Path to Destruction
1. The Bubble Bursts
Housing values fall as supply overwhelms demand. Many subprime borrowers find that their homes are worth less than their mortgages. Defaults rise, which sends prices further south. The downward spiral begins.
2. Run of CDOs
Investors pile into collateralized debt obligations (CDOs), which are complicated securities based on pools of mortgages. CDOs are often (absurdly) rated AA and AAA and considered as safe as Treasuries.
3. Leverage Loves Company
Firms borrow to load up on CDOs and real estate. Lehman Brothers was leveraged more than 30 to 1. AIG sells credit-default swaps (CDSs), derivatives designed to protect investors from failures.
4. The Mortgage Collapse
Consumers who got big mortgages with little documentation begin to default. Lenders like Washington Mutual and Countrywide Financial see their stock prices sink. Fiscal comeuppance rears its ugly head.
5. Finance Takes the Next Hit
Rising delinquencies mean that CDOs lose value. The investment banks must take write-downs and raise capital; the rout begins. Bear Stearns goes down. Lehman Brothers plays an endgame and loses.
6. Begin the Bailout
Fannie and Freddie have to be made federal wards to try to stop the crisis. Wishful thinking. Next, the Fed steps in to save AIG before rolling out a $700 billion bailout. The markets weaken with worry.
7. The Freeze
Some credit markets have already seized up, including auction-rate securities, which hurt municipalities. Large banks are also getting skittish. The spreads on junk bonds and even better-rated corporate bonds are widening. This raises costs for businesses.
8. The Market Gets Volatile
Volatility is bad for the stock market, and recent indicators are off the charts. Investors head to the sidelines, willing to park their money in three-month Treasuries at less than 1% interest until it’s safe to come out again.
9. The Deleveraging Death Spiral
Banks under stress, like Washington Mutual and Wachovia, need to set aside more capital against potential losses. So they have to sell assets, which drives asset prices even lower, which requires more capital. And round and round we go.
10. From Wall Street to Main Street
As lending tightens, short-term loans on which all kinds of businesses rely become less available. This has huge negative potential, because if the gears of commerce get stuck, growth slows and layoffs follow as companies trim costs.
Fuente: Revista TIME