That morning Chancellor Alistair Darling knew the Lehman effect would ripple far and wide. They decided HBOS directors had to be told that 'soldiering on wouldn't do'. The world's biggest insurance company, AIG, had seen its stock market value collapse. There were fears that if the firm, sponsor of Manchester United, were to go under it would bring the world banking system down.
This was because AIG had transformed itself from a boring insurance company into one at the vanguard of the new credit default swap market. AIG was in the business of insuring leveraged debt just at the time when the financial system was on a precipice. It would not be the last time AIG got help. He asked the FSA to put out a statement saying that the former building society was 'well capitalised'. For now, attention swung back to Wall Street.
Rumours circulated that Goldman Sachs might be in trouble. So worried did regulators become that they slapped a temporary ban on short-selling of financial stocks to prevent shares falling further. The week ended with Hank Paulson unveiling an audacious plan to inject hundreds of billions of dollars of taxpayers' money to buy up toxic assets.
On Sunday, German chancellor Angela Merkel got the week off to an acrimonious start by promising to guarantee the accounts of all her countrymen's savers, destroying efforts to build a European concensus on a rescue strategy. Gordon Brown promised to do 'whatever it takes' to halt the panic. But that was only the start of a nerve-shattering week, in which the world's financial system came closer to absolute collapse than at any time since the s.
Businesses up and down the country would later insist that in October, everything, 'fell off a cliff'; and this was the week it began. For Brown, it started with the first meeting of his National Economic Council - a gathering of senior ministers, styled as a war cabinet for the credit crunch. But not far away in the City, as rumours swirled around of an emergency taxpayer-backed rescue for Britain's battered banks, shares were plunging, losing almost 8 per cent of their value by the time the markets had closed.
A month after the ignominious collapse of Lehman Brothers, investors remained gripped by stomach-churning vertigo: the bankruptcy of the Wall Street giant forced traders everywhere to think the unthinkable - no firm, however venerable, was too good to fail.
In fact, plans for a bail-out were still sketchy; but the markets impose a timetable all of their own, and as the sell-off intensified, Treasury officials worked late into the night in Whitehall to fill in the details. Britain was far from alone in grappling with financial panic. Thousands of miles away in Reykjavik, the Icelandic government was rushing through an emergency bill to take control of its collapsing banks, and sending out feelers to the International Monetary Fund about a potential emergency loan, as the credit crunch plunged the overheated Icelandic economy deep into the red.
The day began with a 5am crisis meeting at Number 11 Downing Street to put the final touches to the 'recapitalisation' that Brown would then urge the rest of the world to emulate. At 19 minutes to 12, as Brown prepared for his first prime minister's questions since parliament's summer recess, his phone rang: it was Mervyn King, informing the prime minister that interest rates would be cut by half a percentage point, at noon, in a move co-ordinated with central banks around the world.
Like Brown, King had at times seemed caught on the back foot by the mounting financial and economic crisis of the summer and early autumn; but the Bank, too, was now ready to gallop into action. By , U. This caused real hardship to many Americans. Their homes were worth less than they paid for them. They couldn't sell their houses without owing money to their lenders.
If they had adjustable-rate mortgages, their costs were going up as their homes' values were going down. The most vulnerable subprime borrowers were stuck with mortgages they couldn't afford in the first place. In , it filed for bankruptcy protection. As got underway, one subprime lender after another filed for bankruptcy. During February and March, more than 25 subprime lenders went under. In April, New Century Financial, which specialized in sub-prime lending, filed for bankruptcy and laid off half of its workforce.
Even these were small matters compared to what was to happen in the months ahead. It became apparent by August that the financial markets could not solve the subprime crisis and that the problems were reverberating well beyond the U. The interbank market that keeps money moving around the globe froze completely, largely due to fear of the unknown. Northern Rock had to approach the Bank of England for emergency funding due to a liquidity problem. In the coming months, the Federal Reserve and other central banks would take coordinated action to provide billions of dollars in loans to the global credit markets, which were grinding to a halt as asset prices fell.
Meanwhile, financial institutions struggled to assess the value of the trillions of dollars worth of now-toxic mortgage-backed securities that were sitting on their books. By the winter of , the U. In January , the Fed cut its benchmark rate by three-quarters of a percentage point—its biggest cut in a quarter-century, as it sought to slow the economic slide. The bad news continued to pour in from all sides.
In February, the British government was forced to nationalize Northern Rock. By the summer of , the carnage was spreading across the financial sector. IndyMac Bank became one of the largest banks ever to fail in the U.
That same month, financial markets were in free fall, with the major U. The Fed, the Treasury Department, the White House, and Congress struggled to put forward a comprehensive plan to stop the bleeding and restore confidence in the economy.
The Wall Street bailout package was approved in the first week of October The package included many measures , such as a huge government purchase of "toxic assets," an enormous investment in bank stock shares, and financial lifelines to Fannie Mae and Freddie Mac.
