This week marked the 10th anniversary of the downfall of global financial services firm Lehman Brothers— the largest bankruptcy filing in U.S. history. While that was not the official start of the Great Recession, the factors that led to it and the wild markets and financial damage left in its wake certainly stand as a focal point for the financial crisis.
At the time, I was teaching macroeconomics at Pepperdine University. I quickly realized that the textbook was almost useless in that environment, and I did most of my lessons from news stories. Often, what I assigned for the week was outdated by the time the class met again the following week.
One conundrum that many students and City National clients asked about at that time was the bizarre behavior of currencies. Stocks dropped more than 40 percent in the six months following the Lehman bankruptcy. Bond prices shot through the roof as a flight to safety, so much so that the 10-year Treasury yield fell from near 4 percent to just above 2 percent during the last two months of 2008.
But the U.S. dollar strengthened by more than 15 percent in the two months right after the crisis hit.
On its face that probably seems strange. Interest rates were dropping and the U.S. financial system looked like it was falling apart. Why would the U.S. be attractive as a place for investment during that time?
The answer lies in behavior around “risk seeking" and “risk aversion." Essentially, in the run up to the crazy valuations before the crisis - particularly around structured debt products - many U.S. companies and investors had been looking for higher returns outside of the country. When the crisis hit, one of the great realizations for investors was the value of liquidity —having cash on hand in the face of financial stress.
Much of the dollar's move stemmed from these investors selling foreign assets and moving the funds back into the U.S., meaning that they were selling their foreign currencies and buying U.S. dollars.
My View: Those moves helped solidify the dollar's reputation as a flight-to-safety currency and established the risk-aversion trade of equities and bond yields dropping while the dollar strengthens. Markets followed this pattern for the next several years throughout the crisis. But while that pattern is still somewhat relevant, in many ways we have finally moved on from that crazy time.
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