August 9, 2007: The day the mortgage crisis became widespread

Ten years ago on Wednesday, the first glimpses of the global financial crisis emerged.

August 9, 2007 marked the start of the deepest economic disruption since World War II. Thursday’s events made it clear that excess risk loans would not be “contained,” as then Federal Reserve Chairman Ben Bernanke had predicted a few months earlier. Yet few people appreciated the scale of the disaster that would unfold over the next 18 months.

It is now widely accepted that the global financial industry was over-leveraged, that the US mortgage market was teeming with loans that would not be repaid, that investors and financial institutions around the world were paying high prices for well-rated securities that were in debt. extremely risky reality.

For a decade

Ten years ago, French bank BNP Paribas froze three investment funds over losses from US home loans, an event seen in hindsight as the start of the deepest economic disruption since World War II. Below are some of the stories on from about that day.

Ten years later, it’s clear those mistakes sparked a crisis that in 2008 rocked the world, bringing down Bear Stearns Cos. and Lehman Brothers Holdings Inc. and forcing the $ 182 billion bailout of American International Group. Inc.

But at the time, this broader meaning was not obvious, even to the executives of the financial sector and the central bankers charged with overseeing them. The economy was growing at a pace of almost 4% and stocks were hitting new highs. Many still believed that the mortgage problems would go away.

In the minds of many at the time, what Wall Street began to struggle with on August 9 was a shortage of liquidity in the trading of risky securities, which could be addressed with repeated injections of central bank money.

Looking back, Wall Street faced a widespread crisis of confidence, in a financial world whose myriad interconnections would help transmit and amplify problems.

Investors knew before that day that the downgrade of subprime loans would lead to losses. But few realized they would manifest with such disruptive effects in Europe, thousands of miles from the epicenter of the subprime mortgage crisis in Southern California.

Investors understood that the real estate crisis would affect the finances of major lenders like Countrywide Financial Corp. , house prices fell and losses began to pile up.

The magnitude of the existing losses and the efforts to keep the system running would eventually combine to turn the August liquidity crisis into a real race in the markets.

That day did not only reveal the disarray of the global financial industry. He also shed light on behavioral patterns that have helped deepen the crisis, including investors’ expectation that central bankers and other policymakers would step in when markets start to tremble.

On August 9, for example, a surge in short-term interest rates like Libor prompted central bankers to act, pumping funds into the market and pledging additional support. These efforts were successful, but they did not create the incentives for capital raising and deleveraging, which the markets desperately needed.

Ultimately, these behaviors helped trigger a recurring cycle of panic and intervention that would only be broken when the governments of the United States and Europe step in later in 2008 and put emphasis on their balance sheets. national.

From an August 2017 perspective, it is clear that there have been changes. Subprimes have been banned from the lexicon. Banks are better capitalized and more liquid. Investors are constantly on the lookout for imbalances that could signal an upcoming market catastrophe.

Yet the markets’ dependence on the largesse of central banks appears largely unchanged. Falling volatility readings and rising valuations of all asset classes seem to presume that any market shock or economic downturn can be easily contained. Some lessons may be easier to learn than others.

Write to Colin Barr at [email protected]

Copyright © 2022 Dow Jones & Company, Inc. All rights reserved. 87990cbe856818d5eddac44c7b1cdeb8