Part II: Ten Years Ago, The World Changed

Part II – Ten Years Ago, the World Changed

This is part II in our three-part series remembering the 10th Anniversary of the 2008 Financial Crisis (view part I of the series here).  This week, we look at the month of August of that year and the big events which represented the closing days of the real estate boom.

It was real estate, and the government’s intervention into that market, that drove the collapse of the banks in that year.  It was not too little government, but too MUCH!  President Jimmy Carter signed, and President Clinton extended, a law known as the Community Reinvestment Act (CRA).  This law required banks to loan sub-prime into communities which had bad credit, eliminating the bank’s risk calculus and making the government liable for the debt when Fannie and Freddie bought the paper, or in general, as banks have FDIC insurance to cover accounts.   Failure to loan into bad credit neighborhoods, and the government could revoke your bank charter.  With implicit government guarantees on the debt, the banks happily extended loans to people who would not be able to repay them.

This, by itself, was just one of many issues that had deformed the real estate and bank lending markets.    The one regulation which may have helped – Glass-Steagall – had been repealed by Clinton with Republican support in 1999.  This allowed bank traders to use regular bank depositor funds to trade in the stock market.  Resourceful capitalists that they are – Wall Street began bundling bad credit loans, known as subprime, with good loans in what was known by few as “mortgage backed securities” (MBS Bonds).

When the bad credit loans’ adjustable rate mortgage adjusted upward in the early to mid-2000’s, these people stopped paying.  The bad debt was mixed with the good debt in the bonds as stated above, and Wall Street began to sell them….rapidly.  Those holding the notes – banks and the government – began to see massive losses.  Those who insured the bonds began to receive massive claims they could not cover……you remember what happens next, we cover it in the final Part III next month.

So how did markets and money look in August 2008 – not pretty:

The 4 BIG events in August 2008 which headlined the ongoing financial crisis of that year:

4. “Global Banking Giant HSBC announces 28% drop in profits”: As earnings reports were released that first week of August, HSBC was hemorrhaging money and suggested in a note to clients that the economy was projecting to be the “…worst we have seen in decades.”

3. “Another global bank announces a suspension of withdrawals”: August 10th BNP Paribas announces in a press release that they were suspending all account withdrawals “…because it cannot value the assets in them, owing to a complete evaporation of liquidity…” in the market.  While the biggest shoe to drop to date – the first withdrawal suspension of the crisis – the markets were rather melancholy in response.  They would trade in a 200 point range the remainder of the month.

2. “Geo-political crises are rampant across the globe”: Russia has invaded Georgia … President Musharraf resigns in Pakistan, setting off protests in the streets … the Baltic States – Latvia, Estonia and Lithuania – enter a steep recession which begins migrating through eastern Europe … Al Qaeda launches simultaneous attacks in Afghanistan and Iraq … the financial crisis was one of many that were striking at the confidence of Western society.

1. “Nationwide Insurance reports real estate prices slid 10% just in the month of August”: In one of the steepest declines of the on-going crisis, Nationwide reported a 10% drop on August 28th.  It appeared to be what would force the water over the dam, and it was one of the many factors that would – on 8/28 we were less than two weeks from the Lehman Bros. collapse.

America’s Democratic party would nominate Barack Obama as their nominee this month 10 years ago, and the American team was on their way to winning another overall medal count at the Summer Olympics in China.  The economy was struggling, but we were completely unaware of what was coming soon.

Or were we?

As has been well documented, many traders had been forecasting doom for over a year – Michael Bury, Gregg Lippman, Steve Eisman and Ben Hockett were preaching for well in advance that the system was corrupted and the banks were over-extended.  They were ably portrayed in the hit 2015 movie titled “The Big Short,” based upon the book of the same title.  They were not the only ones – our firm’s “safety first” clients experienced ZERO losses, and started the climb back up with their portfolio 50% ahead of those who remained in risk associated assets.

New clients in the months that followed were often represented by the money manager in the home being dragged into the office by the ear, and when asked if they were ready to get into a principal protection product, they would offer some resistance – the remnants of the “I know better” mentality of the easy money era, only to receive an immediate “Shhh!” from the other spouse.  This was the classic spousal refrain you could see in each couple sitting at the table in the days and months that followed the collapse:  “…You screwed things up listening to Wall Street, now I am making sure we don’t lose the rest of it.”

 August 2008 had some precarious moments, but was really the calm before the storm.  Part III will follow in September with our examination of what would become the biggest financial crisis in recorded history.

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