Creating the financial environment:
• 1983. The financial firms Salomon Brothers and First Boston create the first collateralized debt obligations (CDOs). A CDO is a security whose value and payments come from fixed-income underlying assets. This is significant because CDOs were at the heart of the US financial crisis, since investors were later allowed to buy and sell assets worth ten to twelve times the underlying value.
• 1992. Fannie Mae and Freddie Mac required to set aside percentage of lending to affordable housing. Affordable housing means that the home price is within the range of the median income. This, combined with the creation of CDOs, meant that Fannie Mae and Freddie Mac, which are organizations that purchase the mortgages from lenders, would just before the crisis began be holding a great amount of loans to poorer borrowers.
• 1995. Changes to the Community Reinvestment Act allow mortgage lenders to receive credit toward their affordable-housing lending obligations for buying subprime securities. Subprime market grows. The subprime market allows poorer borrowers, who have a shorter history of obtaining loans, lower incomes, and fewer assets, to get a loan. These loans are much riskier because the borrower is much weaker.
• 1997. Huge growth in number of mortgage-backed securities purchased by investors. Home prices were increasing starting in 1997, which meant that investors felt that these were reliable investments.
• 1999, 09. Fannie Mae eases credit requirements for subprime loans. This was done to help low-income consumers purchase homes, and it further encouraged weak borrowers to obtain home loans.
• 1999, 11. Gramm-Leach-Bliley Act deregulates financial industry in US and allows financial institutions to grow very large. This allowed one institution to act as both commercial bank and investment bank. Commercial banks make loans, while investment banks raise capital and trade securities for businesses. This meant that institutions that were commercial banks and investment banks were not regulated strictly as banks. They therefore had looser capital requirements and the banking side of these new institutions took on the profit-oriented mentality of the investment side.
• 2000, 12. Commodity Futures Modernization Act of 2000 allows trading of credit-default swaps with minimal oversight. A credit derivative contract between a buyer and seller. The buyer makes payments to a seller and received a payoff if the underlying financial instrument defaults. (A future is a contract to sell or buy a commodity in the future.)
Roots of the crisis:
• 2001. Dot-com bubble bursts and in response, US Federal Reserve dramatically cuts interest rates. Federal Reserve Chairman Alan Greenspan has been accused of creating an environment ripe for crisis due to the allowance of very low interest rates. Introduction by David X. Li of Gaussian copula function, which is widely adopted throughout the financial industry and popularizes asset backed securities. The function allowed hugely complex risks to be modeled with more ease and accuracy than ever before. Li, a star mathematician from rural China, made it possible for traders to sell vast quantities of new securities, expanding financial markets to unimaginable levels. Li's breakthrough was that instead of waiting to assemble enough historical data about actual defaults, which are rare in the real world, he used historical prices from the CDS market. This built up the market for asset backed securities on overvalued CDS prices, which turned out to be a very bad idea. But as Li himself said of his own model: "The most dangerous part is when people believe everything coming out of it."
• 2002. Fannie Mae and Freddie Mac start purchasing large amounts of subprime mortgages.
• 2002. Home price appreciation begins. Home prices began to appreciate as investors took their money out of the bottoming stock market and put it into real estate. Demand for housing grew as both these investors and individuals, particularly subprime borrowers, purchased homes, driving up prices.
• 2004. Financial institutions start to issue huge amounts of mortgage-backed securities. This was due a combination of factors that made securities more profitable, especially after leveraging restrictions were lifted, allowing securities priced at many times the underlying value to be issued. Securities issuers could make a lot of money from the high prices of securities, while securities investors assumed home prices would continue to increase and that they would make money on the securities.
• 2004-04. The SEC lifts leveraging restrictions. (see previous)
• 2006. Home prices began a rapid decline. This occurred because as mortgage loan terms changed and interest rates rose, families were no longer able to afford their homes. The homes went into foreclosure and the excess supply of homes put downward pressure on home prices. Subprime mortgage borrowers had been given loans that would increase in interest rates after an initial period of very low interest rates.
Spread of the crisis:
• 2007, 02. More than 25 subprime lending firms declare bankruptcy in February and March, while the largest subprime lender, New Century, declares bankruptcy in April. This occurs due to increasing defaults on subprime loans. As interest rates on subprime loans adjusted upwards, families could not afford to pay the increased payments, and were not able to refinance their homes because their home value had declined.
• 2007, 07. Bear Stearns announces major losses in two of its hedge funds. This was due to investments in asset-backed securities, which Bear Stearns pioneered. As subprime loans failed, the asset-backed securities that were based on the subprime loans also started to fail.
• 2007, 08. Global hedge funds and banks reveal major exposure to subprime problems through holdings of mortgage-backed securities. As it turns out, many, many banks worldwide held these asset-backed securities based on subprime loans.
