Note: A version of this article was first published in 2009, in Trish Power’s book, DIY Super for Dummies (Wiley), and republished in 2015.
I was holidaying in Europe when the Global Financial Crisis (GFC) officially hit in October 2008 (although investment markets had been falling dramatically since December 2007). The impact of the GFC saw the United Kingdom bail out its major banks. Ireland came to a standstill, becoming the first country in the world to guarantee bank deposits in response to the secondary ‘crisis of confidence’ in the banking system. Spain was also grappling with struggling banks, while Iceland simply imploded with calls from the Icelandic community demanding ‘women only’ to take over the running of the country and its male-dominated financial system.
Even with the drama escalating in Europe, most of the GFC action (and reaction to the GFC) was happening across the Atlantic Ocean, in the United States. Billions of dollars were handed out by the US Government to major financial organisations, some landing in the pockets of bank executives as ‘performance bonuses’. Many more bailouts followed in the next 18 months.
The world’s credit squeeze was exacerbated by the massive arrogance (and sometimes fraud) of bankers, investment bankers, and hedge fund managers, and the undue influence they had over government decision-makers leading up to the GFC. The world’s media was also fooled by the so-called market experts who had vested interests in propping up markets on unsustainable debt for as long as possible.
Merely months earlier, in 2007, in Australia, most sharemarket pundits and commentators were predicting the economic boom in Australia was going to go on forever (or at least the next 30 years) because of China’s need for resources.
Slipping from infallible to gullible to culpable
For much of 2007, I was writing articles reminding SMSF trustees and other investors to reset their investment strategies for changing times and to review the riskiness of investment portfolios against possible economic shocks. I didn’t expect world markets to collapse of course, and I was surprised by the severity of the GFC as much as anybody.
Many months before the investment markets started deteriorating from late 2007, however, I was nervous about the state of the US economy and particularly its crumbling property market. I fully understood that the unravelling of the US economy when it happened, was not going to be pretty.
I was tracking this development for several months before the US property market imploded, courtesy of an excellent Australian journalist, the late David Hirst, who wrote a column for the Melbourne Age and other publications, exploring the underlying rot of the US economy and the neglect by Wall Street.
The origins of the GFC were linked to the proliferation of sub-prime house mortgages (loans with ridiculously low interest rates to people who couldn’t afford the loans longer term) in the US residential property market. During the mid-2000s, the sub-prime loans were about to mature into regular home loans with market rates of interest. Most of the individuals subject to these loans would be unable to afford the higher loan repayments when the market rates of interest kicked in. And, this reality came to pass, with devastating consequences.
What compounded the problem in the US is that, unlike Australia, an individual in the United States can effectively walk away from a home loan (and his home) with no recourse to other assets the individual may own, except for the nasty long-term black mark on the former home-owner’s credit rating.
The collapse of the sub-prime loan market may have been the trigger for the GFC, but in my view, the international financial markets had already lost the plot. Mad men were controlling the markets — takeovers and asset sales were rampant at never-before (and probably never again) valuations, and traditional banks had dived into untraditional high-risk ventures. Apparently, no-one had noticed or cared, until it was too late.
To be honest, I hadn’t had much faith in the US economy since the major US banks and investment banks bailed out the hedge fund Long Term Capital Management in late 1998, with the magnanimous nod from the US Federal Reserve. The 1998 bailout was to prevent a catastrophic domino effect on the US sharemarket and debt markets (sound familiar?).
Apart from David Hirst, very few commentators published in Australia in 2007, were talking about the ticking financial bomb camouflaged in the humble guise of sub-prime house mortgages. Many US financial organisations flogging these loans then converted this dubious debt into packaged investments and offloaded this ‘rubbish’ to institutional investors around the world, including Australian super funds and our local councils.
Meanwhile, the investment markets just couldn’t see past the China growth story (even though such growth was driven by US demand for Chinese manufacturing, and similar demand from other western economies). The market analysts and commentators seemed blind to the domestic US economy, and too tolerant of President George Bush’s inertia, when failing to take pre-emptive measures to ward off the impending financial disaster.
GFC in Australia
I don’t believe anyone could have truly predicted the severity of the credit crisis that ensued, but I do believe that many individuals in the financial industry, entrusted with responsibility to look after the interests of investors, and super fund members, were asleep at the wheel when faced with the responsibility of mitigating losses from falling markets, and dud sub-prime investments.
More remarkably, while the US property market was unravelling during 2007, fund managers in Australia continued to flog financial products, known as collaterialised debt obligations (CDOs), representing these packaged sub-prime loans and other debts, to Australian superannuation funds and to local councils.
