Six years ago today on August 9, 2007, the term 'credit crunch' entered the popular lexicon and signalled the start of the worst global financial crisis since the Great Depression of the 1930s. Europe is currently showing the latest tentative signs of recovery but Ireland and many other advanced countries face grim challenges ahead and the reality that the bubble level prosperity of the crazy years may remain elusive for a very long time.
Finfacts reported on February 08, 2007 that HSBC, the global bank, had incurred big losses on subprime mortgages in the United States.
Wishful thinkers claimed that the subprime crisis would be contained and Chuck Prince, then Citigroup chief executive infamously, told The Financial Times in early July 2007, referring to the firm’s leveraged lending practices: “When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you’ve got to get up and dance. We’re still dancing.”
The New York Times reported in November 2008 that in September 2007, Chuck Prince had learned for the first time that the bank owned about $43bn in mortgage-related assets!
Markus K. Brunnermeier, a Princeton University professor of economics, has written in a paper [pdf]:
BNP Paribas said there was a "complete evaporation of liquidity," in the market.
The European Central Bank was faced with its first major crisis and Jean-Claude Trichet, ECB president, on holiday in France, instructed colleagues in Frankfurt to inject liquidity to unfreeze the inter-bank markets.
The value of the three BNP Paribas funds was €2bn and the ECB provided €95bn in emergency funds to 49 banks.
The ECB added a further €108.7bn over the following days and it was joined by the Federal Reserve, the Bank of Canada and the Bank of Japan.
Trichet had said in January 2007 at the World
Economic Forum in Davos, Switzerland, that the explosion of structured financial
products and derivatives had made it more difficult for regulators and investors
to judge the current risks in the financial system.
In the period, 2004-2006 the Federal Reserve had raised interest rates from 1% to 5.35%, triggering a slowdown in the US housing market. Low income people, with no credit histories, who were given subprime mortgages when rates were low, were defaulting at record levels. Meanwhile, big names on Wall Street such as Goldman Sachs had packaged the dodgy mortgages as securities with the purchased seal of approval of a ratings agency such as Standard & Poor's and investors were discovering that they had invested in junk.
In 2006 and 2007, Goldman sold more than $40bn in bonds backed by over 200,000 in risky home mortgages while secretly betting on a plunge in housing prices that would depress the value of those securities.
Finfacts, Dec 2007: How Goldman Sachs made money from US subprime mortgages on the way up and down
In Dublin, the credit crunch hardly dented the delusion of the bubble cheerleaders.
Bertie Ahern, then taoiseach, was the principal booster for housing:
In April 2006, he said that
he had listened for seven years to warnings
and arguments about difficulties in the construction sector. "I think you have
to look at the asset. This is the question: if you are borrowing 'x', if you
sell the asset, if there's a bit of a downturn, will you get 'x' back in return?
That's the issue. At the moment, there doesn't seem to be an indication [of
In July 2007 he said: "Sitting on the sidelines, cribbing and moaning
is a lost opportunity. I don't know how people who engage in that don't commit
suicide because frankly the only thing that motivates me is being able to
actively change something."
A sample from cheerleader economists:
Dan McLaughlin, chief economist, Bank of Ireland, told a conference in May 2007: "In Ireland there has been a spate of forecasts projecting a slowdown in growth, but in truth most of the current macro-indicators, (including retail sales, industrial production, foreign travel and unemployment) do not suggest any softening in the pace of growth. Consequently, I still expect 6% growth in 2007, easing to 5% in 2008. Furthermore, it is not clear from some of these more bearish forecasts whether the authors envisage a cyclical slowdown or a structural shift in Irish growth. The former would be relatively short lived as in time lower interest rates would eventually prompt a cyclical recovery, as in the 2001 - 2003 period. A move to a lower potential growth rate would be more serious but it is not obvious why the potential growth of the Irish economy should fall from 5.5% - 6% to 3.5% - 4% in eighteen months as it would require a sharp fall in productivity or a substantial fall in labour force growth. Some even argue that the Irish potential growth rate is not currently in this 5.5% - 6% range, but if lower, unemployment would have surely fallen, when in fact it has been very stable over the last few years."
Alan McQuaid, chief economist of Bloxham Stockbrokers, wrote in the Irish Times in September 2007 : "I'm sick to death of people writing off the Irish economy and next year could easily see the Celtic Tiger roaring more loudly than many pessimists think."
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