• 2007, 09-13. Northern Rock receives emergency funding from the Bank of England, after which depositors make a run on the bank. Northern Rock faced a big problem as liquidity was cut off after the subprime crisis began, and the mortgage lender could not receive loans from institutional lenders. This was a signal that there was a real liquidity crisis, or shortage in funding from other banking and investment institutions.
• 2008, 01-21. Global stock markets suffer largest fall since September 11, 2001. This was due to fears that the proposed stimulus package in the US would not be enough to prevent a large recession. The scope of the financial crisis was just beginning to be revealed.
• 2008, 01-24. National Association of Realtors shows 2007 had the largest drop in home sales in 25 years. Excess supply of home inventory places significant downward pressure on prices, and as foreclosures increased, people were forced to leave their homes because they could not repay their loans. Thus there were more and more homes for sale.
• 2008, 03-14. Bear Stearns is purchased for $2 a share by JPMorgan Chase. A year earlier share prices had been $170 per share. The problems were caused by overexposure to the subprime mortgage crisis. JP Morgan Chase was prodded to purchase Bear Stearns by the US government, since Bear was on the brink of collapse.
• 2008, 7. The European Central Bank increases the interest rate by 25 basis points.
• 2008, 09-7. Fannie Mae and Freddie Mac are taken over by the US government. This was because they owned more than $5 trillion of mortgage backed securities. They therefore had a huge exposure to potential losses in this market. US taxpayers would be responsible for propping up these institutions where they needed financial support. It also brought both Fannie Mae, which was created by Congress during the Great Depression to help with home ownership, and Freddie Mac, created in 1970 as a competitor to Fannie Mae, back into the fold of the government after a multi-decade attempt at privatization.
• 2008, 09-15. Lehman Brothers files for bankruptcy protection. Lehman had incurred billions of dollars in losses due to the mortgage crisis, and could not find a buyer. The US government also chose not to bail it out as an example to other institutions that they were not necessarily going to be bailed out by the government. This was later seen as a mistake on the part of the US government, since it created problems throughout the financial system.
• 2008, 09-16. US government bails out AIG. AIG had insured mortgage-backed securities. Panic in money markets as one fund declines in value. Reserve Primary Fund dropped below $1 a share because of losses on debt issued by Lehman Brothers. A money market fund is a type of mutual fund that is required by law to invest in low-risk securities. These funds have relatively low risks compared to other mutual funds and pay dividends that generally reflect short-term interest rates. The fact that one fund declined in value meant that potentially even low-risk investments were vulnerable to the crisis. The government stepped in and guaranteed these funds in order to prevent further financial fallout.
• 2008, 09-19. Treasury Secretary Henry Paulson proposes rescue plan called the Troubled Assets Relief Program. The plan proposed authorizing the government to buy troubled assets at discounts from financial institutions. "Troubled assets" were defined as residential or commercial mortgages or mortgage backed securities, or other securities determined by the Treasury as troubled.
• 2008, 09-21. Goldman Sachs and Morgan Stanley convert to bank holding companies. The two investment bank conglomerates did so in order to accept bank deposits to ease cash flow concerns, take advantage of the federal reserve’s lending for banks, and more easily merge with other banks. As bank holding companies, both firms would come under the supervision of national bank regulators. This would force them to lower their leverage but would in turn give them a better chance of survival.
• 2008, 09-25. Bank failures continue.
• 2008, 09-29. British mortgage lender Bradford and Bingley is taken over by the government. The lender found themselves short of liquidity as their share prices and new issues declined, and as TPG Capital withdrew its promise to take a 23% stake in the company. The British government took over the bank’s mortgages and sold off the savings business and the branches. Fortis receives a capital injection. As share prices declined, business customers made large withdrawals, creating massive liquidity problems. The Belgian banking and insurance company received 11.2 billion Euros from the Netherlands, Belgium and Luxembourg. Hypo Real Estate receives capital injection. Hypo Real Estate was the second largest commercial property lender in Germany, and encountered liquidity problems due to liquidity problems in its Depfa Bank subsidiary.
• 2008, 10. Currency crises loom in Eastern Europe as carry trades reverse, due to sharp declines in profitability from investing abroad. Western European banks held exposure to Eastern European mortgage loan borrowers, and as funding was reversed due to the liquidity crisis in Western Europe, Eastern European nations found themselves close to a currency crisis as their pegged currencies were suddenly devalued (since demand for foreign currency would increase), leaving borrowers with skyrocketing debt.
Containment of the crisis:
• 2008, 10-03. US passes $700 financial sector bailout package. This is the TARP package, which initially set out to buy bad debts from failing institutions, but then was used to inject liquidity directly into failing institutions in return for government ownership of preferred stock. The TARP package reversed course in March 2009 to again purchase bad loans and securities from failing institutions. Developing countries face problems caused by food, fuel and financial crises.
• 2008, 10-10. BNP Paribas takes over Fortis operations in Belgium and Luxembourg. Fortis had been partly nationalized a week earlier. The central banks of the United States, European Union, Britain, China, Canada, Sweden, and Switzerland make coordinated interest rate cuts. This was a move of unprecedented scope that reflected the scope of the crisis.
