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Unformatted text preview: - 1 - Anatomy of a Credit Crisis 2010-10-22 This timeline has grown and been amended since it first appeared in the December, 2008, issue of The Australian Journal of Management, as the editorial, under the title of “The Dominoes Fall: a timeline of the squeeze and crunch”. I include below the December preamble. The version of mid-May, 2009, appeared as the editorial of the June 2009 issue of the AJM , under the title “Anatomy of a Credit Crisis.” I include below the June preamble, in which I assay a framework for understanding the genesis of the crisis. December, 2008: IN ITS LEADER of October 13, 2008, the Financial Times characterized the western world’s banking system as suffering “the equivalent of a cardiac arrest.” The collapse of confidence in the system means that “it is now virtually impossible for any institution to finance itself in the markets longer than overnight.” This occurred less than a month after Lehman Brothers (LB) collapsed, without bailout. Six months earlier Bear Stearns (BS) had been bailed out after JP Morgan Chase (JPM Chase) had bought it for $10 a share, at the regulator’s urging. After LB fell, who would be next? And if LB, who was not at risk? Despite the earlier U.S. government bailouts of the erstwhile government mortgage originators (and still seen as government-sponsored enterprises, or GSEs), the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac), and the later bailout of the world’s largest insurer, American International Group (AIG), everything changed with the demise of LB. The FT was describing the freezing of the interbank credit market. After LB’s fall, so-called counterparty risk was seen as prohibitive to prospective lenders, at any price. This was revealed in the TED spread, the difference between the cost of interbank lending, the London Inter Bank Offered Rate, or LIBOR, on three-month loans in U.S. dollars, and the closest instrument to risk-free, three-month U.S. government bonds. In normal times the TED spread is between 10 and 20 basis points (bp), or 0.10 and 0.20 percent per annum, but on October 10, the TED spread reached 465 bp, when a lender could be found. As I write, it has fallen back to below 200 bp. I sit in a coffee shop that sports the sign “We are cash only, sorry for the inconvenience :-)”. I’m sure this is to avoid the hassle of credit cards, but such signs were massing off-stage in mid-October. How so? Imagine that banks refused to honour other banks’ credit card debts. Then cash would soon become king for retail purchases. But what of letters of credit, used in international trade? What of other bank-backed credit instruments? And cash, fiat money, also relies on trust and confidence — of government. And where the government can’t be trusted ... well, look at Zimbabwe....
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