When I received a phone call from a trader colleague at Merrill Lynch on August 9 2007, I was in the middle of chopping wood in the Swedish countryside. As always, I had my mobile on me in case of an emergency.
I answered the call to a frenzied account of an extraordinary development in the financial markets. My colleague kept repeating that things were “crazy” and “completely mad”. At the time, there was nothing in what he said that made me worried about my trading position, let alone the global financial system. Rather, it was the market prices, quotes and numbers that he listed that did not make sense at all.
Put together, it seemed as if all banks, suddenly, had become desperate for cash. The reason soon became apparent: French bank BNP Paribas had barred investors from accessing money in funds with subprime mortgage exposure, citing a “complete evaporation of liquidity”. It was the start of the credit crunch.
A financial crisis tends to be associated with fears of a bank run. Picture long queues outside banks, such as during the Great Depression following the 1929 Wall Street crash. If customers desperately begin to withdraw their deposits from a bank, it can quickly turn into a self-fulfilling prophecy. If you think that others will become afraid that the bank will run out of cash, it might be rational to empty your own savings account first. And so, for many, scenes of long queues outside branches of UK bank Northern Rock in September 2007 is still their earliest memory of the credit crunch and the global financial crisis.
Queues outside Northern Rock in September 2007. EPA/Andy Rain
Before the fear of a bank run spreads to the public, however, the atmosphere on the trading floors has already changed. Trading turns into a situation in which the hot potato is passed around from trader to trader, from bank to bank. Lending money is a risky business and nobody wants the borrower to default. As a precaution, banks desperately try to borrow money from the others before they stop lending. Nobody wants to get burnt by being left holding that hot potato.
Parts of the money markets had already begun to dry up with the demise of the US sub-prime mortgage market around February 2007. Some hedge funds and lenders had reported serious losses – and this malaise had spread to European markets. Then followed the news that BNP Paribas had frozen €1.6 billion of funds, citing US subprime mortgage sector problems.
BNP had always played a big role in the trading community and had made markets in everything I traded: foreign exchange, bonds and interest rate derivatives. They were also French – and the French banks were famous for hiring the best programmers and mathematicians as analysts and traders. If they did not know how to value their portfolios, who did? When I received the phone call, the news flash had just happened and the game of musical chairs had begun.