Over the last few weeks, I’ve been editing a book of Breakingviews’ coverage of the credit crunch.* It’s been an interesting experience, re-living this momentous year in the financial markets.
From the first UK bank run in nearly 140 years, to the seizure of the money markets, to the first US house-price slump since the Great Depression, few can remember anything like it. Here is my pick of the events that defined the year.
The Blackstone initial public offering (IPO)
Blackstone (BX) was widely seen as the biggest, baddest beast in the private-equity jungle. So when it announced in March it planned to float on the New York Stock Exchange, valuing itself at an eye-watering $40bn, or $50m per employee, it fuelled a global backlash against the industry.
But investors were too caught up in the frenzy to care about Blackstone’s weak corporate governance or its exposure to the credit cycle, and snapped up shares at $30 a piece. Now they’re worth $21.
Collapse of Bear Stearns hedge funds
In June, almost without warning, two hedge funds run by Bear Stearns, which had previously held as much as $20bn of assets, collapsed as a result of losses on complex subprime-related investments. With hindsight, this was the signal the party was truly over – that the subprime crisis in the US, which had been gathering pace all year, had the potential to do real damage.
Bear Stearns rescued one of the funds, while the other was allowed to go to the wall. Yet, remarkably, the markets took this huge value destruction in their stride. It was weeks before the significance to the wider market became clear.
The Boots leveraged buyout (LBO)
US private-equity group KKR’s £10bn buyout of Boots in March was Europe’s largest ever and the first ever involving a member of the FTSE 100. Combined with a similar bid for Sainsburys around the same time, it triggered deep anxiety about the role of private equity.
But in the City, attention was focused on the £9bn of debt KKR was planning to load on to the UK chemist chain. KKR managed to get the deal away. But the banks who lent the money got stuck with the loans. It was the first sign that the subprime crisis was turning into a full-blown credit squeeze. It also signalled the end of the LBO boom.
Money market freeze
The world changed on 9 August, when the commercial paper market seized up. Commercial paper is supposed to be the next best thing to cash and is used widely throughout the financial system by banks to fund their activities. On the same day, French bank BNP Paribas suspended two of its money market funds, used by investors as high-yield cash accounts, saying it could no longer find prices for its assets.
Panic broke out in the markets as banks stopped lending to each other, unwilling to lend to anyone contaminated by US subprime mortgages. Central banks responded with emergency action to keep markets open. The only one to refuse to intervene was the Bank of England.
Northern Rock
The Bank’s mistake in not intervening in August became clear on 14 September when Northern Rock (NRK) was forced to borrow from the Bank in its capacity as lender of last resort – leading to the first run on a UK bank for 140 years. Perhaps the Rock would have collapsed anyway. It had expanded recklessly during the boom, taking a 20% market share in the overblown UK mortgage market, despite its dependency on the financial markets – rather than depositors – for 75% of its funding. By late December, taxpayers were on the hook for a jaw-dropping £100bn, with no end to the crisis in sight.
Citigroup rescue
In July, Chuck Prince, the boss of the world’s biggest bank, told the world that Citigroup (C) was “still dancing”. It sounded like a top-of-the-market comment and so it proved. Months later, Prince was out of a job. Citigroup was forced to write off $12bn of dodgy US mortgage exposures and take onto its balance sheet a further $49bn of assets contained in previously off-balance sheet vehicles.
Humiliatingly, Citi was forced to turn to the Middle East, selling the Abui Dhabi Investment Authority a $7.5bn convertible bond with an 11% coupon. Weeks later, Swiss bank UBS (UBS) had to ask Singapore to do the same. It was a sign that power was shifting East.
Co-ordinated central bank bail-out
For most of the year, most central bankers paid lip service to fears about moral hazard – the risk that anything they did to ease the financial crisis by shoring up banks would only encourage more recklessness in the future. By December, they had thrown caution to the wind. They launched an unprecedented coordinated assault, agreeing to flood the markets with money at below market rates.
It was a desperate move to unblock the financial plumbing – and, so far, seems to be working. But whether it was enough to stave off a recession, we will find out next year.
*When the Dancing Stopped, price £20, is available via the Breakingviews.com website. Simon Nixon is executive editor of Breakingviews.com