Global Financial Crisis Timeline date 1980s event interest rate swaps invented

M.J. Peterson implications these trades of the income from a fixed-rate security for the income from a variable-rate security allow hedging against changes in interest rates. creating a separate affiliate allows the swap operations to avoid the rules of normal banking regulation limiting the amount of risk a bank can take on these allow a bank or investment firm to take out a form of insurance against default by a corporation on its investment-grade (highly rated) bonds Most loans under this program were not subprime; most were also made by banks subject to normal banking regulations setting limits on the total risk the bank can carry Savaga had sufficient math training to understand the models being used to assess risks of the swaps help by AIG-FP; Cassano did not.

1990s

1990s

expansion in availability of interest rate swaps as large insurance companies, investment firms, and banks establish affiliates to engage in swaps credit default swaps invented

1992

12/2001

late 2003

2003-2007

6/2004

6/10046/2005 6/2004-

Community Redevelopment and Reinvestment Act adopted, requires banks to provide mortgage loans to low income and minority households in areas where they do business Tom Savage, original CEO of American International Groups Financial Products affiliate(AIGFP) retires and Joe Cassano replaced him subprime portion of US mortgage market amounts to tens of billions, a minor share of the overall mortgage market US stock prices double while Iceland stock prices multiply by 9; Iceland bank assets increase from a few billion dollars (or an equivalent to Icelands GDP) to over $140 billion US Federal Reserve raises interest rates to slow expansion of money supply prime (traditional) mortgage lending declines by 50%; subprime mortgage lending doubles subprime mortgage component of

increases the prime rate used as the basic for calculating adjustable rates

creates huge exposure to risk for

6/2005 6/20046/2007 3/2005

3/2005

AIG-FP credit default swaps increases from 2% to 95% $1.6 trillion in subprime mortgages and $1.2 trillion in Alt-A loans issued NY State Attorney General Elliot Spitzer forces Hank Greenberg to resign as CEO of AIG one day later, credit rating agencies drop AIGs credit rating from AAA (best) to AA

AIG vast expansion of risky loans

late 2005

AIG-FP stops dealing in credit default swaps involving subprime mortgages after Gene Park reveals the extent of the risk It continues to hold the swaps it had already made analysts at Danske Bank (largest private bank in Denmark) produce a report concluding that the Icelandic banking system is vastly overextended because of crony deals and poor choices of assets to buy a wave of increases in interest rates on adjustable rate mortgages occurs as their 2-year introductory period ends beginning of defaults on subprime mortgages in USA causes collapse in price of credit default swaps Goldman Sachs being particularly aggressive in requiring collateral from AIG; AIG under enough pressure that a run on its assets looms inflation in Iceland running at 14%, leading central bank to raise domestic interest rate to 15.5% (UK interest rate then at 5.5% and Eurozone rate typically 4%)

triggers a clause in AIG swaps requiring AIG to post collateral (in the form of money) if the prices of the bonds in a credit default swap decreases, exposing AIG to large immediate liabilities if the market drops The major firms that had dealt with AIG-FP including Merrill Lynch, Morgan Stanley, Lehman Brothers, and Bear Stearns decide to continue acquiring subprime mortgage-based securities and hold the risk of default themselves

early 2006

summer 2007

AIG severely exposed because of the requirement that it post collateral on its swaps

fall 2007

10/200710/2008

foreign investors hold deposits in Icelandic kroner, leading to further expansion of the money supply and greater over-valuing of the kroner against other currencies

3/2008

US Treasury commits to making good AIGs liabilities 100 cents to the dollar. University of Chicago economist Robert Aliber warns Icelanders that their banks are ripe for collapse because they will not be able to roll over their large debts Icelandic banks unable to refinance their high short-term debts and suffer a run on deposits by British investors

5/2008

9-10/2008

Considerable commentary on the fact Treasury Secretary Paulsen had been CEO? of Goldman Sachs before joining government By this time Iceland has attracted lots of foreign investment: $21 billion from German, $305 million from Dutch, $400 million from Swedish, and $30 billion from British banks and other investors 3 main banks put into government receivership; stock market prices fall by 90%