Dynamics of the Financial Crisis
After all, you only find out who is swimming naked when the tide
—WARREN BUFFET, 2001
The financial crisis had features that many firms found it difficult to defend against. A summary of the salient points of the crisis and the buildup of vulnerabilities before the crisis provides context for understanding the quality of financial firms’ governance and risk management. The chapter begins with the buildup of vulnerabilities before the crisis, moving from the glut of global savings and the unprecedented flow of money into US credit markets and the mortgage market in particular, to the consequent housing bubble and its effects on lending standards and borrowers.
Then the credit and housing bubbles peaked and burst. Declining house prices and asset prices generally led to losses, and especially losses in securities whose credit attributes had falsely been considered high. These unexpected losses, especially for highly leveraged financial firms, led to panic in the markets and what can be called a liquidity crisis, when firms found themselves unable to borrow from their usual sources to pay holders of their maturing obligations.
The most important aspect of years before the crisis was the unprecedented influx of money from overseas—the “global saving glut,” as Federal Reserve Chairman Ben Bernanke called it.1 Developing countries increasingly realized the dream of strengthening their economies and lifting large numbers of