|First published on Finfacts in 2009 |
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
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
Markus K. Brunnermeier, a Princeton University professor of economics, has
a paper [pdf]:
"IKB, a small German bank, was the first European victim of the subprime
crisis. In July 2007, its conduit was unable to roll over asset-backed
commercial paper and IKB proved unable to provide the promised credit line.
After hectic negotiations, a €3.5bn rescue package involving public and private
banks was announced. On July 31, American Home Mortgage Investment Corp.
announced its inability to fund lending obligations, and it subsequently
declared bankruptcy on August 6.
On August 9, 2007, the French bank BNP Paribas froze redemptions for three
investment funds, citing its inability to value structured products."
BNP Paribas said there was a "complete evaporation of liquidity," in the
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
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.
"We are currently seeing elements in global financial markets which are not
necessarily stable," he said, pointing to the "low level of rates, spreads and
risk premiums" as factors that could trigger a repricing.
"There is now such creativity of new and very sophisticated financial
instruments . . . that we don't know fully where the risks are located," he
added. "We are trying to understand what is going on - but it is a big, big
Stanley Fisher, governor of the Bank of Israel wondered at Davos "who takes
responsibility for the [financial] system" at a time of crisis, particularly
given that the "hegemony of the US is diminishing."
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
"I mean quite frankly, if you had taken the advice a year ago you would have
lost a lot of money. Everybody said we're going to see a huge downturn in 2005
linking into 2006 - - they were entirely wrong.
"Really we should have an examination into why so many people got it so wrong.
My view is there's not a great problem. Really, the bad advice of last year
given by so many has maybe made some people make mistakes, that they should have
bought last year."
In April 2007 he said: "On the other side of the election we'll get back
to normality. And I think that normality will be the soft landing. The
construction projections were that we will move from something like 93,000
houses to 80-something. Now that's not going to create any kind of a
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."
In September 2007 he said: "But there is no place for negativity. No need
for any pessimism. Above all, there is no place for politically motivated
attempts to talk down the economy and the achievements of our people across all
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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