Scope

After affecting banking and credit, mainly in the United States, the situation evolved into a global general financial crisis verging on a systemic crisis. Domino effect, as many institutions had financial links, and also psychological contagions (see behavioral finance), made it spread at the same time worldwide and to many financial and economic areas:

* Financial markets (stock exchanges and derivative markets notably) where it developed into a market crash,
* Various equity funds and hedge funds that went short of cash and had to get rid of assets,
* Insurance activities and pension funds, facing a receding asset portfolio value to cover their commitments,
* With also incidences on public finance due to the bailout actions.
* Forex, at least for some currencies (Icelandic crown, various Eastern Europe and Latin America currencies...), and with increased volatility for most of them

The first symptoms of what is called the Economic crisis of 2008 ensued also in various countries and various industries, as the financial crisis, albeit not the only cause, was a factor by making borrowing and equity raising harder.

[edit] Historical background

The initial liquidity crisis can in hindsight be seen to have resulted from the incipient subprime mortgage crisis, with the first alarm bells being rung by the 2006 HSBC results. The crisis was widely predicted by a number of economic experts and other observers, but it proved impossible to convince responsible parties such as the Board of Governors of the Federal Reserve of the need for action.[9][10]

One of the first victims was Northern Rock, a major British bank.[11] The highly leveraged nature of its business led the bank to request security from the Bank of England. News of this lead to investor panic and a bank run in mid-September 2007. Calls by Liberal Democrat Shadow Chancellor Vince Cable to nationalise the institution were initially ignored, however in February 2008, the British Government relented, and the bank was taken into public hands. Northern Rock's problems proved to be an early indication of the troubles that would soon befall other banks and financial institutions.

Excessive lending under loosened underwriting standards, which was a hallmark of the United States housing bubble, resulted in a very large number of subprime mortgages. These high-risk loans had been perceived to be mitigated by securitization. Rather than mitigating the risk, however, this strategy appears to have had the effect of broadcasting and amplifying it in a domino effect. The damage from these failing securitization schemes eventually cut across a large swath of the housing market and the housing business and led to the subprime mortgage crisis. The accelerating rate of foreclosures caused an ever greater number of homes to be dumped onto the market. This glut of homes decreased the value of other surrounding homes which themselves became subject to foreclosure or abandonment. The resulting spiral underlay a developing financial crisis.

Initially the companies affected were those directly involved in home construction and mortgage lending such as Northern Rock and Countrywide Financial. Financial institutions which had engaged in the securitization of mortgages such as Bear Stearns then fell prey. Later on, Bear Stearns was acquired by JP Morgan Chase through the deliberate assistance from the US government. Its stock price fell from the record high $154 to $3 in reaction to the buyout offer of $2 by JP Morgan Chase, subsequently the acquisition price was agreed on $10 between the US government as well as JP Morgan. On July 11, 2008, the largest mortgage lender in the US, IndyMac Bank, collapsed, and its assets were seized by federal regulators after the mortgage lender succumbed to the pressures of tighter credit, tumbling home prices and rising foreclosures. That day the financial markets plunged as investors tried to gauge whether the government would attempt to save mortgage lenders Fannie Mae and Freddie Mac, which it did by placing the two companies into federal conservatorship on September 7, 2008 after the crisis further accelerated in late summer.

See also: Federal takeover of Fannie Mae and Freddie Mac

It then began to affect the general availability of credit to non-housing related businesses and to larger financial institutions not directly connected with mortgage lending. At the heart of many of these institution's portfolios were investments whose assets had been derived from bundled home mortgages. Exposure to these mortgage-backed securities, or to the credit derivatives used to insure them against failure, threatened an increasing number of firms such as Lehman Brothers, AIG, Merrill Lynch, and HBOS.[12][13][13][14] Other firms that came under pressure included Washington Mutual, the largest savings and loan association in the United States, and the remaining large investment firms, Morgan Stanley and Goldman Sachs.[15][16]

[edit] Risks and regulations

For some analysts the first half of the 2000 decade will be remembered as a time that financial innovations and the CRA requirement of mandated lending to non creditworthy individuals overwhelmed the capacity of both regulators and banks to assess risk in the financial markets. The case of Citigroup is emblematic: Citigroup had always been under Federal Reserve regulation, and its near collapse shows that the regulation was ineffective, and that government underestimated the crisis severity even after it began. Citigroup was not alone in not being capable to understand fully the risks it was taking. As financial assets became more and more complex, and harder and harder to value, investors were reassured by the fact that both the international bond rating agencies and bank regulators, who came to rely on them, accepted as valid some complex mathematical models which theoretically "showed" the risks were much smaller than they actually proved to be in practice [17]. In George Soros' opinion "The super-boom got out of hand when the new products became so complicated that the authorities could no longer calculate the risks and started relying on the risk management methods of the banks themselves. Similarly, the rating agencies relied on the information provided by the originators of synthetic products. It was a shocking abdication of responsibility"