September, 2008 was very strange time. Markets froze and
stayed frozen for some time. Trust was replaced by fear. People began to
contemplate the unthinkable. I even began to check the ATMs to make sure they
still dispensed cash. Fortunately, the free fall stopped-although the pain
continues for many. Five years later I have compiled a list of lessons I leaned
from that time. They are as follows:
1)
The big banks have gotten bigger and are just as
accident prone as they were before the crisis.
2)
Debt spreads and availability can change
dramatically. For example, high yield bond spreads jumped from pre-crisis 250BP
over comparable treasuries, to 2000BP during the crisis.
3)
Equity risk premiums are also very volatile.
4)
Diversification is no shield against systematic
risk. In a crisis all correlations go to one.
5)
Do not forget about counter party risk. Just
like a pancake there two sides to every transaction.
6)
The only perfect hedge is in a Japanese garden.
7)
Recovery from a debt deflation crisis takes long
time-7+ years on average. See Reinhart
and Rogoff.
8)
An investment grade rating is not just for
sissies. It is key to maintaining capital market access during troubled times.
9)
Asset pricing shifts from fundamental to
technical factors during a crisis.
10) There
are limits to arbitrage. Value and price can diverge and remain that way for a
long time. Keynes was right-markets can remain irrational longer than investors
can remain solvent.
11) Liquidity
risk, the poor man’s alpha, becomes deadly during a crisis. The price for
liquidity spikes during a crisis.
12) Liquidity
means cash, not access to cash. Cash liquidity should be viewed as insurance, not
a low return asset. Liquidity preference is a behavior toward risk. Keynes was
right again.
13) Beware
of academics and consultants preaching “leverage your firm to the hilt” during
the good times. Financial distress costs are more difficult to quantify than
interest tax shield benefits. Nonetheless, they are every bit as real.
14) Debt
means you have to be right. Debt without liquidity means you have to be right
every day.
15) Be
humble-we know less about markets than we think. Do not confuse risk or luck
for skill.
16) Risk
is not a number. It is an exposure that is not always reflected in history.
Absence of evidence is not evidence of absence.
17) More
money has been lost betting against market efficiency than has been made.
18) Financing
windows can shut without notice. The capital when you can-not when you must.
19) Beware
of bridge financing becoming bridges to nowhere.
20) As
Robert Marks noted-the relationship between price and value is the key to
investment success.
These lessons seem to un-learned and relearned over time.
Perhaps, James Grant was right when he said all knowledge in markets is
cyclical. Do not despair as this presents buying opportunities for disciplined,
liquid and well capitalized buyers - sounds like Buffett doesn’t it?
J
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