Martin
Gilbert.
Aberdeen Standard
Investments
- Collateralized debt obligations, or CDOs, were a major
financial casualty of the 2008 crisis. - Many sounded the alarm on these instruments, including Martin
Gilbert, the co-CEO of Aberdeen Standard Investments, which
oversees $736 billion in assets and is the UK’s largest active
manager. - In an interview with Business Insider for the 10th
anniversary of the collapse of Lehman
Brothers, Gilbert shared the class of financial product he’s
wary about now.
Martin Gilbert can claim bragging rights as one of the people who
called the 2008 financial crisis — or at least an important part
of it.
In a 2007 conference in Monaco, he warned about Wall Street’s
affinity to collateralized debt obligations, or CDOs, the complex
financial instruments that went down with the mortgage market.
Ten years after the
financial crisis, the co-CEO of Standard Life Aberdeen, a
$736 billion asset manager and one of Europe’s largest, is
flagging another debt instrument.
It’s covenant-lite loans, which lenders are increasingly issuing
out to companies that seek less-restrictive financing terms. In
these arrangements, lenders waive or water down certain so-called
covenants, such as whether a company can pay dividends. Breaching
these would normally give lenders the option to redeem the loan
early.
Companies with weaker credit ratings are taking on more risk with
covenant-lite loans and their investors could face a greater
downside during
the next downturn, according to
Moody’s.
Gilbert shared with Business Insider, via email, why he’s wary of
these loans, and other reflections on the anniversary of the
collapse of Lehman Brothers.
Lehman
Brothers headquarters seen September 15, 2008.
Mario Tama/Getty
Business Insider: You steered Aberdeen clear of
the market for collateralized debt obligations ahead of the
crisis. What similar instruments are you wary of now?
Martin Gilbert: Yes, we steered clear of CDOs. I
was pretty vocal about the risk they posed when speaking at a
conference in Monaco in 2007. I viewed them as financially
engineered vehicles that enabled misallocation of capital. We
avoided getting involved with them.
Currently, I’m wary of covenant-lite debt paper for a variety of
reasons, a good example of which are certain weaker covenants,
which allow borrowers to essentially strip assets away from the
restricted group. This has found its way into some high-yield
documentation recently and became topical during the J.Crew
restructuring in the US. The market has, however, managed to get
this language removed in a number of cases but it’s nevertheless
indicative of a wider trend.
The following week was a maelstrom in markets.
BI: Where were you and what you were doing
during that weekend in September, and when you heard Lehman
Brothers had finally filed for bankruptcy on Monday?
Gilbert: I was in London that weekend and the
following week. There was a lot of panic that weekend because
many people had assumed the US Treasury simply would not let an
institution as big as Lehman go. The bank’s problems were no
mystery at the time, but it was the fact that they were allowed
to fail that was a watershed moment. It was when investors
realized there was a limit to what the US authorities would bear.
The following week was a maelstrom in markets and I spent the
entire week working with colleagues to analyze how the event
would impact us as the dominoes kept on falling. I have to say
though, the atmosphere in the office was not one of panic.
Everyone had a clear sense of purpose and was trying to find
practical solutions to the issues that markets were throwing up.
It was stressful and intense, but it was all about keeping a cool
head in those days and weeks in the immediate aftermath.
BI: What are some of the biggest lessons from
the crisis and ensuing market crash, especially for younger
investors who want to learn from history?
Gilbert: Don’t sell at the point of maximum
pain. The scale of the great financial crisis was really
something else but there are common threads running through all
crises. Markets have a habit of bouncing back and you have to do
whatever you can to take a step back.
Another lesson is to stick to the basics. Invest in what you
understand, spread your risk and know that if something looks too
good to be true, it almost certainly is. The products that the
banks were churning out in the run-up to the crisis were ever
more complex and built on even shakier fundamentals.
Don’t sell at the point of maximum pain.
This relates to another lesson, and that is that the nature of a
globalized economy makes neatly apportioning blame very hard.
Banks have rightly taken a lot of the blame for the crisis, but
it was a failing at all levels by governments, regulators,
investors, rating agencies, and the banks. When the crisis hit,
each party spent quite some time pointing the finger at everyone
else. No one party was to blame, but they were all culpable.
BI: What could regulators have done differently
post-crisis?
Gilbert: Regulators did a pretty decent job in
their immediate response to the crisis.
One of the problems with financial markets is that they act a bit
like water running down a hill. If something, like regulation,
tries to block a certain route, the market tends to find a way
around it sooner or later. This unfortunately means that we might
not understand the shortcomings of the post-crisis regulation
until it is really tested in the next crisis.
It could be desirable to see more support for securitization.
Regulators rightly came down on securitization hard after the
crisis because it played a big part in what happened.
Securitization is a brilliant tool to match risk and return
profiles to appropriate investors. When it is misused to create
or obscure unnecessary layers of leverage, though, the crisis
shows that it can be extremely harmful.
What I find encouraging is that, on the whole, regulation has
been pragmatic. I’m a big believer in working with regulators.
They have a tough job and the task of avoiding a repeat of 2008
is not solely theirs.
BI: If there’s another 2008-style crunch, what
should the balance between government and private-sector
intervention be, given that bailouts to Wall Street remain a
grievance?
Gilbert: It’s inevitable that in periods of
major crisis governments get involved. The degree to which their
responses will be coordinated globally is an open question.
The political environment has changed significantly since 2008,
so governments may not unite and work together. In many
countries, the “too big to fail” mindset is history and
governments feel less inclined to intervene and individual
companies will be left to sink, swim, or be rescued (acquired) by
a competitor.
That said, governments are very sensitive to public opinion so
may well act in situations if the private sector doesn’t. They
also recognize that the financial sector oils the wheels of the
economy to get growth going again.
Leverage and illiquidity are also the normal ingredients for more
systemic-style crises.
BI: What might the next 2008-style crisis be?
Gilbert: That’s the $1 billion question, or the
$650 billion question given by how much the US economy shrank
from September 2008 to the end of 2009. Unfortunately, as Nassim
Nicholas Taleb has argued, black swan events that trigger
financial crises come from left field and are difficult to
predict.
As we experienced 10 years ago, the global financial system is so
interconnected that even a relatively small part, such as
sub-prime mortgages, can cause a domino-like effect.
BI: What risks should investors be watching to
avert another crisis like that?
Gilbert: I’m not sure investors can avert a
future crisis if seeds have been sown and problems have grown.
What investors can watch for are signs of complacency, greed, and
overt risk-taking within the financial system. Leverage and
illiquidity are also the normal ingredients for more
systemic-style crises.
If investors see signs of these emerging then they should perhaps
prepare for the worst and hope for the best, in terms of
diversifying their portfolios.
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