10 years ago: A harbinger of 2008 financial crisis
NEW YORK CITY, USA – The failure of Lehman Brothers on September 15, 2008 triggered a series of convulsions in global finance that ultimately led to the worst crisis since the Great Depression.
Yet a harbinger of the Great Recession came more than a year before the Lehman landmark almost exactly a decade ago.
On August 9, 2007, French banking giant BNP Paribas suspended a trio of funds because of difficulty estimating the value of subprime mortgages.
The Dow Jones Industrial Average plunged nearly 3% on the news, although it stabilized soon after.
"It was clearly the first sign," said Kenny Polcari, who has been on Wall Street since 1985 and worked at global brokerage ICAP at the time.
"People were trading products that were less regulated than they should have been," he said. "People were trying to understand the web created by all those very complex products."
At a White House press conference later that day, President George W. Bush suggested worries about a violent housing bust were overblown.
Bush was briefed "about whether or not there would be precipitous decline in housing, or whether it would be what one would call a soft landing," the then president said.
"And it appears at this point in time that it looks like we're headed for a soft landing," Bush continued. "That's what the facts say."
Under former Federal Reserve chair Alan Greenspan, low interest rates encouraged consumers to take on debt and cleared the path for just about anybody to become a homeowner.
"People could walk into a bank and borrow money even without a job," Polcari said. "They were giving money away."
A key step that set the stage for the crisis came when President Bill Clinton in 1999 repealed the depression-era Glass-Steagall law, clearing the way for consumer banks to work in investment banking and for greater risk to enter the financial system.
Financial institutions devised sophisticated securities packages leveraged to subprime mortgages that were risky but classified as safe investments by credit ratings agencies that later came under fire for rubber-stamping the assets.
The mortgages started to come under pressure when the Federal Reserve began raising interest rates in 2004, denting the value of mortgage-linked securities, which were diffused widely among markets and soon became toxic assets.
Some on Wall Street shifted strategy as the mortgage market turned. After suffering their first losses on mortgage-related securities, Goldman Sachs in December 2006 altered strategy and began placing bets against subprime-linked securities, said a person familiar with the situation.
However, the US investment bank later came under criticism with regulators over its role in creating an investment vehicle that allowed bets against the housing market.
In 2010, Goldman agreed to pay a $550 million fine to the Securities and Exchange Commission to settle charges it misled investors in the creation of the fund. Goldman did not admit or deny the allegations.
Many investors simply avoided subprime-linked vehicles altogether.
"All those products became untradable," said Polcari, recalling the liquidity crisis after investors lost faith in subprime-linked securities. "When people couldn't sell them, they came to the equity markets and sold stocks."
"The part of the industry I was in had nothing to do with the global financial crisis," said Polcari.
"It suffered as a result, but the crisis was created by complex derivatives designed by supposedly smart people around the world who in fact had no idea what they actually designed because regulators didn't actually understand it."
The layoffs were deep at ICAP, said Polcari, who now works at O'Neil Securities and is a regular contributor on US financial media. – Rappler.com