THE ORIGINS OF THE 2008 FINANCIAL CRISIS
The economic environment has changed dramatically over the past 12 months as the world appears to be headed into the deepest slowdown since the Great Depression. In October 2008, the Dow Jones Industrial Average had plunged 29 percent, oil prices were down 18 percent, the EUR/USD had fallen 10 percent and volatility in the stock market had surged 272 percent. For many of these instruments, the changes since July have been even more dramatic.
The current financial crisis has been called everything from the subprime mortgage crisis to the Wall Street crisis, credit crisis and a crisis of confidence. Each of these labels holds true because the financial crisis has been evolving, and that is why it is extremely important to be cautious.
DOT COM CRASH AND 9/11 (2000 – 2001) – It is difficult to pinpoint the exact origin of this financial crisis but many people argue that it stemmed from the loose monetary policy enacted by the Federal Reserve following the crash of the dotcom bubble and 9/11.
HOUSING MARKET BUBBLE (2001 – 2005) – Interest rates were taken to 45-year lows and the availability of cheap credit fueled a strong appetite for risk and a housing market bubble.
SUBPRIME CRISIS (2005 – 2006) – The housing market began to collapse in 2005 and 2006 when defaults started to increase on subprime and adjustable rate mortgages.
WALL STREET CRISIS (2007 – PRESENT) – It then exacerbated and turned into a Wall Street crisis when hedge funds went belly-up and banks started to report large write-downs in 2007. In March 2008, Bear Stearns became the first major investment bank to fail, requiring a bailout and acquisition by the Fed and JPMorgan. This turned out to be just the beginning of a slippery slope with IndyMac being seized by US regulators in July of 2008, while Fannie and Freddie were taken over in September. A week later, Lehman Brothers filed for bankruptcy, the government took an 80 percent stake in AIG and Bank of America gobbled up Merrill Lynch. Shortly after that, the last two remaining publicly traded U.S. investment banks (Goldman Sachs and Morgan Stanley) filed for change of status to bank holding companies while JPMorgan absorbed Washington Mutual.
CRISIS OF CONFIDENCE (2008 – PRESENT) – Century-old institutions evaporated from the financial markets as the credit crisis turned into a crisis of confidence. Banks became skeptical of lending to each other as they did not know who might be the next to fail.
SOVEREIGN DEBT CRISIS (2009 – PRESENT) – The debt crisis has escalated and started hitting whole countries like Greece, Ireland, Spain and Portugul who are struggling to cope with high levels of debt.
Crisis Management – Global Response
In response to the demise of many financial institutions, countries around the world have taken unprecedented actions. In addition to nationalising banks and injecting a massive amount of liquidity, the Federal Reserve and the U.S. Treasury have introduced an alphabet soup worth of new initiatives including the TARP (Treasury Asset Protection Program) the CPFF (Commercial Paper Funding Facility) and the MMIFF (Money Market Investor Funding Facility).
Other countries around the world have also upped their guarantees of bank deposits and are aggressively cutting interest rates. Don’t expect these to be the last initiatives introduced either. Since the financial markets have yet to stabilise, policymakers must be creative to combat a global recession.