|The dismal "science"|
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A banking crisis usually refers to a situation in a general "market adjustment" when faith in banking institutions falls, and people start trying to move their money to other places for safe keeping. This is called a "run on the banks." It can also occur due to overextending low quality loans, which in a down market can become essentially worthless.
One of the most famous banking crisis in modern history occurred during the Great Depression, which only massive government intervention and guarantees was able to turn around.
 Panic of 1907
Most people agree the banking panic of 1907 forged a consensus of the need for banking regulation and a central bank in the United States. This led to creation of the Federal Reserve in 1916 to oversee banks and serve as a lender of last resort in times of a cash crunch (or more formally, "liquidity crisis").
 1932 - 1933
By 1930 there were approximately 30,000 banks in the United States. Most of these were mom 'n pop, unregulated neighborhood banks. When the Crash of '29 occurred, unemployment and foreclosures began to rise. Some people needed to withdraw their savings from these banks, only to find the bank didn't have the cash in the vault and was holding worthless paper loans on defunct businesses that laid everyone off, or foreclosed real estate that had sunk in value with no market buyers.
In February 1932 the governor of Michigan declared a banking holiday throughout the state. This sent a tremor throughout the country. Rumors of inflation and going off the gold standard flooded the country, leading to more withdrawal of gold from the banks. Foreign depositors began withdrawing balances which set in motion an increased flow of gold out of the country. By inauguration day of the new president twenty-one states had closed their banks.
President Franklin Roosevelt's first act was to declare a bank holiday. After three days of re-organization and mergers, when the banks re-opened, fewer than half survived. Fractional reserve banking was implemented with regulatory oversight by the Federal Reserve mandating reserve requirements (a portion of bank deposits held in cash reserve). Banks were also required to purchase deposit insurance to rebuild bank customers confidence with FDIC bailout gaurantees. Other reforms followed such as the Glass-Steagall Act, to regulate and monitor who was granted a bank charter, and how they managed their assets and other people's money. And the Banking Act of 1935 which established the Fed's Open Market Committee.
 2007 - 2008
 Deregulation and interconnectedness
Deregulation of the US credit and investment markets enabled many American lenders to make risky lending decisions. Non-conforming high-interest rate "sub-prime" loans - people who prior to 1999 did not qualify for Fannie Mae backed loans, were ripe for losses.
 Credit default swaps
In late 2008 was the Commodity Futures Modernization Act (CMFA) of 2000, introduced by Republicans and signed by President Bill Clinton on the advice of Larry Summers. This Act not only prohibited the SEC from securities oversight of credit default swaps (CDS), it prohibited insurance regulation as well. As a result, the CDS market boomed, and it was the product of choice used to hedge risks.
The main "writers" of credit default swaps were large insurance companies, asked by Investment banks around the world, who were securitizing much of the newly created sub-prime loans. The end result was that the true risk of lower-quality borrowers was held by individuals and institutions who had not evaluated, and were not aware of the risks. Because of the gaussian copula formula, and a belief that the various securitizations were not coorelated, the least-risky tranches of securitizations were packaged together and sold via CDS to these insurance companies, who believed them to be almost riskless.
Because state regulators were not requiring insurers to retain enough in reserve to protect from a system wide shock, AIG underwrote over THREE TRILLION DOLLARS worth of these derivatives. And these default swaps, of course, were purchased by holders of crappy loan bundles (mainly Goldman Sachs, in the case of AIG) as insurance against a systemwide shock.
 Beginning to fall apart
This house of cards, however, was fragile. As interest rates rose and individual borrowers were unable to make payments on their adjustable rate loans after the expiry of teaser rates and other features, default rates in securities began to rise. Noticing this, a number of market participants tried to get "short" of the housing market, creating even more demand for CDS, but now based not on insuring actual housing risk, but just making bets.
The system, however, had to correct itself, and did so in late 2007 and 2008. Spreads on housing risk indices increased dramatically as expected losses rose, and a number of large market participants who had large, leverageds bets on the continued housing boom began to fail, from Structured Investment Vehicles, designed as a rating-arbitrage vehicle, to derivatives products companies, a pure-synthetic highly leveraged vehicle failed first, but were shortly followed by a number of housing-related hedge funds.
By September 2008, the US government was struggling to prevent the all-out collapse of the financial system, and eventually settled on an undersized $700 billion "rescue package" to try to tackle the crisis before the US economy (and by extension, the entire world) froze into a second dark age. The original draft was 3 pages that included a non-reviewable provision, but grew to 451 pages. It passed with House Democrats help on September 29, 2008.
