The Global Financial Crisis

The Setup

The displacement came out of the last crash: with the dot-com bust and 9/11 behind it, the Fed held rates at 1% into 2004 while a glut of global savings — Asia’s post-1997 reserves prominent among them — hunted for anything safe that yielded more than Treasuries. American housing debt, laundered to AAA, became the world’s favorite answer.

The machinery was securitization. Originators sold loans the day they were signed; Wall Street pooled them into bonds, re-pooled the leftovers into CDOs, and the rating agencies — paid by the issuers — stamped the top slices AAA. Shadow banks bought the paper with money borrowed overnight.

Originate-to-distribute severed lending from repayment: the machine needed mortgages, any mortgages, and overnight-funded shadow banks held the AAA output. Doubt the collateral, and the funding runs — a 1907 bank run wearing a repo haircut.

When house prices themselves became the only thing keeping the loans current — refinance or default — the machine responded by lowering standards to keep fed: no income, no job, no problem.

S&P CoreLogic Case-Shiller US national home price index, monthly, 1998–2012 · S&P DJI via FRED (CSUSHPINSA)

Displacement, 2001–03

Emergency rates for an emergency that fades, plus a wall of foreign savings: the raw material of every credit bubble, delivered to the one asset Americans believed could never fall nationwide.

Boom, 2003–05

Subprime origination triples. Since the originator sells the loan by Friday, the only underwriting question that matters is whether Wall Street will buy it — and Wall Street buys everything.

Euphoria, 2005–06

Interest-only, negative-amortization, piggyback seconds; a fifth of buyers in the hot states are flippers. Prices peak in mid-2006 with the machine still running at full speed — the loans made at the top are the worst ever written.

Distress, 2006–08

The two-year distress phase is the shadow bank run in slow motion: subprime lenders die through 2007, BNP’s August freeze reveals that nobody can price the AAA paper, Bear Stearns is sold for the price of its building in March 2008. Everyone knows; nobody moves first.

Panic, autumn 2008

Lehman files on September 15 and the run goes general: money funds break the buck, commercial paper freezes, AIG is nationalized over a weekend. The panic ends only when the state stands under the whole system — guarantees, TARP, swap lines, QE. Houses grind down to −27% by 2012; the S&P has already given up 57%.

The Reckoning

−57% S&P 500, October 2007 to March 2009

$700bn TARP — plus trillions in guarantees

8.7M US jobs lost

2008 is the book’s vindication chapter. A credit bubble on the most leveraged asset in the economy produced exactly what Kindleberger’s model predicts — and the response, lending freely against the panic, is what he spent his career arguing for. The Fed’s swap lines quietly made it the lender of last resort to the entire world, the role the book’s final chapters say someone must fill and nobody wants to name. A decade of moral-hazard argument later, the crypto mania was already underway.

What it cost

By the time the Financial Crisis Inquiry Commission reported in January 2011, about four million American families had lost their homes to foreclosure and another four and a half million had slipped into the foreclosure process or were seriously behind on their mortgage payments. US unemployment had peaked at 10.0% in October 2009, 15.4 million people. In Europe the bill arrived later and stayed longer: Greek unemployment reached 27.8% in 2013, Spanish unemployment 26.1%.

~4 million American families that had lost their homes to foreclosure by the time the Commission reported, with another four and a half million in the foreclosure process or seriously behind on their payments Financial Crisis Inquiry Commission, The Financial Crisis Inquiry Report, January 2011, preface and chapter 22
10.0% US unemployment in October 2009, 15.4 million people out of work, against 4.6% and 7.1 million for 2007 as a whole Economic Report of the President 2013, Table B-35, on Bureau of Labor Statistics data
9.8% → 27.8% Greece’s unemployment rate, 2009 to 2013; Spain’s went from 17.9% to 26.1% over the same four years Eurostat, Unemployment by sex and age — annual data (une_rt_a), ages 15–74, both sexes

Karen Mann, an appraiser from Discovery Bay, California, testified to the Commission about her own family. Her daughter and son-in-law had refinanced into an adjustable-rate mortgage; when the rate adjusted upward, new financial trouble put the payments beyond them. Because the house was worth about what they owed, their attempts to have the mortgage modified came to nothing, and a short sale they had lined up was nixed. The couple and their four children moved in with Mann and filed for bankruptcy. Two months after the bankruptcy was completed, the lender asked them if they wanted to modify their mortgage.

Financial Crisis Inquiry Commission, The Financial Crisis Inquiry Report, January 2011, chapter 22, on Mann’s testimony to the Commission

What followed

The governments that fell were European. The Congressional Research Service counted governments in Greece, Ireland, Italy, the Netherlands, Portugal, Slovenia, Slovakia and Spain that had collapsed or been voted out of office after calling early elections, each after deep cuts in public spending, rising unemployment and recession. In Greece the neo-fascist Golden Dawn entered the national parliament at the elections of May and June 2012.

Congressional Research Service, The Eurozone Crisis: Overview and Issues for Congress, R42377, 25 March 2013 · Iceland and Ireland, 2008