• 2008, 10-28. Hungary receives loan from IMF. Hungary, Ukraine and Iceland had faced sudden banking and currency crises as foreign investment fled the country. One 10-29 through 31, the Federal Reserve cuts the interest rate by 50 basis points; the Central Bank of Norway cuts the interest rate by 50 basis points; the Central Bank of China cuts the interest rate by 27 basis points. The Central Bank of Japan cuts the interest rate by 20 basis points.
• 2008, 11-06. The IMF approves a loan to Ukraine. (see above) The Central Bank of Denmark cuts the interest rate by 50 basis points; the European Central Bank cuts the interest rate by 50 basis points; the Bank of England cuts the interest rate by 150 basis points; the Central Bank of Switzerland cuts the interest rate by 50 basis points; the Central Bank of the Czech Republic cuts the interest rate by 75 basis points.
• 2008, 11-09. China announces stimulus package. China’s $586 billion stimulus package was the largest in its history and was a wide-ranging plan that would, among other things, expand social welfare spending and create jobs through construction of infrastructure. This was done to cope with rapidly slowing economic growth, as a downturn in investment and exports led to factory closings in southern China. The day after, on 11-10, Franklin Bank and Security Pacific Bank fail in the US.
• 2008, 11-14. The Euro Area is officially in recession.
• 2008, 11-20. The IMF approves a loan to Iceland. (see above)
• 2008, 11-23. Citigroup receives a $20 billion cash injection in return for the government taking preferred shares in the bank. The money came from the $700 billion bailout package to assist the firm which faced potential losses on $306 billion on high-risk assets.
• 2008, 11-26. EU unveils the anti-crisis plan; the Central Bank of China cuts the interest rate by 108 basis points.
• 2008, 12-1 through 5. Big fall on stock markets; London Scottish Bank fails (is forced into administration). The Central Bank of Australia cuts the interest rate by 100 basis points; the Bank of Japan starts to accept BBB-rated corporate bonds as collateral. The Central Bank of Sweden cuts the interest rate by 175 basis points; The Bank of England cuts the interest rate by 100 basis points; the European Central Bank cuts the interest rate by 75 basis points; the Central Bank of Denmark cuts the interest rate by 75 basis points. Big fall on European stock markets; the US labour market lost 533000 jobs in November.
• 2009, 01-20. Barack Obama takes his post as the new President of the United States. His top priority was to fix the US’s ailing economy by creating jobs and increasing accountability in the financial system.
• 2009, 01-27. Iceland’s government collapses due to financial turmoil, followed by that of Belgium and Latvia in February. Social and political tensions in Latvia were said to cause the worst rioting since the collapse of the Soviet Union after 1991.
• 2009, 02-17. President Obama signs stimulus package into law. The $787 billion stimulus package would implement tax cuts, create jobs in building infrastructure, and provide further social welfare funding. The package also promised money to education and health care, as well as to science and technology.
• 2009, 04-02. G-20 Summit resolves to improve financial regulations. The meeting committed $1.1 trillion mostly to the IMF, to assist trade, emerging economies in crisis, and in Special Drawing Rights, the IMF’s synthetic reserve currency.
• 2009, 05. Results of bank "stress tests" released. “Stress tests” tested to see whether banks could survive among potential additional losses. ”Stress tests” showed banks would need less capital than was feared, although US government regulators told banks they needed to raise around $75 billion more in capital.
Signs of (slow) recovery:
• 2009, 06-01. Large US car company, GM, announced bankruptcy filing. GM emerged from bankruptcy about six weeks later, on July 10.
• 2009, 06-17. US Treasury released proposal for reforming financial regulatory system. This proposal is downloadable here: http://www.financialstability.gov/roadtostability/regulatoryreform.html, and was created to prevent future crises.
• 2009, 07. China announced growth rate in GDP of 7.9% in the second quarter of 2009. This figure was up from 6.1% growth in the first quarter, due to the effects of the stimulus package.
2009, 08. Ben Bernanke is re-nominated as President of the Chairman of the Board of Governors of the Federal Reserve.
2009, 09. The Treasury Department issues the 'Next Phase' report that outlines the winding down of emergency government support.
2009, 10. The Dow Jones Industrial Average closes above 10,000. 43 poorest countries are still suffering from the global crisis.
2009, 11. CIT Group files for bankruptcy.
2009, 12. Treasury Secretary Timothy Geithner announces that TARP will be extended to October 3, 2010, and will focus on preventing foreclosures, providing capital to small banks, and possibly increasing the Term Asset Backed Securities Loan Facility. The US House of Representatives passes legislation that would create a Financial Stability Council and a Consumer Financial Protection Agency, as well as help regulate OTC derivatives, hedge funds, and failing financial institutions. Greece enters crisis: http://www.reuters.com/article/idUSTRE6124EL20100203.
2010, 02. EU leaders pledge to support Greece through its financial crisis.