During 2008, Australia’s sharemarket dropped nearly 40 per cent, while some major Australian companies disintegrated. The federal government guaranteed bank deposits to ward off massive cash withdrawals by panicked depositors. Many listed and unlisted property trusts were forced to freeze redemptions (withdrawals) by investors holding units in the property trusts — unit holders who wanted to move cash out of the debt-ridden property trusts, and into the safe haven of government-guaranteed bank deposits. The property trusts froze withdrawals to prevent forced asset sales and, in so doing, attempted to protect the value of the property assets held by the trust, and to protect the long-term interests of investors.
During 2009, most major companies announced earnings downgrades, and more and more companies announced job losses, while personal bankruptcies were on the rise, triggered by burgeoning credit card debt.
The major blind spot that still exists within the financial services industry, and that will cause investors further financial pain in the future, is the lack of reflection on what went wrong with the world’s economies during 2008 and 2009. The revelations from the Financial Services Royal Commission are disturbing examples of apparent incompetence and dishonesty within the financial services sector, and confirms how little the financial services industry has learnt from the past (for strategies to help your super account survive the super system’s flaws, as uncovered by the Financial Services Royal Commission see the four lessons later in the article, and SuperGuide article Beyond the Royal Commission: 10 super strategies to protect your retirement).
Four important lessons
I believe we can all learn some valuable lessons from the aftermath of the GFC. In my view, the four main lessons (or reminders) that can be learnt from the GFC debacle are:
- Prudent fund managers, super funds and individual investors must heed all of the market information available, instead of just the information that the market wants to hear.
- Experts aren’t always right, and sometimes they’re just plain wrong. More precisely, investments experts are never infallible and can even be gullible (and potentially culpable), just like individual investors.
- The future is impossible to predict accurately, and the only defence against future’s uncertainty is to spread your risk.
- If you’re willing to take greater risks, be sure you understand the financial consequences — that is, what’s the worst thing that can happen?
Finally, as an investor, a lesson that I learnt many years ago is that when investing for the long-term you need to keep one eye on what’s happening today, and one eye on the future — and I mean both long-term and medium-term future. The economic malaise that hits the investment markets during a market downturn eventually passes, and a robust investment portfolio needs to survive to thrive another day.
Postscript: Boring old risk management wins out
In June 2007 while I was Superannuation Editor for the online investment publication, Eureka Report, I reported that Australia’s large super funds were starting to shift money out of shares and placing more money into more conservative investments. I commented that this move wasn’t about chasing bigger returns but about managing risks.
I noted that, generally speaking, risk management is a weakness of the retail investor and it may be timely to check out the asset allocation of some of the larger funds and find out the reasons why the larger funds have changed their asset weightings. I did note, however, that larger funds are representing thousands of investors and generally need to err on the side of caution.
In July 2007, I warned retail investors to stay away from the more aggressive hedge funds because of the unknown risks associated with the underlying investments, and because of a sense of foreboding after the recent collapse of a major Australian hedge fund (run by Basis Capital, which subsequently went into administration).
In August 2007, and before the sharemarket started to dramatically fall from December 2007, I reminded SMSF trustees of the importance of risk management when investing, even when investing in strong markets. And like a broken record, in June 2008, a few months before the GFC officially began, I restated how important it was for SMSF trustees to review a fund’s investment strategy in light of changing economic times.
I haven’t yet met an investor who didn’t lose some money during 2008 and early 2009, but the investors who are in the strongest position post-GFC are those investors, including SMSFs, who conducted due diligence on their investment strategy and investments post-GFC, and continued to do so through the ensuing years.
For more information…
For information on how super investing works, see the following SuperGuide articles:
- Superannuation investing: How does it all work?
- Want investments that help you sleep? Understand your risk profile
- Superannuation investment: What is the difference between a balanced and growth option?
- Choosing an investment option (Investment choice)
- What types of investments and asset classes are popular with SMSFs?
For more information on the top-performing superannuation funds for the latest financial year (and previous financial years) see the following SuperGuide articles:
- Top 10 performing super funds for 2017/2018 financial year (and previous years)
- Top 10 performing super funds over 10 years (to 30 June 2018)
- Asset classes: Naming the investment winners for the 2017/2018 financial year (and previous years)
- Super funds gain 9.4% for 2017/2018 financial year
- Super and pension funds with the lowest fees
For more information on the top-performing superannuation funds for the latest calendar year (and previous calendar years) see the following SuperGuide articles:
- Top 10 performing super funds for 2018 calendar year (and previous years)
- Top 10 performing super funds over 15 years (to 31 December 2018)
- Asset classes: Naming the investment winners for the 2018 calendar year (and previous years)
- Super funds return 0.8% for 2018 calendar year
- Super and pension funds with the lowest fees