Scandals and Setbacks: a Financial Summary of 2008
2008 will forever be the year that subprime mortgages and corporate scandals altered the face of Wall Street. With $800 billion in writedowns and losses the market found itself buried under the weight of the subprime crisis. Stock markets worldwide crashed by more than $30 trillion taking mega investment houses like Bear Stearns down with them. At the core of the problem were investments tied to faulty valuation models and high-risk mortgage-backed securities and their derivative spin-offs, collateralized debt obligations (CDOs), which all lead to State, municipal and corporate pension funds suffering huge losses.
Then there’s the near financial collapse of mortgage giants Fannie Mae and Freddie Mac and American Insurance Group (AIG), which required a financial intervention courtesy of the U.S. government. Lehman Brothers, the fourth largest investment bank in the United States, filed for bankruptcy protection in 2008. Washington Mutual and IndyMac, along with some 20 other banks were forced to close their doors. Government bailouts reached an astronomical $9 trillion. And as a final nod to 2008, investors lost some $50 billion in a Ponzi scheme orchestrated by the former Nasdaq chairman, Bernard (Bernie) Madoff.
For investors, 2008 is the year that went from bad to worse. It began with the collapse of the auction-rate securities market in February 2008 and continued with credit default swaps and structured investment products. For the first time since the 1930s, the Dow Jones Industrial Average experienced losses of more than 30%, closing the year at 8,776.39. By comparison, the Dow finished out 2007 at 13,264.82. Bank stocks in particular took a beating in 2008, with Bank of America and Citigroup losing nearly 70% of their value. As for shareholders, they saw about $7 trillion of their wealth wiped out.
In the world of ultra-short bond funds, 2008 provided the lesson that ultra short does not translate to “ultra safe.” A number of supposedly safe and conservative ultra-short funds got into trouble in 2008 by investing in risky mortgage-backed securities and collateralized mortgage obligations (CMOs). When losses in those toxic assets began to skyrocket, investors lined up to pull their money out in droves, sparking a wave of fund redemptions.
As a result, several fund managers were forced to liquidate their funds’ assets. State Street Global Advisors’ SSgA Yield Plus Fund began liquidating in May after the fund fell 19%. It turns out more than 50% of the fund’s assets were tied to mortgage-related securities funds. One month later, the Evergreen Ultra- Short Opportunities Fund liquidated, as well, when its assets plunged more than 20% in value.
Investors, meanwhile, are suing the funds, charging that they investments were represented as conservative “cash alternatives” and similar to money-market funds. Far from safe or conservative, the funds were heavily concentrated in risky mortgage and asset-backed securities
Capping out 2008, of course, is the Bernie Madoff scandal. The disgraced hedge fund manager was arrested December 11, 2008 by federal agents on charges of securities fraud for scamming $50 billion from investors. Meanwhile, the Securities and Exchange Commission (SEC), the supposed protector of investors and their investments, apparently turned a blind eye to Madoff’s subterfuge over the years by ignoring red flags that signaled problems with his funds and their “too-good-to-be-true” returns.
Confidence in Wall Street was ultimately lost, with the enormity of the Madoff scandal, and the failure of government officials to step in before it was too late. Subsequently, investors and Wall Street will forever be scarred from a year that was punctuated by the subprime crisis and corporate scandals – including the implosion of Bear Stearns, the collapse of the auction rate securities market, the bankruptcy of Lehman Brothers and inept accounting practices by Fannie Mae and Freddie Mac and other institutions.