Yesterday was the second year anniversary of a forgotten event. It was not raised by the White House. Democratic and Republican politicians made no mention of it. There was silence in both the mainstream media and the blogosphere. Yet two years ago something happened and we are and will be dealing with its consequences for years to come.

On August 9, 2007, a French bank BNP Paribas froze three hedge funds which had been heavily involved in subprimes. Markets around the world reacted to the news with panic. There was a fear that the world’s financial system would seize up, much as it did a year later with the Lehman bankruptcy. In the next few days, central banks made some $300 billion available in short term credit to calm market fears, add liquidity, and prevent a meltdown. Although dwarfed by later efforts, at the time, it was an extraordinary intervention. It also marked the end of the housing bubble.

The housing bubble had been showing indications of increasing weakness since early 2006. Throughout that year, once high flying mortgage writing companies, like Ameriquest, Mortgage Lenders Network USA, and Ownit, floundered and then went bankrupt in early 2007. These were warning signs. Then in June and July 2007, a couple of small Bear Stearns hedge funds invested in mortgage backed securities went belly up. At this point, the writing was on the wall and the clock was ticking, but Wall Street remained in denial, something it has shown a real talent for. What made the BNP Paribas action so stunning was that it showed that the exposure to the US housing market was not local or isolated but global and sufficiently large to take down the world’s financial system.

For a moment, the markets got scared. The Dow dropped 382 points to 13,270. But it didn’t last. Once the immediate crisis had been dodged, the markets went back to their old ways. By October the Dow was above 14,000. The markets, investors, bankers, Paulson and Bernanke (and the little known President of the New York branch of the Fed, a guy named Timothy Geithner) had learned nothing. Well, rather they had learned one thing. At long last, they acknowledged there had been a bubble in housing, although they continued to discount its importance and the threat it represented. This scenario replayed itself in March 2008 when the first of the Big Five investment banks Bear Stearns hit the wall and was sold to JPMorgan in what could only be called a sweetheart deal. The market dipped below 12,000 but by May it again moved above 13,000 (for the last time).

All of the time between August 2007 and September 2008 was time lost, time wasted. This was precisely when the blinders should have fallen from the eyes of the people at the Treasury and the Fed. They should have been assessing how big a problem the bursting of the housing bubble was, what the exposures were of the banks, and what the consequences of the downstream CDOs and CDSs were. They should also have been moving aggressively to mitigate and forestall the threats from these. They already knew from the BNP Paribas episode that the global financial system was not immune from the risk of systemic failure. Even if they thought that the worst was behind them, the failure of Bear Stearns should have dispelled such fanciful notions and focused them on all shoes out there which were ready to fall.

Instead Paulson, the former Goldman CEO and Bernanke, the Greenspan disciple, dithered. During the summer, the Dow lost another 1600 points (I am using the Dow as just a general barometer of reaction to the financial crisis). And then September 2008 arrived, to paraphrase, a month that shall live in infamy. On September 5, 2008, the government put mortgage giants Fannie and Freddie into receivership. Between them, they accounted for some 40% of the $12 trillion US mortgage market. Then on the weekend leading up to September 15, 2008. Bank of America was forced into buying the investment bank Merrill Lynch. AIG was effectively (or more accurately ineffectively) taken over by the government, saving Paulson’s old firm Goldman in the process. And Paulson’s old bête noire Lehman was left to the wolves, a decision which was made without even the simplest and most basic effort to guage what the consequences of such a failure would be. No one asked the most obvious question of all: who the bondholders were who had exposure to Lehman. It turned out some of them were money markets. When Lehman went, they panicked. Credit in the shadow banking system on which the whole financial industry depended locked up and the meltdown was on. The Dow fell some 3,000 points in a month.

Two years on, the day the bubble burst is forgotten. Its anniversary passed as if it had never been. We find ourselves in another irrationally exuberant stock market. We again are being told that the worst is behind us. We dodged the bullet. We stared into the abyss but stepped back in time. Markets are stabilizing. The positives are emphasized. Risks are minimized. Why should we then remember the day the bubble burst? We continue to have learned nothing from it.

Hugh

Hugh

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