 If that was tl;dr...
Here's Charlie Brooker in a one minute summary:
Didn't get that either? Even more simplified.
 Casualties of the crisis
As the losses started to mount, many banks faced hard times. Some collapsed, some were nationalized, some were swallowed up by larger rivals, and others needed government bailouts. By September 2008, over 284 banks and lenders worldwide had collapsed, the largest ones being:
- Bear Stearns - One of the first to appeal to the US government for help, Bear Stearns was propped up by the US government and eventually sold to JP Morgan.
- Northern Rock - A large British bank and mortgage lender, Northern Rock had a business model where it borrowed money from larger banks in order to extend mortgages to its borrowers. When the markets lost liquidity, it borrowed £25 billion from the Bank of England, but even this failed to save it. Eventually in early 2008, the UK government nationalized the bank, leaving thousands of shareholders with nothing and costing 2000 jobs.
- Dresdner Kleinwort - German investment bank taken over by Commerzbank AG. 31 August.
- Fannie Mae and Freddie Mac - The two largest US mortgage lenders were taken over by the US government, except on a much larger scale. The two government sponsored enterprises, which guarantee about half of the US mortgage market (worth a cool $12 trillion) were placed in conservatorship in September 2008, costing the federal government a potential $200 billion.
- Lehman Brothers - Up to the credit crunch, Lehman was the fourth largest investment bank in the US, but it fell victim to the crisis and filed for Chapter 11 bankruptcy protection in September 2008. Previously, it had approached the Korean Investment Corporation for backing, who wisely walked away when it became clear how exposed Lehman were to the crisis. Thousands of jobs were lost, although UK bank Barclays picked up some of the US assets.
- Merrill Lynch - Another major investment bank, Merrill Lynch actively sought to be taken over by Bank of America in order to prevent its own collapse (Merrill had already written off $50 billion due to sub-prime losses, and had failed to secure overseas investment). The deal was worth a bargain basement $50 billion.
- AIG (American International Group) - The biggest insurance group in the US, AIG was rescued by the US Federal Reserve to the tune of $85 billion, effectively nationalizing the company.
- HBOS (Halifax Bank of Scotland) - In September 2008, the UK's largest mortgage lender, HBOS, came under scrutiny from investors, concerned at its exposure to the slowdown in the UK market. As a result, its shares plummeted and it was taken over by rival bank Lloyds TSB in a deal worth only £12 billion. Such a takeover would have been impossible before the credit crunch, as UK competition laws would have prevented a merger of two of the largest UK banks.
- Washington Mutual - At the end of September 2008, WaMu was closed by its regulators and sold to JP Morgan for a pocket-change amount of $1.9 billion. With assets of $307 billion it was the largest bank to fail to date, and its acquisition by JP Morgan meant that the latter is now the second largest bank in the US.
- Bradford & Bingley - Mortgages from B & B placed into public ownership by the British government on 29th September 2008, while the bank's £20 billion in savings deposits, 2.7 million customers and its 197 branches were sold to Spanish bank Santander, who also bought up the struggling Alliance and Leicester bank.
- Fortis - One of the largest banks in the Low Countries. Rescued and part nationalized by Belgium, the Netherlands and Luxembourg. 29 September.
- Wachovia (phonetic pron: Walk-over-ya) - Bought out by Citigroup. 29 September.
- Glitnir - Icelandic bank nationalized. 29 September.
- Hypo Real Estate - German bank bailed out by German government. 29 September.
- Dexia - Belgian bank bailed out by Belgium, France and Luxembourg. 30 September.
- The nation of Iceland? 6 October.
- Landsbanki - Icelandic bank bailed out by Russian funds, 8 October. Refuses to recognize deposits by foreign nationals.
- Yamato Life - The first Japanese victim of the crisis, insurance company Yamato Life went bankrupt on 10th October.
- You and me. 'Nuff said.
 The moral of this story
We were then treated to the somewhat bizarre spectacle of a particularly right-wing Republican administration nationalizing vast swathes of the American economy, to the point where the US government now not only owns about half of the mortgaged properties in the US, but also is in the business of insuring against defaults on those very same properties—a potential "double-whammy" of monstrous proportions. At this juncture, the slinging about of phrases like "house of cards" might not be considered inappropriate.
 Problems in the Eurozone
Free market libertarianism hasn't worked. Keynesian policies enacted since the Great Depression prevented what used to be a common occurrence in "free markets" - disastrous contractions which created extreme hardship - even though the market players and their political tools continue to try to break things, most notably via supply side economics and deregulation of financial institutions.
