“It is not what you don’t know that gets you into trouble. It is what you know for sure that just ain't so.” Though the author of the quote is still unknown, there is nothing better than this to define the global financial crisis of 2008. Lewis Renary came up with mortgage-backed securities (MBS) in the late 1970s. While the American banking industry made good money by selling these MBSs and collateralised debt obligations (CDO), the bedrock of the US economy, the housing market, was heading towards a disastrous collapse. To put it simply, banks were on a lending spree, giving loans to people who did not have the capacity to repay them. They sold securities in the form of CDOs in the market backed by these bad loans. And in the latter half of 2008, when the real estate bubble burst, Lehman Brothers went bankrupt. Bear Stearn's stock hit zero and Merrill Lynch sold itself to Bank of America. Worse, as many as three million people lost their jobs and five million were rendered homeless. Here is a trip down that terrifying period that left economic pandits shocked.
February-December 2007: Freddie Mac, an American federal home loan mortgage company said it wouldn’t buy the riskiest subprime mortgages. In April, New Century Financial Corp, one of the top subprime mortgage lenders, filed for bankruptcy. Credit rating agencies like Standard and Poor's, and Moody's downgrades more than 100 bond-backed subprime mortgages.
Bear Stearn, the top investment banks, told investors it would suspend redemption from a fund investing in subprime bonds. BNP Paribas of France halted the redemption of three of its investment funds. The bank said that the subprime assets on which collateralised debt obligations (CDO) were made had turned worthless as the borrowers had failed to pay back.
In September 2007, Northern Rock, the fifth-largest mortgage lender in the UK, was taken under state ownership after two takeover offers failed. Despite all this, the Federal Open Market Committee (FOMC) did not change policy rates.
January 2008: With the American housing market going bust, the Fed Fund rate was reduced twice to help people pay off their adjustable rate mortgages. However, since the repayment position had turned so bad that even banks began facing a liquidity crisis, the move did not offer any relief to the home loan borrower, whose liability only kept on increasing.
February 2008: To help the struggling housing market, US President George Bush signed a tax rebate bill that increased the limits of loans backed by the Federal Housing Administration. If borrowers fail to repay the lenders, FHA would. This move allowed Freddie Mac to repurchase some jumbo loans. Though home loan sales went up briefly, they were still lagging on a year-on-year basis.
March 2008: Realising that the tax rebate bill was not going to be enough, the Fed announced $200 billion worth of Treasury Notes to bail out dealers caught in the web of mortgage-backed securities and CDOs. Fed had an emergency meeting and asked JPMorgan to buy Bear Stearn. It also created a Fed discount window called Term Auction Facility to enable banks to deal with their subprime mortgage debt.
April, May, June 2008: Fed kept on decreasing the policy rates and released more money under the Term Auction Facility.
July 2008: IndyMac Bank failed. People waited outside its office to withdraw their deposits from the failed lender. Freddie Mac and Fannie Mae were headed down the same path. Congress passed a small bailout bill giving the Treasury Department authority to guarantee as much as $25 billion in loans held by Fannie Mae and Freddie Mac.
September 2008: After having pumped in a huge amount to help banks, the US government said no to any further bailout. As a result, the Wall Street behemoth Lehman Brothers collapsed on September 15, 2008. The bank had to file for bankruptcy as none of the potential buyers showed intent. This huge event sent a panic wave across the globe as Lehman Brothers had assets worth $629 billion that were interdependent on other banks as well. Merrill Lynch sold itself to Bank of America for $50 billion. On September 16, 2008, American International Group had to seek an $85 billion bailout from the Federal Reserve.
September 17, 2008: The crisis deepened as panic-stricken investors fled money market mutual funds. Businesses ran out of money to fund their day-to-day operations.
September 18, 2008: The Congress was asked to approve a $700-billion bailout to buy MBSs that were about to default. This would have taken the debt off from the books of the banks, hedge funds, and pension funds that were holding them.
September 22: Goldman Sachs and Morgan Stanley now felt the need for Fed protection. They applied to become regular commercial banks from investment banks. Later on September 26, Washington Mutual Bank went bankrupt as panic-stricken investors withdrew $16.7 billion in 10 days.
September 29: The stock markets crashed as the Congress rejected the bailout proposal. Dow Jones Industrial Average plummeted 770 points. Global markets, oil tumbled, gold prices shot up.
October-December: Congress approved a $700 billion bailout plan. However, the global stock markets continued to fall. Fed lowered the rates and the Treasury inserted $105 billion in Troubled Asset Relief Program (TARP) funds into eight banks in return for preferred stock. In the entire financial horror show, over three million jobs were lost, and around five million people were left homeless.