You can partly blame the French for starting the brush fire that became the credit crisis. Obviously there is so much more to this, and its extremely complicated weaving through the mess, but it all started to unravel here. When I say unravel, please be advised that this is when investors and the main stream media ever figured out what sub prime was. Sub Prime was in fact in the making many years before this.
What precipitated the first peel of the onion was the BNP issue.
BNP Paribas along with Society General were huge players in Fixed Income trading, primarily US MBS and US Credit Default Swaps, the later actually getting $6.9B from the US Taxpayer as part of the CDS Bailout. But for this exercise, we are going to concentrate more on BNP Paribas.
If you all remember in the early part of 2007, the whole credit system along with equities were flying, banks all around the world were hitting new all time highs. In mid may 2007, BNP Paribas hit an all time high of $95.07 in Paris. This was off strong 1st quarter earnings which resulted from robust fixed income MBS trading.
Then when the bank announced better then expected 2ND quarter results on August 1, 2007, the stock rallied a few bucks after falling for the last 3 months or so. Investors were quite relieved that the earnings were good. Investors in BNP Paribas were starting to get worried about US Sub Prime exposure, not terribly so, but the headwinds were there and I remember the conference call was packed with analysts who were interested to know what BNP had to say about MBS trends. The analysts were both particularly surprised and reassured that there was no real write offs associated with US Sub Prime Mortgages, given BNP's sizable portfolio of MBS. The CEO proudly boasted that more prudent risk management helped the bank avert losses in the quarter, he also stated that sub prime was less then 2% of the banks MBS portfolio. From this the stock rallied back up to around 86 from 78 a few weeks earlier.
If you remember, there was a quantitative quake already happening right around July/August 2007, the first cracks of what was to come was appearing.
tradersutra.blogspot.com/2009/07/markets-evolve-uncoilget-used-to-it.html
World markets around the world had started to head south around late July 2007 as there were rumors of some serious losses in derivative trading with regards to US Sub Prime. The SP 500 had dropped from around 1553 down to 1440 or so in the weeks before BNP released earnings. I am not directly saying the markets dropped just because of sub prime or BNP, but there were serious losses in many hedge funds, and those hedge funds had to liquidate for what ever reason.
After BNP had released earnings and hedge fund liquidation had for the time being stopped, world markets bounced some 5% in a few days after the Fed announced that it had left rates unchanged. If you remember the Fed Funds Rate had steadily risen from around 1% in May 2004 to around 5.25% in August 2006, an there was even talk of a rate hike once again at the early August meeting, once the rate was left unchanged, the markets rallied through August 8Th.
Then on August 9Th, the first shots were fired, BNP which only a week earlier had reiterated that MBS exposure was controlled, had halted withdrawals from three funds that they managed, because they could no longer "fairly" value their holdings. These funds had about 1.6B Euros in assets on August 7Th, but had dropped some 20% in the two weeks previous. They stopped calculating net asset value for these three funds, these three musketeers had 1/3 of their holdings in sub prime securities, they alerted everyone that these are sub prime but rated AA and higher by the ratings agencies, so investors should not be alarmed. This development coupled with the fact that the CEO of BNP was oblivious to the situation just 8 days prior sent the entire European Markets into a tail spin. The over night repo market for loans all but disappeared.
In response the ECB was forced to intervene and provide European banks with 96.8B Euros in ultra low interest credit to keep overnight lending alive, the next day they again pumped in an additional 61B in Euros. The Fed when US Markets opened for business on that Friday,was completely caught off guard by what was going on in Europe, also chipped in with about $39B in loans to keep the credit markets functioning. All in all, just pumping money into the system without finding out what the root cause was.
Then the following Monday, the markets were trying to stabilize, the Fed actually managed to get the Fed Fund Rate back to its target, it all looked OK for the time being. Until again the ECB twice provided their markets with funding. 47.7B was followed by 25B on the 13Th and 14Th of August. The ECB was well aware of what was going on and did not want the European credit system to come to a grinding halt, they did everything in their power to keep the machine going. The SP 500 had one final acceleration to the downside on August 16Th as investors startled with the news flow coming out of no where had to liquidate at any price.
The next day, the FRB reversing their tightening bias, lowered the discount interest rate to 5.75% from 6.25%, because this is how the Fed handles any issue, throw more or make money more available when times are tough. This started the intermediate bias for additional Fed easing's. Then the Fed Fund Rate went to 4.75% from 5.25%, which again surprised the market which was looking for only a .25 reduction. Of course world markets rallied furiously right through mid October, taking out the most highs. Yes...The ECB and the Fed were hailed as hero's for saving the day.
Until...................
Part 2 - Countrywide
tradersutra.blogspot.com/2009/08/part-2-countrywide.html
Coming Tomorrow.
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