The dominoes fall: a timeline of the squeeze and crash ...(Editorial)

In its leader of October 13, 2008, the Financial Times characterized the western world's banking system as suffering 'the equivalent of a cardiac arrest.' The collapse of confidence in the system means that 'it is now virtually impossible for any institution to finance itself in the markets longer than overnight.' This occurred less than a month after Lehman Brothers collapsed, without bailout. Six months earlier Bear Stearns had been bailed out after JPMorgan Chase had bought it for $10 a share, at the regulator's urging. After Lehman fell, who would be next? And if Lehman, who was not at risk? Despite the earlier U.S. government bailouts of the erstwhile government mortgage originators, Fannie Mae and Freddie Mac, and the later bailout of the world's largest insurer, American International Group (AIG), everything changed with the demise of Lehman Brothers.

The FT was describing the freezing of the interbank credit market. After Lehman's fall, so-called counterparty risk was seen as prohibitive to prospective lenders, at any price. This was revealed in the TED spread, the difference between the cost of interbank lending, the London Inter Bank Offered Rate, or LIBOR, on three-month loans in U.S. dollars, and the closest instrument to risk-free, three-month U.S. government bonds. In normal times the TED spread is between 10 and 20 basis points (bp), or 0.10 and 0.20 percent per annum, but on October 10, the TED spread reached 465 bp, when a lender could be found. As I write, it has fallen back to below 200 bp.

I sit in a coffee shop that sports the sign 'We are cash only, sorry for the inconvenience :-)'. I'm sure this is to avoid the hassle of credit cards, but such signs were massing off-stage in mid-October. How so? Imagine that banks refused to honour other banks' credit card debts. Then cash would soon become king for retail purchases. But what of letters of credit, used in international trade? What of other bank-backed credit instruments? And cash, fiat money, also relies on trust and confidence--of government. And where the government can't be trusted ... well, look at Zimbabwe.

Thankfully, the U.S., U.K., European and Australian governments understood the abyss that faced the world economy, and the U.K. action at supporting its ailing banks and guaranteeing interbank lending was soon imitated elsewhere. The financial crisis, although severe, has not been catastrophic, although many have been inconvenienced or worse, but few have lost assets. Millions, however, have seen the value of their assets on the stock market dwindle. Of course, the crisis was triggered by the end of the U.S. housing bubble, and these prices have tumbled as the crisis has led to further sales to improve liquidity. Many have also lost their jobs, at first in the finance industry, but now increasingly in the real economy.

But shed no tears for the shareholders or top managers of the U.S. finance companies. The best description I have seen of the process that resulted in the subprime (SP) mortgage meltdown is a piece by Michael Lewis (2008), author of Liar's Poker. Lewis gives a very insightful timeline of the unfolding of the crisis.

There are three kinds of indicators: prices and interest rates in financial markets, the performance of firms in the finance industry (at least at first), and then government responses to the growing crisis. Using Lewis' description and the weekly updates in The Economist, I have attempted to put together my own timeline of the past eighteen months, which I present here, with no further analysis. Other sources, apart from on-line newspapers, have been Kate Jennings' (2008) 'American Revolution', and pieces by John Lanchester in the London Review of Books. (I find that the succession of shocks means that I soon forget what happened when, and leave the analysis of these events to others.) Except where otherwise indicated, all dollar amounts are U.S. dollars. (I thank Chris Adam for his help.)

 
1999 March:          At the Futures Industry Association, Alan 
                     Greenspan, Chairman of the Board of Governors of 
                     the U.S. Federal Reserve (the Fed) from 1987 to 
                     2006, argues that derivatives should remain 
                     unregulated, despite the demise of Long-Term 
                     Capital Management the previous year. 
 
1999 November 12:    The U.S. Gramm-Leach- Bliley Financial Services 
                     Modernization Act repeals the Glass-Steagall Act 
                     of 1933, the purpose of which was to prohibit the 
                     emergence of consolidated financial/insurance 
                     one-stop-shop corporations, in order to reduce 
                     the threat of contagion: banks were not allowed 
                     to own insurers or securities companies (and vice 
                     versa) and had to operate in a single state, inter 
                     alia. Lobbying by Citibank (subsequently to become 
                     Citigroup) and others has finally borne fruit. 
 
2000 December 13:    The U.S. Commodities Futures Modernization Act, 
                     which allows banks to continue to self-regulate 
                     derivatives, is passed. 
 
2004 July 21:        The U.S. Securities and Exchange Commission (SEC) 
                     launches the 'Consolidated Supervised Entities' 
                     program, a voluntary program that relaxes the 
                     minimum capital requirements for investment banks. 
 
2006 April:          Merrill Lynch warns that Iceland's banks have 
                     unsustainable levels of borrowing. 
 
2007:                In 2006 Moody's makes more than 40% of its 
                     revenues from rating 'structured products' such as 
                     Collateralized Debt Obligations (CDOs), a type of 
                     asset-backed security and credit product. Likewise 
                     Standard & Poor's and Fitch's. Moreover, sub-prime 
                     (SP) mortgages can be repackaged into CDOs in a 
                     way that makes 'default an extremely low 
                     mathematical probability ... If banks were 
                     forced to sell securities that had been 
                     downgraded, liquidity could dry up.' from The 
                     Economist, July 12, 2007, 'AAAsking for trouble.' 
 
2007:                Two thirds of the U.S. SP mortgages issued in 
                     2006 were securitised. Michael Milken calls 
                     securitisation the 'democratization of capital.' 
 
2007 April:          BHP Billiton's friendly approach to Rio Tinto is 
                     rejected. 
 
2007 June:           Global buy-out volumes peaked at over $150 bn in 
                     June. 
 
2007 July:           Rio Tinto buys Alcan for $38.1 bn, mainly using 
                     debt. 
 
2007 July:           As high-yield credit-default-swap (CDS) premiums 
                     year upwards, the first news articles appear about 
                     the U.S. SP mortgage impact on global credit 
                     markets. 
 
2007 July 5:         Swiss bank UBS's CEO quits. UBS is the world's 
                     biggest manager of other people's money. 
 
2007 July 17:        Two of Bear Steams' hedge funds, betting on CDOs 
                     ...