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2008-10-23

What Had Started This Credit Crisis?

Because this credit crisis started stealthily, few people saw it coming. It’s like the old adage about boiling a frog. If you were to drop a live frog into a pot of boiling water, it would jump right out. But if you were to drop a frog into a pot of cold water and then heat the water slowly— well, the frog doesn’t realize the peril it’s in until it’s too late.

The first obvious heat for the U.S. economy’s pot of water was the subprime mortgage crisis, when thousands of risky mortgages started to go bad in 2006. Then the heat got turned up in June 2007 by the failure of a Bear Stearns hedge fund that had invested in the securitized version of these risky subprime loans. Less than a year later, in March 2008, the Fed engineered a bailout of Bear Stearns via JP Morgan. The temperature rose higher still in September 2008 as the U.S. government bailed out Fannie Mae, Freddie Mac and AIG. It also subsidized the mergers of some investment and commercial banks while letting Lehman Brothers go bankrupt. And then came the bailout bill.

But the primary heat source that came before all of these others was an overabundance of credit in the marketplace, thanks to the Fed’s easy-credit stance at the turn of the 21st century.

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