Down the Hatch

LAST February I was walking the freezing streets of Cleveland Ohio and wishing I had brought a coat that covered my behind. I had gone to visit Cleveland's mayor Frank Jackson who was suing Wall Street's biggest banks for acting like "organised crime" selling subprime mortgages to people who couldn't afford them. The direct consequences of the subprime debacle were horribly obvious. Street after street of abandoned houses, many on the point of collapse after vandals had ripped all the metal out of them and even taken bricks.

Jackson put me in touch with Aquila Eberhardt, a single mother of two who had managed to convert her $1,400 a month in benefits into a $103,589 home loan thanks to a subprime mortgage seller. She couldn't keep up with the payments and her family faced eviction. To some degree Jackson was getting his payback. Wall Street titans had fallen along with their banks' profits. Asked why they were so keen on subprime Jackson said: "The money was just too good. You ask these financiers on Wall Street why they persist in doing this when they know the risks they are running and the damage they are doing to their communities and shareholders. Do you know what they will tell you? The money was just too good." The major was out for more blood. Little did he know, he was about to get it on a scale that would bring the world's financial system to its knees.

At the start of 2008 most business leaders were braced for a mild downturn. There was no doubt that budgets were going to be cut but it looked like the credit crunch was going to knock the froth off that Starbucks cappuccino rather than drive us screaming and jobless in to the streets. In Britain Northern Rock had been propped up by the government, becoming the first victim of the crunch, and now looked stable. There were doom mongers out there but most seemed to believe the economic pain would not be too great. It wasn't long before the clouds rolled in to worry those sunny optimists.

In mid-January Citigroup, then the biggest bank in the world, admitted that it needed $14.5 billion to balance its battered books. A week later Jerome Kerviel, a trader at French bank SociÈtÈ GÈnÈrale, made an early bid to be this season's rogue trader. Kerviel lost Ä4.9 billion in unauthorised trades. By the end of the year he would be an also ran.

In February Northern Rock was nationalised after a buyer could not be found. It was a spooky foreshadowing of things to come. The credit crisis had revealed that much of the world's financial system was a house of cards, and badly built one at that. Some of the biggest names in banking were drowning in "toxic assets". When you hear people in the street talking about "collateralised debt obligations," then you know we are in trouble. Governments around the world started worrying that the private sector alone was incapable of solving its problems.

Thomas Sowell, the economist, author and columnist, believes the US government's actions in the past had forced such dramatic moves now.

"The government has brought on the housing problem, partly by these very low interest rates, which encouraged many people to go way out on a limb," said Sowell. "They've brought it on by highly restrictive building policies, which have caused housing prices to skyrocket artificially. And they've brought it on by the Community Reinvestment Act, which presumes that politicians are better able to tell investors where to put their money than the investors themselves are. When you put all that together, you get something like what you have."

The consequences of not stepping in were ably demonstrated in September when Lehman Brothers was allowed to fail. The financial world went in to meltdown and the rest of the world followed. In the first half of the year the credit crunch had been largely a financial phenomenon. Now it started to squeeze the rest of the economy as banks cut off credit to other businesses in an attempt to conserve cash and shrink their balance sheets.

The troubles in the housing market began rising up the property ladder. A booming market had kept those subprime homes above water but now they were sunk and the rest of the market was coming too. Hot markets like Vancouver saw sales drop as listings rose for the first time in recent memory. In the UK sales began to dry up and house builders began to lay off staff. Unsurprisingly consumer confidence evaporated, not good news as consumers account for 70 per cent of US GDP. Circuit City and Linens `n Things, two big US chains and Britain's MFI and Woolworth's were among those to go bust. Job losses have rocketed across the world. The jobless numbers in the US are now at levels unseen since 1982.

Oil prices peaked in July at more than $145 a barrel - slamming US drivers and killing the already struggling US car industry. America's Big Three are now on the bailout scheme. Oil prices slid and at year's end crude was trading slightly above $44 after falling to less than $40 a barrel. But the collapse of commodities prices brought more trouble as it helped upend economies from Russia to Australia.

Henry "Hank" Paulson - US Treasury secretary, former Goldman Sachs boss and Herman Munster look-a-like - started the year on the sunny side of the street believing free markets would adjust. By September Paulson had gone over to the dark side and was begging Congress for $700 billion to bail out the banks. "If it doesn't pass, then heaven help us all," he reportedly said. It did but heaven's help would still come in useful.

But all this bailing and cutting has done little to calm the financial markets. Not so long ago a 300 point swing on one of the major stock markets was a newsworthy item, whether the swing was up or down. By the middle of 2008 stock markets were leaping up and down on a daily basis like a kangaroo on speed. But the general trend was down, down, down.

So who's fault is the crisis? Blame has been thrown in many directions, but Glen Meakem, managing director of Meakem Becker Venture Capital, has his own thoughts.

"The fact that the crisis was unaddressed is squarely the responsibility of the liberal Democrats," say Meakem. They fought any reform at all. That's clearly documented. So that part of the economic failure is clearly not Bush's fault. As for the liquidity crisis, I think (Federal Reserve Chairman) Ben Bernanke has not been a very successful Fed chief. I think he misread the economy over the past year, and I think they needed to put a lot more liquidity into the economy."

At the end of December I was due to be back in England, seeing my parents in Manchester then coming down to London to see friends and colleagues. Two days in to my trip I was back on the plane to New York. Bernie Madoff, a pillar of Wall Street and a former chairman of the Nasdaq stock exchange, had confessed to bilking his clients out of $50 billion. His sons had dogged him in to the authorities. Madoff too had been a victim of the credit crunch. Faced with credit crunches of their own, Madoff clients had asked for $7 billion of their money back. Madoff had already made off with the money. Days later the story took a darker turn with the suicide of Rene-Thierry Magon de la Villehuchet, a Madoff investor ruined by the scandal. It was a tragic end to a bleak year.

"There hasn't been a year in living memory to compare it to," said Ken Goldstein, who has been an economist at New York think tank the Conference Board since 1971. "We have never been here before and we never expected to be here in the first place. We are in uncharted waters."

What next? President Obama's election was one of the few bright sparks of 2008. His team is now drawing up an economic stimulus package that has seen no rival since the New Deal at the end of the Great Depression. Some economists are predicting a bounce back later this year. Others are less optimistic. Russell Roberts, an economics professor at George Mason University in Virginia, is certainly sure of who will pay for the financial mess.

"Your children and mine," he says. "Not in the form of debt, which is the standard answer, although they'll pay for that too. But the real cost is, to me, that we will lose the goose that lays the golden eggs -- which is our unbelievably flexible and powerful financial system. We have -- until recently -- had the best capital market in the world. We look across both the stock market down to venture capital to angel investing -- the opportunity to find financing for great ideas was really unparalleled in the United States. That right now is at a standstill. If it does not come back, we will all be poorer for it."

Jim Cox, law professor at Duke University, said this year could be just as dramatic. "There is so much unravelling left to do. New scandals just keep popping up as the tide goes out." He expects 2009 to be full of law suits, many of which may uncover new scandals.

Nouriel Roubini, the economist at New York University who called the 2008 market disaster correctly, foresees "a deep and protracted contraction lasting at least through the end of 2009." Even in 2010, he added, the recovery may be so weak "that it will feel terrible even if the recession is technically over."

On one thing they are all agreed. Everyone is glad to see the back of 2008.