 The Republican dissent
In December 2010, the Financial Crisis Inquiry Commission released its report to Congress. However, during the process of writing the report, the Republicans broke off from the rest of the commission and released their own report, putting wingnut talking points into the record: They excised words like "Wall Street," "deregulation," and "shadow banking system." The official alternate-universe narrative is as follows: "Democrats, especially Bawney Fwank, blocked new regulations on Fannie Mae and Freddie Mac, which forced them to loan to po'
black hispanic people. They were forced to make these bad loans because of the Community Reinvestment Act, passed by the dastardly Jimmy Carter. Democrats did it, gummint bad, gummint bad, gummint bad, Reagan smash!"
Fannie and Freddie did buy up and repackage a lot of bullshit loans, yet it's completely absurd to put the blame for a global financial crisis entirely on them. And the CRA as well -- nobody is quite sure how a law passed under Carter and revised in the early 90s could be responsible for a housing bubble in the 2000s. Fannie and Freddie actually stepped out of the prime lending market and joined in the fun buying up shitty loans from Wall Street banks after loosening their guidelines and jumping into the subprime market. But at least "Fannie and Freddie weren't guaranteeing loans in Latvia."
And all of this to deny the fact that the real culprits, Ronald Reagan (by winning the Cold War the country didn't need as much defense spending), and Newt Gingrich (balancing the budget after 1995 reduced government borrowing and lowered interests), produced a flood of cash for consumers to pursue the American dream, the root of the crisis.
Adding further insult to injury, see the completely ravaged, horrific commie wreck of an economy only a few kilometers north, eh.
 See also
- Inside Job, essentially the crisis for dummies. Won Best Documentary Feature at the 83rd Academy Awards.
- ↑ And that's putting it lightly.
- ↑ Origin of the Federal Reserve System, Free to Choose, Milton R. Friedman, 1980.
- ↑ Eric Dinallo, Testimony to Congress, November 2008 on (Naked) Credit Default Swaps; a more lasting result was passage of New York’s anti-bucket shop law in 1909. The law, General Business Law Section 351, made it a felony to operate or be connected with a bucket shop or “fake exchange.”…Section 351 prohibits the making or offering of a purchase or sale of security, commodity, debt, property, options, bonds, etc. without intending a bona fide purchase or sale of the security, commodity, debt, property, options, bonds, etc. If you think that sounds exactly like a naked credit default swap, you are right. ritholtz.com
- ↑ Historical Dictionary of the Great Depression, 1929-1940 (Google eBook), James Stuart Olson, Greenwood Publishing Group, 2001.
- ↑ The failure of Austria's wp:Credit-Anstalt in 1931 was the first in a wave of international banking crisis which further unsettled Wall Street after the Crash of '29.
- ↑ Fannie Mae Eases Credit To Aid Mortgage Lending, Steven A. Holmes, New York Times, September 30, 1999.
- ↑ See the Wikipedia article on Commodity Futures Modernization Act of 2000.
- ↑ Clinton: I Was Wrong to Listen to Wrong Advice Against Regulating Derivatives*, Evan Harris, ABC News This Week, April 17, 2010. Larry Summers was appointed by Obama as Director of the President's National Economic Council on November 24, 2008.
- ↑ Equal to about one quarter of all federal outlays at the time, and $200 billion more than the balance sheet of the Federal Reserve Board, which would have to purchase the new government debt from the U.S. Treasury.
- ↑ Too Big Too Fail
- ↑ http://news.bbc.co.uk/1/hi/business/7637026.stm
- ↑ Fortis downfall
- ↑ Wachovia bought out
- ↑ Glitnir - Icelandic bank nationalised
- ↑ Dexia bailout.
- ↑ Iceland goes broke?
- ↑ 
- ↑ 
- ↑ http://www.guardian.co.uk/commentisfree/2008/sep/19/marketturmoil.usa
- ↑ http://www.mainstreamweekly.net/article1060.html
- ↑ http://www.huffingtonpost.com/jonathan-tasini/its-bozo-the-clowns-fault_b_143882.html
- ↑ Really. They prided themselves on government regulation.
- ↑ The racism here might seem latent, but take a look at this Byron York interview. Shorter York: Poor black people diddit. And for further debunking of this point, and some more racism by Neil Cavuto, see this article in McClatchy, and, oh yeah, can't forget Ann Coulter: Affirmative Action caused the housing bubble!
- ↑ Wall Street Whitewash