The public indignation was widespread. It appeared that bankers were being rewarded for recklessly tanking the economy. But it got the economy moving again. It also should be noted that the investments in the banks were fully recouped by the government, with interest. The passage of the bailout package stabilized the stock markets, which hit bottom in March and then embarked on the longest bull market in its history. Still, the economic damage and human suffering were immense. About 3. The most ambitious and controversial attempt to prevent such an event from happening again was the passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act in On the financial side, the act restricted some of the riskier activities of the biggest banks, increased government oversight of their activities, and forced them to maintain larger cash reserves.
On the consumer side, it attempted to reduce predatory lending. By , some portions of the act had been rolled back by the Trump Administration, although an attempt at a more wholesale dismantling of the new regulations failed in the U. Those regulations are intended to prevent a crisis similar to the event from happening again.
Which doesn't mean that there won't be another financial crisis in the future. They created interest-only loans that became affordable to subprime borrowers. In , the Federal Reserve raised the fed funds rate just as the interest rates on these new mortgages reset. Housing prices started falling in as supply outpaced demand.
That trapped homeowners who couldn't afford the payments, but couldn't sell their house. When the values of the derivatives crumbled, banks stopped lending to each other.
That created the financial crisis that led to the Great Recession. The repeal allowed banks to use deposits to invest in derivatives. Bank lobbyists said they needed this change to compete with foreign firms.
They promised to only invest in low-risk securities to protect their customers. The following year, the Commodity Futures Modernization Act exempted credit default swaps and other derivatives from regulations. This federal legislation overruled the state laws that had formerly prohibited this form of gambling.
It specifically exempted trading in energy derivatives. Who wrote and advocated for passage of both bills? He listened to lobbyists from the energy company Enron. Senator Gramm's wife, who had formerly held the post of Chairwoman of the Commodities Future Trading Commission, was an Enron board member. Enron wanted to engage in derivatives trading using its online futures exchanges. Enron argued that foreign derivatives exchanges were giving overseas firms an unfair competitive advantage.
Big banks had the resources to become sophisticated at the use of these complicated derivatives. The banks with the most complicated financial products made the most money. That enabled them to buy out smaller, safer banks. By , many of these major banks became " too big to fail. How did securitization work? First, hedge funds and others sold mortgage-backed securities , collateralized debt obligations , and other derivatives.
A mortgage-backed security is a financial product whose price is based on the value of the mortgages that are used for collateral. Once you get a mortgage from a bank, the bank sells the loan on the secondary market. The hedge fund then bundles your mortgage with a lot of other similar mortgages. They used computer models to figure out what the bundle is worth based on several factors. These included the monthly payments, the total amount owed, the likelihood you will repay, and future home prices.
The hedge fund then sells the mortgage-backed security to investors. Since the bank sold your mortgage, it can make new loans with the money it received. It may still collect your payments, but it sends them along to the hedge fund, who sends it to their investors.
Of course, everyone takes a cut along the way, which is one reason they were so popular. The bailouts of weren't just about the government buying shares, but also about changing the face of banking. Investment banks Morgan Stanley and Goldman Sachs couldn't get involved with commercial consumer banking until the financial crisis.
At that point, the Federal Reserve allowed them to become commercial banks so they could access funds by borrowing heavily, using the discount window the Fed offers commercial banks, as well as access to other government guarantee programs extended to these types of banks. Both Morgan Stanley and Goldman Sachs borrowed billions at these low rates to help stabilize their operations.
On top of that, becoming commercial banks has allowed them to tap into the consumer market in a way that they were unable to do before. Today, Morgan Stanley offers a variety of banking services in addition to investment banking. Goldman Sachs is still one of the most powerful banks in the world with an esteemed reputation. All core business units witnessed growth. Bank of America had to take on losses related to those companies, including shouldering legal fees associated with Countrywide's questionable mortgage lending practices.
Even with these costs, though, Bank of America is booming today. It's America's second-largest bank. It did struggle during the pandemic, with both revenues and income down in from However, its assets and deposits continue to steadily grow. More than a decade after the financial crisis, there's a good chance that facing a similar situation, the government would pledge money to bail out financial institutions. While that much money might not have been spent directly, the government essentially offered itself as a backstop to dozens of banks considered essential to the U.
However, if faced with another meltdown, it's doubtful that the government would stop at propping up so few financial institutions. The financial crisis threatened to wipe out trillions of assets in the U. The government stepped in with a massive bailout package to prevent these institutions from going under and further damaging the economy. Though a few of these institutions were allowed to fail, such as Lehman and Bear, the government prevented the collapse of other large banks, all of which continue to thrive today.
The New York Times. CNN Money. The Wall Street Journal. Department of the Treasury. The Financial Times. Morgan Stanley.
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