The Trillion Dollar Meltdown

Remember the Spring of 2007?

Everything was great with the economy. Consumer spending was strong. The credit markets looked strong. Sure, the real estate bubble had burst.

I am reading this 2008 book by Charles Morris, "The Trillion Dollar Meltdown: Easy Money, High Rollers, and the Great Credit Crash":

The first shock came in mid-June when two Bear Stearns mortgage hedge funds could not make margin calls. Moody’s downgrade cut the value of some of their investment-grade subprime mortgage-based bonds. So the fund tried to sell its bonds but most of them were not salable at any price. The value of all subprime-debt dropped dramatically.

The talking heads said the subprime market was small. The Federal Reserve chief Ben Bernanke and Treasury Secretary Hank Paulson said the problem was contained.

Then subprime-related problems popped up all around the world.

Markets panicked.

In August, the Federal Reserve and the European Central Bank flooded their economies with money. It did not help.

The moment of truth came in a November analysts call with the Citigroup CFO who revealed he did not know how to value his own company.

In September 2007, analysts estimated subprime-related losses at $20 billion. Two months later, the estimates were as high as $400 billion, which seems close to the truth.

Twenty years ago, the sum of all financial assets — stocks, bonds, loans, etc — roughly equaled global GDP. Now they are four times global GDP. That’s the credit bubble.

In 1986, 80% of lending was regulated. By 2006, only 20% was.

Banks learned to make loans at no cost. They made loans and sold the loans as CDOs (collateralized debt obligations) and CLOs (collateralized loan obligations). They collected fat fees. After the 2000 dot com crash, interest rates went to near zero for banks.

Because of credit insurance, investors bought low-rated CDOs and CLOs because of their extra yields.

"When money is free and lending is costless and riskless, the rational lender will keep lending until there is no one else to lend to."

During the second half of the 1990s, long-term interest rates went down. The big banks began pushing refinancing. Consumers caught on that they could use their homes as ATM machines.

In 1995, refis amounted to $14 billion. Eleven years later, they were worth a quarter of a trillion dollars.

Home ownership tends to do good things for families and communities. It makes them more stable. It grounds them in concrete commitments. It inculcates thrift and long-term planning. Putting off present pleasures for future gains and that sort of stuff.

Have you heard of NINJA loans? Those are loans given to people with no jobs, no income and no assets. Just imagine giving mortgages to such folks. That’s reckless lending.

About Luke Ford

I've written five books (see My work has been followed by the New York Times, the Los Angeles Times, and 60 Minutes. I teach Alexander Technique in Beverly Hills (
This entry was posted in Economics and tagged , , , , , . Bookmark the permalink.