock to the system has been caused in part or mainly by an erosion of trust between banks and distressed asset valuations.
When it comes to a potential shock on the real economy which is more relevant for e.g. Volkswagen we have to look into the impact of the financial crisis on lending activities as an example for automotive loans. My assumption here is that both the declining value of real estate prices as well as tightening lending standards led to a sharp and potentially sudden drop of lending which combined with the larger uncertainty in the economy caused automotive demand to drop drastically.
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I do agree with you that the financial markets collapse happened in September 2008, starting with Lehman bankruptcy. And the biggest deterioration in the economy was after this point.
But my point was that there were already signs of weakness in financial markets, the housing market, and the economy before that event, that almost everyone ignored until the very last minute.
So, if someone decides to take those signs before the collapse more seriously, I think there could be more than enough time to react than everyone else, without it being a big shock for them.
But an investor also have to be open to that. Because as you just mentioned, even if everything looks fundamentally good to withstand losses (we don’t know if it was indeed the case), if there is just 1 big enough event that can cause enough panic/fear in the markets, there can still be a serious shock to the economy.
Signs before the collapse that I have found so far:
- Since 2007, there were already news about the potential problem in defaults with mortgages
Mortgage delinquencies seen peaking in 2008 | Reuters - Bearn Stearns failed since March 2008, due to default and losses in mortgage-backed securities. Bear Stearns: Its Collapse, Bailout, Winners & Losers
- Days before Lehman Bankruptcy, Fannie Mae and Freddie Mac had to be taken over by the government because of the losses in mortgages. The markets also did not even react to this.
Federal takeover of Fannie Mae and Freddie Mac - Wikipedia
I understand your point.
Here is a short excursus about my experience with risks and why I understand that a lot of people missed the 07/08 financial crisis:
The problem with risks from my perspective is that you never know if they materialize into real problems or if they are just potential problems that turn out to be fine.
Over the 8 years i have been investing there have always been risks like
- 2015: Fears that valuations are too high after the strong stock market performance of the previous years.
- 2016: Trump presidency with uncertain effects
- 2017: Watching Trump, China debt worries
- 2018: Trade war with China and Europe, Fears of the Fed hiking rates too fast
- 2019: Weaker growth, Sudden spike in Repos
- 2020: Covid
- 2021: A bubble in risk assets
- 2022: Ukraine war, Rising interest rates
Those are just some of the risks off the top of my head and I am sure that there have been further worries including on effects of low-interest rates (even before they have been cut in 2020), the state of the Euro, and so on. While all of those risks turned out to be fine, they seemed worrisome back in the day and there have always been bears and doom prophets warning about an imminent and bad crash to happen.
In my scenario and most long-term investor’s scenarios, it is obviously very good to invest despite risks and in my experience, the chances of risks turning into problems are less than 10%.
Ironically when everyone was the most certain that everything would turn out fine (2021) was the worst time for investing. (It’s always like that)
(Note: The current risks that we are seeing coming from the sharp rise in interest rates are worse than the risks of the past in my assessment, this is why we are focusing so much on macro. We have to be specific though and find real breaking points in the economy to get ahead of the market. If we don’t find them it might be due to the fact that the risks are not as bad as feared which is a knowledge that makes it easier to take advantage of investment opportunities.)
When looking back to 2007 and 2008 it is totally understandable to me why so many great investors like Warren Buffet did not sell and did not see the risks coming. Losses in mortgages and even the bankruptcy of Bear Stern seemed likely manageable and selling just because something might break is a bad long-term strategy.
(Excursus: On a high level, an investor has to always deal with risks, as there are never situations in which risks do not exist. It would be literally impossible to invest at all by waiting for a period of no risks or selling every time risks appear. Instead, investors need to Instead differentiate between real problems and just fears (signal and noise) which enables them to participate in the development of the economy. )
In my current theory, there must be a reason why people believed everything was manageable and a moment at which everything went wrong with cascading effects that caused the sudden meltdown. In my opinion, studying this very specific moment and what exactly happened in the system at this moment is the most interesting part of studying the 2007/2008 financial crisis. (backlog task)
By studying the exact details how things broke it will also be easier for us to assess how easy or difficult it would have been for investors to accurately anticipate that things will break and we might learn some general principles about breaking points and warning signs to look for. (Although if something breaks this time it’s probably at another place)
(Note: Back in 07/08 there have been people who accurately predicted that things will break. Those people like Steve Eisman or Michael Burry failed with other bearish bets though. As an example, Eisman bet against Tesla and Burry sold all stocks in 2022, which might have been too drastic in hindsight.)