Ten years ago this month the initial shocks started to appear across banks, financial service firms and market regulators. In this first part of a two-part series, we look at the key events leading up to the loud bangs that let the world knew that a global financial crisis was here.
Ten years ago this month the initial shocks started to appear across several organisations, banks, financial service firms and market regulators. The global financial crisis, which is believed to have lasted from mid 2007 to late 2009, was the worst and biggest credit crunch since the great depression of the 1930s. For most of the Americans, the financial crisis marked a heavy damage ranging from job losses to the collapse of the economy.
In March 2009, most of the global stock markets plummeted to the levels last seen three years before it. In October 2009, the unemployment rate in the United States rose to 10% for the first time since 1982. We take a look at the key events that told the world that there is a crisis going on.
Early shockwaves: February-July 2007
The initial signs of troubles were mostly missed by various stakeholders in the financial system. In February, Freddie Mac — the American federal home loan mortgage company — announced that it would no longer buy riskiest subprime mortgages and mortgage-related securities. In April, New Century Financial Corp, one of the leading subprime mortgage lenders, filed for bankruptcy. The leading credit research firms, Standard and Poor’s and Moody’s Investor Services downgraded over 100 bonds backed subprime mortgages in June. However, in the same month, the Federal Open Market Committee (FOMC) voted to maintain its target for the US Federal Reserve’s key policy rate at 5.25%.
Bear Stearns, one of the top investment banks in the US, informed investors that it would suspend redemptions from a fund investing in subprime bonds. Following this, Standard and Poor’s placed 612 securities backed by subprime residential mortgages on a credit watch. Meanwhile, insurance company Countrywide Financial Corp warned of “difficult conditions”. Later, American Home Mortgage Investment Corp filed for bankruptcy in July.
BNP Paribas: August 2007
Another trouble struck the financial markets when France’s largest bank BNP Paribas halted redemptions on three of its investment funds. The bank said it had not valued the underlying assets of the CDO (collateralised debt obligations) instruments. The subprime assets on which the so-called CDOs were made became worthless when borrowers defaulted. Amid all this, the FOMC still voted to maintain its target for the US Fed’s policy rate at 5.25%.
Northern Rock: September 2007
The UK’s Chancellor of the Exchequer authorised Bank of England to provide liquidity support for Northern Rock — the country’s fifth-largest mortgage lender. The credit crunch hit with full force when Northern Rock suffered the first run on a British bank since 1866. After two failed takeover offers, and with the continuing weakness in the financial system, Northern Rock was taken under state ownership by the Treasury of the United Kingdom in February 2008.
Regulator springs up
September 2007: The FOMC voted to reduce its target for the US Federal Reserve’s policy rate by 50 basis points to 4.75%.
October 2007: The FOMC again voted to cut its target for the federal Reserve’s rate by 25 basis points to 4.5%.
December 2007: The FOMC recommended yet another rate cut, voting to reduce its target for the federal reserve’s policy rate by 25 basis points to 4.25%.
January 2008: Meanwhile, Bank of America announced that it would purchase Countrywide Financial in an all-stock transaction worth approximately $4 billion. FOMC moved quickly, and in its continuing efforts to spur lending, it voted to reduce its target for the US Fed’s policy rate by a huge 75 basis points to 3.5%. Again in the same month, FOMC voted to reduce its target for the Fed rate by another 50 basis points to 3%.
President George W Bush signed the Economic Stimulus Act of 2008 into law in February 2008. Following this, in March 2008, the Federal Reserve Board announced the creation of Term Securities Lending Facility (TSLF), which would lend up to $200 billion of Treasury securities for 28-day terms against federal agency debt, federal agency residential mortgage-backed securities (MBS). In the same month, the FOMC voted to reduce its target for the US Fed’s key policy rate by 75 basis points to 2.25%.
Bear Stearns taken over: March 2008
Global investment bank Bear Stearns was highly active in the securitisation process and had issued a large number of asset-backed securities. The Federal Reserve Bank of New York announced that it would provide term financing to facilitate JPMorgan’s acquisition of The Bear Stearns Companies Inc. The Federal Reserve was afraid that the trillions of dollars on Bear Stearns’ balance sheet would become worthless and could possibly spark a global panic, if it doesn’t step in. Bear Stearns was bought by JPMorgan for $240 million — for a price of a measly $2 per share on 14 March 2008.
A breather and a short breath
April 2008: FOMC voted to reduce its target for the US Fed’s policy rate 25 basis points to 2%. Meanwhile, the International Monetary Fund (IMF) also predicted potential losses in the trillions of dollars.
June 2008: FOMC voted to keep its target for the US Federal Reserve’s interest rate at 2%.
July 2008: The Securities Exchange Commission (SEC) issued an emergency order temporarily prohibiting naked short-selling in the securities of Fannie Mae, Freddie Mac, and primary dealers at commercial and investment banks.
August 2008: The FOMC again voted to maintain its target for the US Fed’s key policy rate at 2%.
Fannie Mae and Freddie Mac: September 2008
Difficulties started surfacing at giant US government-backed mortgage buyers Fannie Mae and Freddie Mac. The Federal Housing Finance Agency (FHFA) placed Fannie Mae and Freddie Mac in government conservatorship. By 7 September 2008, the US government was forced to bail out the two entities.
Lehman Brothers collapse: The doom of 15 September 2008
For many, the bugle of the global financial crisis was sounded by the fall of the United States’ fourth largest investment bank Lehman Brothers. In September, Bank of America announced its intent to purchase Merrill Lynch & Co for $50 billion. Later in the day, the unimaginable happened as Lehman Brothers filed for bankruptcy after potential buyers walk out of the deal. The panic was at a high throughout the world markets, especially as Lehman Brothers had assets worth $639 billion, which were inter-dependable on other major banks too.
The very next day the Federal Reserve was forced into an $85 billion bailout of the American International Group (AIG). On its part, the SEC announced a temporary ban on short selling on all of the financial sector stocks. The FOMC voted to maintain its target for the US Federal Reserve’s key policy rate at 2%.
Read Part 2 to know about the hectic events that followed soon after the fall of Lehman Brothers during the course of the global financial crisis.