| Bank failures |
Investment banks today are highly leveraged players. For every dollar of actual capital they posses, they borrow up to $30, to $60 dollars. Any big loss therefore has the potential of wiping out their entire capital base.
It is a risky business. They are insulated in part because of the liquidity in money markets. If they do face losses they could borrow to quickly meet their obligations and pay off from future profits.
In the wake of the Subprime crisis, banks which had had exposure to the products related to the housing market, faced huge losses.
The market on the other hand was spooked because it did not really know which firm had had how much exposure. If they lent to, say to company A, and it had these toxic bonds, then it may face a big enough loss to render it unable to payback.
This fear froze the markets all together. No lending was taking place. Liquidity had completely dried up. Banks were also not lending to businesses outside the financial sector to keep funds in hand to meet emergencies.
In September 2008, Fannie Mae (Federal National Mortgage Association) and Freddie Mac (Federal Home Loan Mortgage Corporation), two US government backed mortgage lenders were placed in conservatorship by the FHFA. The decision was backed by the Secretary of Treasury, Henry Paulson, and Federal Reserve Chairman Ben Bernanke.
A week later, on September 14 the US financial system was shaken to it very foundation by bankruptcy filing by the Lehman Brothers, one of the big 5 Wall Street banks. The same day the Merrill Lynch another Wall Street giant was sold off to the Bank of America to avoid bankruptcy. Reports indicated that Lehman’s collapse was precipitated by JP Morgan Chase which froze the bank’s assets well before it filed for bankruptcy.
A third company, American International Group (AIG), the largest US insurer, suffered a liquidity crisis two days later, and appeared tottering on the brink of a collapse. The collapse of Lehman had already destabilized the markets.
It was felt that the collapse of AIG could seriously harm the market, the government gave emergency funding amounting to $85 billion to the company in exchange for a 79.9% stake in the company. Though AIG was saved it was left bruised and battered. Of the big 5 firms on Wall Street only two were left standing after the crisis. JP Morgan and Goldman Sachs. Goldman Sachs one of the most venerable financial institutions in the world, which only a few years ago was giving out bonuses to the tune of hundreds of thousands, and millions in some cases, recorded a 53% fall in profit mid 2008. In December the firm recorded its first quarterly loss since it went public in 1999, around $2.29 bn in the 4th quarter 2008.
Screaming headlines around the globe dubbed it the worst week in the history of Wall Street. Analysts predicted that the era of swashbuckling investment banking had ended.
More than 500,000 jobs were lost in the US in November alone. In mid September, when the extent of the financial crisis was just becoming apparent, job losses in the financial sector already stood at 110,000 (computed for 2008). JP Morgan Chase itself announced a cut of 9,200 jobs in December.
Others went so far as to see the mayhem on Wall Street, as the beginning of the end of US’ economic dominance.
The Fed on its part kept aggressively lowering its lending rate; it was to reach near zero by mid December. The Federal Reserve also poured in $105 billion into the markets on September 18th to stave off an immediate market collapse.
For better or worse (we are still to know the answer) the US government had embarked on an aggressive interventionist policy to prevent financial meltdown, when it decided to lend to AIG.
The financial crisis was not limited to the US. On October 16, the Swiss government announced a rescue plan for the Swiss banks UBS and Credit Suisse.
Three days later, the government of the Netherlands rescued ING from imminent collapse with a €10 billion package. Germany’s BayernLB too decided to apply for funds from the German €500 billion rescue program.
After the forced nationalization of Northern Rock, the UK government decided to inject GBP37 billion in the nation’s three largest banks, Royal Bank of Scotland (RBS), Lloyds and HBOS. The government would own majority stake in RBS and 40% stake in the other two banks.
France also announced a €10.5 billion rescue plan for six of its largest banks, including Crédit Agricole, BNP and Société Générale.
|
|
|
