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The Great Panic

How the world changed one day last summer.


It can be tricky trying to pin down the beginning or end of world events. When asked about the impact of the French Revolution nearly two centuries later, Zhou Enlai replied: "It is too soon to tell."

Still, the birth of the credit crunch-the child of a burst bubble in housing-can be traced to a Thursday last summer, a day when many Wall Street executives, bankers, and government officials were enjoying their vacations.

On August 9, 2007, it became clear that fear had paralyzed the world's credit markets. The question was no longer only about the quality of assets or the availability of cash. Everything was suspect and no one was willing to take any chances.

The world had turned subprime.

The chill in the credit markets was already apparent beginning in February in the wake of the collapse of the subprime mortgage market in the United States. Many mortgage lenders were in trouble. Two Bear Stearns hedge funds that had bet heavily on securities tied to subprime mortgages collapsed earlier in the summer. In July, the German government organized a $5 billion bailout of IKB bank.

Then, an announcement by a big French bank starkly revealed to the world that the credit markets had frozen up.

Early that August morning in Paris, BNP Paribas announced that it was stopping investors from withdrawing from three funds because it could not determine the market for their holdings.

"The complete evaporation of liquidity in certain market segments of the U.S. securitization market has made it impossible to value certain assets fairly regardless of their quality or credit rating," the bank said in a statement.

The statement ignited rumors of possible problems at other banks and at hedge funds. Stocks on European markets slid. Fear held dominion in the markets.

"This is the day the world changed," Adam Applegarth, then the chief executive of Northern Rock, said looking back, as the British lender had to be rescued from collapse by the just days later. (To see just how much the world has changed in a year from the credit storm, click here.)

Nearly as startling on August 9 was the rapid response of the world's central bankers. The European pumped $147 billion into euro money markets to try to unblock lending among banks. It was a bigger infusion than the one that came in response to the 9/11 attacks.

The Federal Reserve, the Bank of Canada, and the Bank of Japan followed with similar, but smaller steps.

Liquidity, however, was not the core issue. It was confidence. Banks did not trust other banks. Investors fled from risk. Trust would not be restored with below-market-rate loans from central banks.

Even after the unusual moves by the central banks, stocks in the United States slid. Spreads widened. After the market close, Countrywide Financial, the biggest American mortgage lender, warned that "unprecedented disruptions" in the credit markets threatened its financial health.

Fears mounted. Loans, for businesses and consumers, soon became more expensive and more difficult to get. Dealmaking came to a standstill. The crunch was being felt.

In response, the Fed first went by the playbook, then threw the book out. Some economists contend that Ben Bernanke and other policymakers were too slow to respond, Zubin Jelveh reports.

The credit crunch has reshaped the financial landscape. Banks, insurers, and other institutions have written down hundreds of billions of dollars in assets. Bear Stearns and Countrywide no longer exist. A year later, it is still difficult to tally up the damage on Wall Street or to forecast its future, Megan Barnett writes.

No end is in sight. The credit crunch, on top of the slide in housing prices and the surge in energy prices, has probably tipped the into a recession. It is squeezing consumers and businesses. Banks are still scrambling to raise capital and still marking down assets as loan delinquencies and foreclosures increase. The Treasury Department has a rescue plan for mortgage giants Fannie Mae and Freddie Mac. Sweeping overhauls of the financial regulation system have been proposed.

In a year, the worldview of has been turned upside down. In the spring of 2007, Wall Street was basking in a "golden age" of private equity and deals. Regulators believed the subprime implosion could be contained. "Troubles in the subprime sector seem unlikely to seriously spill over to the broader economy or the financial system," Bernanke told a South African audience on June 5, 2007.

And on August 9, President Bush sought to play down the jitters in the market, saying that "the fundamentals of our economy are strong."

How much has changed. His successor may now have to confront another year of financial pain.

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