The management of risk—especially systemic risk—in the ﬁnancialworld was evidently deeply ﬂawed. An important part of the problem wasthat core ﬁnancial institutions had used a shadowy secondary bankingsystem to hide much of their exposure. Citigroup, Merrill Lynch,
,Barclays Capital and Deutsche Bank had taken on a lot of debt and lentother people’s money against desperately poor collateral. Prior to the
privatizations of the 1990s,
investment bankswould have been barred by the Glass–Steagall Act of 1933 from dabblingin retail ﬁnance, and Northern Rock would have remained a solid, andvery boring, building society.The trigger for the credit crunch was rising defaults among
holdersof subprime mortgages in the last quarter of 2006 and early 2007, asinterest rates were inched up to protect the falling dollar. This led to thefailure of several large mortgage brokers in February–March 2007, butthe true scope of the problem only began to register in the late sum-mer. Interestingly, the ﬁrst bank to report a problem was DeutscheBank, which was forced to bail out two property-based funds in July.In October the
Treasury encouraged three of Wall Street’s largestbanks—Merrill Lynch, Morgan Stanley and Bank of America—to set upa $70 billion fund to establish a clear value for threatened assets. Thisdid not work. Analysts complained: ‘The path they have taken of skim-ming off the cream from the top doesn’t resolve the fact that there ispoison at the bottom’.
At the end of 2007, with the credit crisis still as bad as ever, the world’scentral banks tried to pump vast amounts of liquidity into the globalﬁnancial system, but the impact was temporary, and the banks remainedunwilling to lend to one another. Lawrence Summers, the former
Treasury Secretary, warned of a looming ‘major credit crunch’—as if six months’ paralysis had been a mere bagatelle; this danger stemmedfrom the ‘impaired’ asset base of major banks if more capital was notinjected.
The subprime debacle and the drying up of credit, them-selves the consequences of deteriorating conditions, were hastening
This article in dedicated to the memory of Andrew Glyn (1943–2007) whosewisdom, generosity and criticism are sorely missed. I would like to thank YallyAvrahampour, Jane D’Arista, Duncan Foley, Max Gasner, John Grahl, GeoffreyIngham and Julia Ott for helpful comments and suggestions.
‘Some Wonder if Stabilization Fund Will Work’,
New York Times
, 12 November 2007.
Lawrence Summers, ‘Beyond Fiscal Stimulus’,
, 28 January 2008.