Financial Stability, + Website by R. Christopher Whalen & Frederick L. Feldkamp

Author:R. Christopher Whalen & Frederick L. Feldkamp [R. Christopher Whalen]
Language: eng
Format: epub
Publisher: Wiley
Published: 2014-09-28T16:00:00+00:00

With that introduction to what created the subprime crisis, let’s look at the day-by-day agony of steps leading to that financial disaster. Fred compiled his list of these steps from comments he circulated to correspondents, in real time, between July 2007 and November 20, 2008. Charts 9.1, 9.2, and 9.3 and Table 9.1 compile the daily data and translate the patterns shown into their economic impact, respectively. Each chart tracks a particular credit market spread. The numbered events marked on Chart 9.1 correlate with the descriptions— offered by Fred as the events occurred—that follow in the “Twenty Events That Led to Bankruptcy” section. Each was significant when it occurred, based on bond investors’ concurrent market reaction. We will review the numbered events on Chart 9.1 and sometimes reference events noted on Chart 9.3

Chart 9.1 tracks the difference between daily indices for U.S. high grade (investment grade) and high yield corporate bonds from FINRA (Financial Industry Regulatory Authority). It uses the bond trade data the SEC began to mandate in 2005. This is the spread that most closely correlates to the daily cost of Adam Smith’s great wheel of circulation, as measured by the U.S. bond market. Chart 9.2 shows high yield bonds minus 10-year Treasuries, the daily sum of the spreads from Charts 9.1 and 9.3. It represents a high-level look at the 2007–2009 crisis and its aftermath from the perspective of the U.S. government; events are not marked on it.

Chart 9.3 tracks the daily spread between high-grade corporate bonds and the market rate for 10-year Treasury notes. It measures banks’ ability to meet the needs of borrowers and shows when they cannot do so because they are having a difficult time funding themselves.

All three charts cover the period from July 16, 2007 to May 8, 2014. July 2007 marks when a refusal by Bear, Stearns to support investors in a couple of their mortgage funds triggered widespread concern that AIG might actually default. That caused what was then the biggest one-month spread spike seen in these relationships since 2005 (when the SEC mandated publication of the bond trading data on which the charts are based). That July spike was soon to be dwarfed by events that occurred between September 6 and November 20, 2008.

The peak of the lines on all of these charts represents a point at which just about every major private-sector enterprise in the United States and every nation in the world was in a state of equitable insolvency (unable to pay debts as they became due). As the principal of one of the largest hedge funds in the world remarked to Chris in 2010, “for a few months we were all broke.” After describing events leading to the subprime crisis, we’ll use Charts 9.1, 9.2, and 9.3 to trace the world’s recovery after November 20, 2008.

Table 9.1 shows the impact of changing credit spreads. It uses the formula for compound interest to show that each basis point of change in spreads above the complete market level of Charts 9.

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