There are more than a year, the crisis of mortgages with high-risk "Subprime" hit the U.S. economy and led to heavy losses for banks in the world. Losses have reached 350 billion dollars while the International Monetary Fund (IMF) said they would amount to a trillion dollars in coming years.
While observers expected the decline of the effects of the crisis and the recovery of the global economy, especially after the exchange price of the dollar had increased in front of major currencies in the world and rates of inflation had fallen, shock shook the world Monday September 14th : the announcement of bankruptcy "Lehman Brother" bank.
It comes at a time when the U.S. administration has managed to save two refinancing banks "Fannie Mae" and "Freddie Mac" by putting them under the supervision of the government, and the sale of the "Bear Stearns" bank. Prior to wake up from this nightmare, the financial community has received another blow : the historical decision of U.S. authorities to nationalize the American Insurance Group "AIG" to save it from bankruptcy. A decision that has upset financial markets as a financial "tsunami".
This has prompted the European Central Bank, the Bank of England, Bank of Japan and the U. S. Federal Reserve Board (FED), to inject some 144 billion dollars to the banking sector to enable it to meet the needs of cash. These central banks have taken other measures to maintain the stability of the global financial system through the crisis of "subprime".
To find out how the crisis occurred, let's follow the evolution of the concept of mortgage loans at high risk. This type of credits began with a simple idea based on the needs of millions of poor people in the United States of housing when they can not afford to have one. This need has simply pushed the brokers to offer loans, which seems at first glance very attractive because interest rates are reasonable in the early years.
According to this idea, institutions that provide credit fix the interest rate on the loan. An idea which was poorly explained to borrowers who subscribe to such credits and sometimes several at once. These loans, with variable interest rates, are then sold to investment funds, and then dissected by the financials and integrated in "small pieces" in packages that also contain other assets of less risky credits.
A financial package contains three categories of assets of Credit : low-risk assets that are little but are very secure (Most of the package), riskier assets that are financially more interesting and, finally, a small portion of assets at very high risk such as "subprime". Depending on the place accorded to these financial products, credit rating agencies "label" package compared to the potential risk of it. These packets are then processed to securities and placed on financial markets where they are bought by banks worldwide.
From late 2006, a large number of borrowers could not repay their banks due to the sharp rise in interest rates, prompting banks to seize their homes for resale. But what happened has caused the collapse of the real estate market in the United States because of the large increase in supply when demand was very low.
Suddenly, funds which have invested massively in the "subprime" found themselves in difficulty : First results in 2007, two funds of "Bear Stearns" close. This was only the beginning of a series of reactions that affected banks in the world : In February 2008, the British government nationalized the "NorthernRock" bank, specialized in real estate loans, to reassure customers of the bank after images of long queues of depositors wanting to withdraw their money from the bank, have gone around the world.
In France, "BNP Paribas" was forced to close several of its funds to reduce losses, while the "Société Générale" announced a depreciation of 2 billion euros because of "subprime" at the time where the bank was in the middle of scandal of Kerviel case, which caused a loss of 4,9 billion euros for the bank.
To understand the domino effect that has spread in the stock markets, it must be understood that the sums of money bet each day by banks were more important in the real value of their assets. The old slogan "ready to lend to the richs only" is put in place : the bank who announced good results attracts investors to pump more money in it. The banks lend each other and re-inject this money on the financial market.
With the start of the real estate crisis in the United States, the reactions of banks that own securities containing "subprime" were similar to the rules of "Poker" : each bank knows how many " hot securities" it has, but it ignores the content of other banks portfolio. Desiring security, the banks refused to lend to each other, or at a very high interest rates, which has weakened many institutions dependent on interbank loans.
This explains how the bankruptcy of "Lehman Brothers" has led to the collapse of financial markets. Starting with Germany, where a scandal erupted on September 18th : On the eve of the announcement of the bankruptcy of Lehman Brothers, the State Bank "KFW" had lent at least 300 million euros to the bank while everyone knew about Lehman Brothers problems.
In Asia, the market has been affected by the panic that prevailed in some thirty banks who lent money to "Lehman Brothers". In Great Britain, the "HBOS" Bank, one of the largest British banks, was forced to merge, with the blessing of British Prime Minister Gordon Brown, with his rival and compatriot "Lloyds TSB" to avoid bankruptcy.
This comes at a time when some countries fear the impact of the extension of the crisis, as Russia where the stock markets has preferred to close its doors Thursday September 18th after two days of huge losses.
Faced with the crisis, central banks had only two options : reduce interest rates on loans or inject more funds in institutions in difficulty (nationalization), or in banks that buy the bankrupt financial institutions. When the central bank lowering its key rate, it helps commercial banks to increase borrowing cash from the central banks and thus enable them to provide their counterparts.
Since early 2007, FED resorted to reducing its rate to encourage banks to lend to each other, from 5,25% in June 2006 to 2% in April 2008.
However, the Fed has been forced in less than two weeks to go further and nationalize three of the largest U.S. financial institutions to avoid chaos in the U.S. market, which is a surprise in an economy that calls for a maximum of economic freedom.
In this context, the U.S. government approved on March 17th 2008 the sale of "Bear Stearns" to "JP Morgan" for 236 million dollars, after the Fed had lent to "Bear Stearns" more than 29 billion dollars to avoid bankruptcy.
On September 7th, the Fed has saved "Fannie Mae" and "Freddie Mac" from bankruptcy after having granted 200 billion dollars aid. But, ten days after, the U.S. government found itself forced to intervene again to save the giant American insurance "AIG" of bankruptcy : 80% of the company's shares have been repurchased for 85 billion dollars from the Treasury.
At the same time, financial institutions less affected by the crisis have bought competitors in difficulty, as "Bank Of America" has acquired "Merrill Lynch" on September 15th for 50 billion dollars, after "Merrill Lynch" has succeeded to save itself for a first time in January 2008 by calling sovereign funds to invest in it.
But although the Fed, the European Central Bank, the Bank of England and the Bank of Japan, have contributedwith more than 140 billion dollars on financial markets, which "temporarily" calmed down the markets, this procedure does not give a long-term solutions, given the number of financial institutions in need of aid, which threatens to aggravate the crisis.
It seems that the effects of the crisis will affect traders and lower their purchasing power. A large number of traders are in danger of being unemployed after the huge losses suffered by the stock markets. Yann H., 26 year old trader, said that things have changed since last summer. "Things are even worse and I would not be surprised if Goldman Sachs and Morgan Stanley put the key under the door", said the trader who left Goldman Sachs this summer.
Goldman Sachs and Morgan Stanley are so far the only two major U.S. banks that have managed to preserve their independence from the crisis "Subprime". They had the green light to change their status that will make them "holding" bank regulated by the Fed.
The economist Alessandro Giraudo, author of the famous "economic myths and legends", believes that the enemployment threatens not only the world of finance. "The current crisis will force players in the economy to smack their business and take nuch less risks, which will reduce job opportunities", he added.
So, Americans risk to pay the cost of the recent interventionist policy of the Bush administration which has injected hundreds of billions of dollars, as U.S. Treasury Secretary Henry Polson confessed, while in many industrialized countries, the draconian measures imposed by banks to credit threaten to weaken the purchasing power of citizens and business investment due to lack of visibility about the future of the world economy.