Eight years after the collapse of Lehman Brothers' triggered the global financial collapse, fund managers reveal the biggest lessons learned and those which remain on the horizon and are continuing to threaten the asset management industry.
Peter Doherty, partner and CIO, Tideway Investment
Widespread redefinition
The Lehman default and broader financial crisis shone a bright light into some very dark corners. Assumptions and mathematical models built into many financial models, balance sheets and entire businesses proved to be deeply flawed.
In particular, the price of liquidity was shown to be far too low and, closely related, correlation risk was dramatically underestimated. On the way down, all asset prices fell a lot and in tandem as correlation went sky high.
This combination of a huge increase in the price of liquidity and asset price correlation proved toxic. The result was not only an exaggerated collapse in asset prices, but more importantly the very definition of what was a good or bad asset and business model was redefined.
It was this widespread redefinition on a massive scale that shocked everyone the most because the underlying assumptions of an asset or counterparty creditworthiness turned out to be based on liquidity being available for long periods, uninterrupted and at a low cost.
Institutions challenged
The ability of closely linked financial institutions to allocate losses to investors was binary. Very bad ones went bust and solvent, but challenged institutions could not force bondholders to take losses, so governments were forced to step in.
The amount and quality of capital held within the banking system globally has increased very significantly.
In broad terms, banks are required by 2022 to have well over four times the equivalent amount of Tier 1 Capital prior to 2008 and in addition there are provisions for more senior bonds in the capital structure to absorb losses under TLAC rules Total Loss Absorbing Capital. TLAC will make up as much as 25% of a banks' risk-weighted assets.
Liquidity issues have also been addressed by a much tougher regime for counterparty risk whereby a large pool of cash and liquid government bonds is kept as a buffer.
