Financial Crisis

The US stock market peaked in October 2007, when the Dow Jones Industrial Average indexexceeded 14,000 points.

It then entered a pronounced decline, which acceleratedmarkedly in October 2008. By March 2009, the Dow Jones average had reached atrough of around 6,600. 4 years later, it hit an all-time high and wasprobable, but debated, that the Federal Reserve’s aggressive policy of quantitative easing spurredthe partial recovery in the stock market. Market strategist Phil Dow said that the Dow Jones average’s fall ofmore than 50% over a period of 17 months is similar to a 54.

7% fall in theGreat Depression, followed by a total drop of 89% over the following 16 months.In March 2009  the decline was notrelatively large like the great depression although the decline amounts werenearly the same at the time, but the rates of decline had started much fasterin 2007.The firstnotable event signalling a possible financial crisis occurred in the UnitedKingdom on August 9, 2007, when BNP Paribas, citing “a complete evaporation ofliquidity”, blocked withdrawals from three hedge funds. The significanceof this event was not immediately recognized but soon led to a panic asinvestors and savers attempted to liquidate assets deposited in highlyleveraged financial institutions. The IMF estimated that large US and European banks lost more than$1 trillion on dangerous assets and from loans from 2007 to  2009. These losses are expected to top$2.

8 trillion from 2007 to 2010. One of the first victims was Northern Rock, a British bank and its highly leveraged nature of its business led the bank to requestsecurity from the Bank of England, which inturn led to investor panic in mid-September 2007. Investorsbegan to worry less about a recession and more about inflation, as the price ofoil continued to rise (hitting almost $144 per barrel in July).

At thebeginning of 2008, the stock market had fallen almost 15% from its peak in thefall of 2007. Then, in May 2008, the Dow Jones climbed to13,058, within 8% ofthe record 14,164 set in October 2007. To the surprise of both borrowers andregulators, high-quality collateral was not enough to ensure access to the repomarket. Repo lenders cared just as much about the financial health of theborrower as about the quality of the collateral. In fact, evenfor thesame collateral, repo lenders demanded different haircuts from differentborrowers. Despite the bankruptcy provisions in the 2005 act, lenders werereluctant to risk the hassle of seizing collateral, from a bankrupt borrower.

 Some largeinvestment banks, bank holding companies, and insurance companies, includingBear Stearns, Merrill Lynch, Citigroup, and AIG, experienced massive lossesrelated to the subprime mortgage market because of significant failures ofcorporate governance, including risk management and by its exposure to riskymortgage assets, its relianceon short-term funding, and its highleverage.  


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