With things changing so fast in the stock, bond and commodities markets, it has not been easy to go back and reflect on the events of the past year to ask if we could have seen this crisis coming.
I have been researching the past year's history trying to find some answers to what might happen in the future, but my crystal ball is very cloudy. I have watched these past few weeks with shock and awe as money invested in the stock markets went literally into a black hole. And like the unknown features of the black holes in the universe, I wonder what is on the other side of the black hole that currently plagues our markets.
Let's go back in time to Aug. 6, 2007, when American Home Mortgage filed for bankruptcy. They were a major provider of subprime loans and no one really took notice. On Aug. 9, short term credit markets froze up after a large French bank, BNP Paribas, suspended three of its investment funds worth 2 billion euros, citing problems in the U.S. subprime markets. The European Central banks pumped 95 billion euros into the European banking system and the U.S. Federal Reserve and Bank of Japan took similar actions.
On Aug. 10, the EUB pumped in another 61 billion euros to provide additional liquidity to the European banks and the Fed said it would do the same if necessary. On Aug. 13, the EUB again infused another 47.7 billion euros in the money markets. Goldman Sachs said it would pump $3 billion into a hedge fund hit by credit problems. On Aug. 16, Countrywide Financial draws down its entire line of credit, $11.5 billion. On Aug. 17, the U.S. Federal Reserve cuts the discount rate. This is the rate at which it lends to banks. Subsequently, the entire central banking community of the developed world injects funds and starts accepting a larger range of securities as collateral of loans.
All this happened in Aug. 2007 alone and yet there were no alarm bells going off anywhere yet. Many of us in the investing business were calling around wondering if we should be making any changes and I for one, was not getting any advice from Wall Street that would indicate a problem was brewing.
That, in addition to no word from the regulators or those representing us in Congress, is what currently makes me very upset and angry today. I wrote an article breaking down the collateralized debt obligation markets last month, but I did not go into the securitization mania that had spread to other forms of credit. Hedge funds that specialized in credit have grown exponentially over the years and as an unregulated entity, were allowed to use leverage to a far greater extent than mutual funds or bonds.
Currently, and who knows if this number is correct, the estimated nominal value of collaterized debt contracts outstanding as of this writing is between $42 trillion to $60 trillion. To put this into perspective, this is roughly equal to the entire household wealth of the entire United States (figures are before October 2008).
I am not sure, based on these numbers how anyone thought that the risk inherent in overuse of leverage was not going to end badly but apparently there was plenty of denial to go around. And there still is.
• Chronological data provided by the BBC. The opinion expressed here is that of Carol Perry and does not reflect that of AWA Wealth Management or LPL. You should consult your own advisor about how this information pertains to you and your portfolio.