Ten years ago, in September of 2008, Lehman Brothers, the large investment bank, declared bankruptcy and thousands of people lost their jobs. At that time, there were widespread fears that the entire financial system would collapse. Recently there have been several articles and documentaries about the financial crisis and whether we are vulnerable to another financial crisis. The evidence is mixed—we now have some legislation that forces more transparency for financial reporting, and the financial institutions are better capitalized—but the large financial institutions, which were called “too big to fail” during the crisis, are even larger now. There is an even greater interconnection among financial institutions. One outcome of the financial crisis was that the government and the Federal Reserve intervened and used public money to rescue many institutions. That outcome caused much frustration and questions about why policy makers and leaders of the financial institutions allowed the situation to deteriorate to the point of pushing the economy into the most serious recession since the Great Depression and forcing the government to take such drastic action to intervene in the economy.
Of course, there were many factors that precipitated the crisis, but at the core of the problem was a critical misunderstanding of risk. Through clever financial engineering, mortgage loans were segmented into tranches and packaged as mortgage securities. Even though many of these individual mortgages appeared to be high risk, this financial engineering obscured the risk, and thus asset values were distorted. The true risk did not go away; it was hidden, and when housing values began to fall in some areas, the value of the bonds dropped rapidly. The asset value fall was multiplied due to high leverage-borrowing to purchase the financial assets.
What is the lesson to be learned? It is the age-old problem that there are always temptations of seeking high monetary returns coupled with the illusion that risk is low. What needs to be in place to thwart such activity are businesses led by virtuous leaders who seek God’s council—those who deeply understand the facts and do the right things—and are not tempted by quick returns. Psalm 32:8 “I will instruct you and teach you in the way you should go; I will counsel you with my loving eye on you (New International Version).”