The credit crunch (2007) began in August 2007 when the easy money of the past few years dried up almost overnight. Banks were losing mountains of money in places they thought were safe. Now they did not know who or what they could trust. They stopped putting their money out at low interest rates and started keeping it for themselves against whatever ugly surprises might be on their own books.
The big banks in New York are still losing a ton of money, with no end in sight.
Some say this is the beginning of bad times to come.
It started when increasing numbers of Americans were unable to make their interest payments to banks and started losing their homes. But the interest payments were not just going to banks in America – they were going to banks all over the world. So the trouble has spread overseas.
The government banks – the Fed in America, the ECB in Europe and even the Bank of England – started pouring money into the markets to calm nerves. It has worked, at least for now.
The trouble was that money has become so easy in the last few years that it was given to people to buy houses who ordinarily could not be expected to pay it back: they had bad credit histories. This sort of doubtful debt is called a sub-prime mortgage.
The banks had a way to make this debt safe: they took these sub-prime mortgages and put them together with better quality debt into what are called collateralized debt obligations or CDOs. Even if the sub-prime people failed to make their interest payments, it would not affect the overall value of the CDO by much.
The CDOs not only pay interest but they are backed by the houses that were bought with the mortgages that make up the CDO. What could possibly go wrong?
The CDOs seemed like they were as good as gold. Banks all over the world started buying them up.
All was well.
Then the holders of sub-prime mortgages started getting into in trouble in increasing numbers. Interest payments stopped coming, people lost their homes. But that drove down the price of houses in America. That in turn drove down the value of the CDOs. Fear set in and drove down the prices even further.
Banks have huge amounts of money tied up in these CDOs, so when they fall in value, they have less money they can give out.
And so now the days of easy money are over.
The banking industry is like that: up and then down. The good times always end in tears when banks find that they are not as godlike as they thought they were.
Whether this means bad times are coming no one knows for sure yet. It is too soon to tell. But it looks bad: much of the good times of the past few years was underwritten by rising housing prices, especially in America.
– Abagond, 2007.