I'll be the Reckless One

There are so many different theories as to when and why the recent crisis erupted that if I try to go through them all both you (reading) and I (typing) could be here a very long time. However I will try sum up the before and after, probably in two separate posts.

With the past behind them people look ahead to an optimistic future with sunny skies. When house prices started to rise people once again believed that they would never fall.

With this belief and the past forgotten there was a housing bubble, not only in the US, but each country had their own housing bubble i.e. Ireland, Dubai, United Kingdom etc. In fact The Economist  observed that "It looks like the biggest bubble in history."  There was easy credit, NINJA loans, CDO, securitization, massive bonuses to bankers, which could have increased moral hazard leading them to take on greater risk than they would have before. Deposit insurance was available, there was a lender of last resort.

There were credit rating agencies. Agencies that could have perhaps prevented the crisis from being as damaging as it was if they did not have an inherent conflict of interest. Roubini however makes the point that "relying on rating agencies was much like relying on a fox to guard the hen house"  Another argument I have read is how can you accurately assess how risky something is if you cannot measure the risk in the first place. 


There were shadow banks, who look like, act like, lend like, may as well be a bank, but avoided all the regulation that banks endured.

Along with the easy credit, there were defaults. As all the mortgages had been sliced and diced and repackaged up and sold on with a pretty bow and the golden stamp of AAA nobody was really expecting this. Everything had been securitized and sold on to foreign investors so everything and everyone was infected. Bear Sterns was one of the first to tumble which lead to first them getting emergency loans, and subsequently J.P Morgan purchasing them.

When Lehman Brothers sank, one observer stated that "We are in a mine field. No one knows where the mines are planted." This was very true. The banks had created opaque balance sheets, no one could see what exactly they were up to. For the same reason you can't judge a book by its cover, people weren't able to judge a bank from its balance sheet, and consumers couldn't distinguish between bad(insolvent) and good (illiquid). This meant that it wasn't just Lehman Brothers problem, but everyone's.

In Europe the situation wasn't very different. BNP Paribas suspended activity on many of its hedge funds in 2007; IKB, a German bank, fell victim to a run on its SIVs and Sachsen LB was bailed out. The crash wasn't something that really just spread out like a disease. It happened at the same time. Yes it happened in America first, but realistically it could have been anywhere that was the first bubble to pop.