This week marks the seventh anniversary of the financial crisis. Sometimes people forget just how close to the brink we were. Yes, the U.S. and global financial system was brought to its knees, but it did not crumble. To measure our progress, it might be helpful to remember just how intense it was in that first week.
- 9/15/2008: Lehman Brothers Holdings filed for Chapter 11 bankruptcy protection; Bank of America announced its intent to purchase Merrill Lynch
- 9/16/2008: The Federal Reserve Bank of New York lent $85 billion to AIG
- 9/16/2008: The net asset value of shares in the Reserve Primary Money Fund fell below $1. When the fund “broke the buck,” it caused panic among investors who considered money market accounts nearly the equivalent of bank savings accounts
- 9/19/2008: The Treasury Department announced that it would insure up to $50 billion in money-market fund investments. The year long initiative guaranteed that the funds' value would not fall below the $1 a share.
- 9/21/2008: The Federal Reserve Board approved applications of investment banking companies Goldman Sachs and Morgan Stanley to become bank holding companies, so that they could access money from the Federal Reserve and to fund their daily operations
Many people thought that the government’s intervention was over the top. “Let them fail!” was the rallying cry, but I always believed that saving the system was paramount, even if I did not necessarily agree with the terms of the various bailout deals (I thought that taxpayers should have gotten more of the upside of the financial service companies’ recovery, rather than simply receiving a repayment of the dollars, with interest) and the government’s more than $800 billion stimulus plan (“The American Recovery and Reinvestment Act of 2009"). Still, while both of the shotgun measures could have been more effective, they likely helped the country avert what could have been a Depression, rather then the horrible recession that we endured. The so-called Great Recession, which started in December 2007 and concluded in June 2009, was the worst contraction since the Great Depression.
Seven years later, what have we learned? Because the financial crisis stemmed from too much easy borrowing and lending in the housing market, one of the best lessons was the concept that borrowing can be dangerous. Just because some bank is willing to lend you a lot of money to buy a house or will extend to you a giant credit card limit, does not mean that you should take it. For most people, putting down a 20 percent down payment for a house is prudent. Even if FHA will allow borrowers to put down less than 10 percent to qualify for a mortgage, there is a good reason that the 20 percent down rule of thumb exists: just in case the housing market collapses, you have more equity in the house. Similarly, even if you have the ability to buy a lot of fun stuff on your credit card, you should only be charging what you can pay off on a monthly basis.
A corollary of the loan warning is to read the fine print on all documents. There were too many instances when borrowers really did not understand the terms of the loans that they were assuming. Although many regulations now require more transparency and disclosure on everything from mortgages to credit card statements, after the financial crisis we still must be vigilant in reviewing documents to protect ourselves.
The crisis taught us that an adequate emergency reserve fund (6 to 12 months of expenses for those who were employed and 12 to 24 months for those who were retired) could prevent us from selling assets at the wrong time and/or from invading retirement accounts. And of course for investors, we learned that a diversified asset allocation plan, that takes into consideration your risk tolerance and when you need to access your funds can prevent a lot of sleepless nights. Nobody wants to test these lessons any time soon, but let’s heed them.