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Credit Crunch Watching a financial crisis feels much like watching a natural disaster as long as you are watching from a safe distance. The raw, uncontrollable power of each is riveting. Although one is made by man and the other isn't, there is something deeply mysterious about each; it isn't quite clear how, or why, or why now. Of course, each can create enormous damage and can be heartbreaking for those directly involved. The repercussions last well beyond the immediate shock; nearly everyone is affected at least indirectly, and each leaves scars that never entirely disappear. The subprime shock was as serious a financial earthquake as any the nation had seen since World War II.1 There have been some big financial calamities through the years: the collapse of Penn Square Bank in 1982, the savings and loan crisis of the late 1980s, the collapse of hedge fund Long Term Capital Management in 1998, and the Internet stock bust at the turn of the millennium, to name a few. On the financial Richter scale, these other crises might rate a 5 or 6. The subprime shock was off the scale. This was evident in the size of the losses suffered by global investors. Although the ultimate cost wouldn't be known for years, most reasonable estimates put the tab close to $1 trillion.2 This includes both losses on thousands of defaulting mortgages and the decline in value of the securities backed by other shaky loans. The S&L crisis by comparison cost the country a mere $250 billion. Even Japan's banking crisis of the 1990s, from which the economy has never fully recovered, doesn't measure up; its losses come in near $750 billion. Nearly every sector of the financial system took a bath because of the subprime shock. Global banks have lost an estimated $475 billion; insurance companies and pension funds another $275 billion; and hedge funds and all other institutions $200 billion. All kinds of institutions saw their residential mortgage and mortgage security holdings hammered no surprise there but the extent of their other losses was startling. There were write-downs on commercial mortgage holdings and on business loans and credit of all types; even consumer loans such as credit cards, auto loans, and student loans suffered big losses. Every corner of the financial system was shaken. Trading in private residential mortgage securities came to a standstill along with the markets for collateralized debt obligations backed by asset-backed securities and for commercial mortgage securities. Low-rated "junk" corporate bonds and bonds backed by credit card loans were still issued, but investors now held out for a much higher interest rate before parting with their cash. Even the market for municipal bonds, where state and local governments raise money to build schools or sewers, was thrown into turmoil. It wasn't that municipal or state governments were suddenly likely to renege on their obligations, only that in panicked times, every deal seemed suspect. The subprime shock was also noteworthy for its length. There were tremors beginning in early 2007, when the Chinese stock market swooned; but the shock struck hard in July 2007 and was still reverberating a year later. There were moments when the crisis seemed to ebb, but financial markets remained unsettled throughout. Historically, financial market crises begin and quickly abate in just a few days or weeks. Almost none last more than a few months.
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