Anatomy of a Panic

What exactly is a panic anyway?

To understand one, let's examine the Panic of October, 2008. In broad strokes, here's what I believe happened:

  • Mortgages that had been packaged and sold start to default in large numbers in 2007, leading to the imminent failure and sale of Bear Stearns in March of 2008.
  • Continuing defaults on mortgages lead to a run on the banks with large exposures to these products, including Lehman Brothers. When Lehman Brothers was allowed to fail on September 15th, 2008, investors lose confidence in any packaged mortgage products, including Mortgage Backed Securities (MBSs).
  • As investors try and determine the value of their portfolios, they start to make claims against Credit Default Swaps (CDSs) which were supposed to act as insurance policies in the event of such a default. Since these CDSs were not regulated, companies had been selling them naked, without any loan-loss reserves. With a large portfolio of unfunded claims, AIG becomes insolvent practically overnight.
  • Had AIG been allowed to fail, banks, companies, and investors around the world would have also become insolvent. Instead, the Federal Reserve and the US Treasury bailed out AIG on September 17th, and honored their CDSs at 100 cents on the dollar.
  • By now, the game was up. People finally understood that MBSs were not worth what they thought they were, and neither were their CDSs . From this point on, the markets for all Collateralized Debt Obligations (CDOs - bundled residential real estate loans, commercial real estate loans, credit card loans, auto loans, student loans, etc.) started shutting down as well.
  • Since many banks and other companies had these investment products in their portfolios, and since no-one knew for sure what their total exposure was, all debt markets world-wide started to shut down in early October, getting so bad that banks refused to loan money to each other.
  • In response to a total shutdown of global debt markets, central banks around the world announce extreme, coordinated measures to restore confidence in the first weeks of October, 2008. They've been attempting to restore confidence ever since.

The end result, what were once highly valuable portfolios of debt and equities, are now worth less (in some cases worthless) to the tune of an estimated 16 TRILLION Dollars world-wide. Not only have borrowers defaulted, lenders have incurred losses. In turn, many of those lenders are now in jeopardy of defaulting on obligations of their own. And so it continues, until the "great reset" completes.

In the next post, the fun begins - that's when we'll start exploring things that are likely to occur, and how we can benefit from the changes ahead. Until next time ...

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