The Credit Crisis Turns One

It was a year ago August that the real estate slump turned into a global economic disaster—and it's still growing

By Prashant Gopal

• View Slide Show

Happy birthday, credit crisis. It was a year ago August that the world began to suspect the economy was heading into something worse than a slump. Now as another August heaves into view, the credit crisis is a year bigger and—like many 1-year-olds—indiscriminate about where it makes its messes. The real concern is how much bigger it will get.

The crisis has transformed the housing market from weak to downright disastrous. Home prices are tumbling, foreclosures are spiking, and the bottom of the market seems more distant than ever. Gone are the loose lending standards that helped millions of people buy houses they couldn't afford otherwise. Today, securing a loan can be tough, even for buyers with decent credit.

The world was not braced for the impact the real estate slump would have on the financial industry. It was on Aug. 1, 2007, that two Bear Stearns hedge funds heavily invested in mortgage-backed bonds filed for bankruptcy, and another had its assets frozen following mortgage-related losses. Within a week, Luxembourg's Sal. Oppenheim, one of Europe's largest private banks, announced it had temporarily closed a €750 million asset-backed securities fund it managed for Austrian investment foundation Hypo KAG. And, on Aug. 9, BNP Paribas (BNPP.PA), France's biggest bank, followed suit by freezing $2.2 billion worth of funds exposed to the subprime mortgage market. On that same day Dutch merchant bank NIBC canceled a flotation plan after revealing a $188.6 million loss from U.S. asset-backed securities. It was becoming apparent that many of the mortgage-backed securities that had been used to pump billions of dollars into the global economy were considerably overvalued. Lenders around the world were getting very nervous, very fast. They had reason to be.

Losses from the Crisis

Since last August losses suffered by all financial institutions on assets originated through 2007 are expected to total some $925 billion, equal to about 3% of all assets, according to Moody's Economy.com. The largest losses, expected to total $525 billion, will be on residential mortgage loans. Once mighty companies such as Bear, Countrywide Financial, and IndyMac have gone under or been acquired, and dozens more, such as Fannie Mae (FNM), Washington Mutual (WM), Citigroup (C), and Wachovia (WB) are hanging on by a thread. And it's not just the housing and financial sectors that have been battered. The credit crisis has spread to infect the automotive, airline, travel, and retailing industries.

The outlook seemed much rosier last summer. Treasury Secretary Henry Paulson in June 2007 declared that "we are at or near the bottom" of the housing slump. At that time, median single-family home prices had fallen just 1.5% in the second quarter of 2007 from the previous year, according to the National Association of Realtors. And Paulson said he believed that housing losses had been "largely contained" and would not significantly damage the overall economy.

Since then the housing slump has spread across the country, helped along by more restrictive lending standards.