Extraordinary measures to restore stability
In September and October 2008, Western governments have taken exceptional measures to prevent the disintegration of their financial systems. It is not yet clear that these will be sufficient to quell the turbulence in money and share markets. A package of official support measures for British banks announced on 8 October was at least as large as the $700 billion bailout of American banks approved by Congress five days earlier.
At the heart of the panic was a collapse in something usually taken for granted: the mutual trust that enabled banks to lend to each other in the money markets, providing the underpinning for all commerce. Underlining the dearth of market liquidity that was caused by this loss of confidence, the Federal Reserve, the US central bank, said on 7 October that it would begin to provide short-term financing directly to top-rated non-financial companies, whose normal funding routes were being disrupted. The seriousness of the crisis – and its likely impact on the economies of the western world – was also indicated by six central banks' announcement of a coordinated cut in interest rates.
For a year after the troubles began in summer 2007, it had been too easy to dismiss the 'credit crunch' as something that was happening in rather obscure parts of the financial markets. Even though many Americans were in difficulties with home-loan repayments, the problem was somehow seen as one for Wall Street and its equivalents in other countries, and not for the 'real' economy.
All the while, however, banks across the world were struggling to fund themselves on the money markets. In September 2008, these difficulties became unmanageable: because banks could not trust each other's credit, they stopped lending to each other for all but the shortest periods. This forced the weakest banks to the wall, necessitating a series of rescue operations.
The biggest trigger of the chaos was the 15 September bankruptcy of Lehman Brothers, the US investment bank, which the US government chose not to rescue. Lehman Brothers' failure left many institutions exposed to potential losses, and made it even more difficult for them to judge the creditworthiness of others.
Since bank credit is the foundation of all business, the banks' funding problems were always going to have an impact on the wider world. But this was not at all an accepted fact even as recently as 24 September, when US President George W. Bush urged Congress to support the $700bn government bail-out of financial institutions. Without the rescue, he said, more banks would fail, share and property prices would plummet, and millions of Americans would be without jobs and access to credit. Many members of Congress, apparently, did not believe him; the House of Representatives' first vote was to reject the package, even after bipartisan negotiation, as politicians baulked at spending taxpayers' money to save rich bankers.
By the time Congress passed the legislation on 3 October, rescues had been arranged for more American and European banks. Days later, the possibility that the dominoes could continue to fall led to widespread fears about the safety of savers' deposits, especially in Europe. The potential for the effects to be felt beyond the financial markets had suddenly become obvious to all.
Containment efforts
Until mid September, the general perception was that the crisis was being contained mainly among those who were responsible for originating it, namely unwise borrowers in the American real-estate market and financial institutions exposed to bad property finance. This was a classic boom-and-bust scenario. The long period of economic growth in the US and elsewhere had fostered expectations that real-estate prices would continue to rise. Money was plentiful because of the huge flow of investment funds into the United States and other strong economies. But the boom in property prices had drawn in many 'subprime' borrowers with poor credit records, and there was bound to be pain when it came to its inevitable end.
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