CREDIT CONTRACTION, FINANCIAL COLLAPSE AND GLOBAL RECESSION

KEY POINTS
 We have now entered the third stage of the most tumultuous period in financial history Feature
since the stock market crash in 1929 and consequent Great Depression.
 This is not the end of open liberal markets but the affirmation of the need for a more
balanced, managed and responsible form of market-driven financial capitalism.

Author George Walker

Credit contraction, financial collapse and

global recession: pt 1
INTRODUCTION
The global financial crisis has unfolded
with a brutal and remorseless
continuity and predictability. We have
now moved through three clear phases of
turmoil from an initial credit contraction in
August 2007 to successive bank and financial
failures and bail-outs in the summer of 2008
and then to a full stock market crisis and
consequent global recession in autumn 2008.
We are now in the third stage of the
most tumultuous period in financial history
since the stock market crash in 1929 and
consequent Great Depression. If the five days
between Monday 15 September and Friday
19 September 2008 were not unsettling
enough, the global financial system teetered
on the edge of collapse three weeks later
between Monday 6 and 10 October 2008.
US markets had stabilised little following
the protracted and untidy agreement on
3 October on the US$700bn bail-out
plan while European leaders singularly
failed to agree any common collective
response. The British government was then
forced into undertaking an inspired but
uncharacteristically dramatic lead (especially
following Northern Rock) in adopting the
first informed and comprehensive package of
response measures to the crisis on 8 October.
Many nevertheless anticipated that
these measures would only be given bland
or formal recognition at the G7 Finance
Ministers and central bankers’ meeting on
the weekend of 11/12 October 2008. These
discussions then shifted to the G20 ‘Bretton
Woods 2’ meetings held in Washington
on 14/15 November which, at the time of
writing, will be followed with further events
in Paris and London subsequently. Whether
the necessary domestic and co-ordinated
international action will be taken to limit
the damage from the current crisis and to
prevent future crises recurring remains to
be seen.
George Walker examines the background to the global financial crisis in the current
article and then assesses the content, coherence and credibility of the emerging
response in a following piece next month. He has already commented on the
background to the crisis and some of the more general challenges that remain to be
resolved in national and international markets at this time.1
CREDIT CONTRACTION a number of major non-bank financial
The turmoil originated with the credit institutions announcing further losses.
tightening on inter-bank markets beginning The original pressure in the credit markets
9 August 2007. Inter-bank credits froze after then infected other parts of the financial
BNP Paribas suspended payments on three system with the most infamous casualties
investment funds. The German Sachsen being the giant US mortgage lenders Fannie
Landesbank was sold to the Landesbank Mae and Freddie Mac and the remaining
Baden-Wuerttenberg on 28 August 2007 major independent Wall Street investment
with IKB losing $1bn in US subprime firms, Lehman Brothers, Merrill Lynch,
debt. Shares in Northern Rock fell on Morgan Stanley and Goldman Sachs, the
14 and 15 September 2007 following the largest global insurance company, American
announcement of its request for liquidity Insurance International ‘(AIG’), and other
assistance from the Bank of England with US commercial banks including Wachovia
Northern Rock eventually being brought and Washington Mutual (‘WaMu’).
into public ownership (nationalised) on 17
February 2008 after the Treasury’s rejection Fannie Mae and Freddie Mac
of the remaining private sector bids. The US government announced that it would
Société Générale suffered a €4.9bn take control of Fannie Mae and Freddie
(£3.7bn) loss through its trader Jerome Mac on Sunday 7 September 2008. This
Kerviel with Evan Dooley misplacing $41.5m amounted to a de facto nationalisation with
at MF Global. The instability spread to confirmation that the government would
the US Monoline insurance market worth provide up to $100bn (£56.3bn) as required.
$2.3trn with the Federal Reserve having to This would allow both agencies to remain
announce a special $30bn facility to allow solvent and continue to cover their debts with
JPMorgan to purchase Bear Stearns initially the government acquiring $5trn (£2,825bn)
for $2 per share on 17 March 2008. This of mortgage-backed securities. The UK
was the first occasion in recent times that the Treasury only acquired £100bn of mortgage
Federal Reserve has assisted bail-out of a non- debt on the nationalisation of Northern
bank financial institution. Rock. The effect was to stabilise the $12trn
The most dramatic episodes of the crisis US mortgage market but at the expense of
then appeared to be over following the shareholders and investors in both entities.
managed acquisition of Bear Stearns by JP This would act as a significant disincentive for
Morgan. The subsequent escalation six months future capital injection by private investors.
later took everyone completely by surprise.
Lehman Brothers
US FINANCIAL CRISIS The share value of Lehman Brothers halved
The credit crisis spread to other financial during the week to Friday 12 September
sectors at the end of summer 2008 with 2008 after it recorded $3.9bn in losses.

Butterworths Journal of International Banking and Financial Law January 2009 5

CREDIT CONTRACTION, FINANCIAL COLLAPSE AND GLOBAL RECESSION
Feature
Chairman and Chief Executive, Dick Fuld,
had attempted to placate the markets with a
survival plan involving the sale of 55 per cent
of its asset management unit worth $30bn,
the $30bn commercial real estate portfolio
and a further $4bn in UK property assets
with dividends being cut. Lehman was
then forced to contact other banks to find a
possible ‘white knight’ although any rescue
plan would have been unattractive without
Treasury support. Treasury Secretary Hank
Paulson had taken the decision that the
US authorities could not bail out another
investment bank and that a private sector
solution would have to be found. Lehman
was then forced into Chapter 11 bankruptcy
on 15 September 2008 after Barclays walked
away from negotiations. Barclays would
later acquire Lehman’s North American
investment banking platform for less than
$2bn. This terminated Lehman’s 158-year
history as an independent investment
bank and became the largest bankruptcy
in US corporate history. While the US
authorities had calculated that the closure of
Lehman would not have any major systemic
consequences, this would later be identified
as the main causal event that led to the
subsequent much more severe second stage of
the financial crisis.
Merrill Lynch
With the crisis at Lehman, Merrill Lynch
was forced to accept a $50bn offer by Bank of
America after a week of negotiations with the
deal being announced on the same day as the
Lehman bankruptcy. Shares in the remaining
two largest US independent investment
banks, Goldman Sachs and Morgan Stanley,
continued to fall on Thursday 18 September.
Morgan Stanley approached the Wachovia
Bank in the US and the China Investment
Corporation (‘CIC’) for capital support but
with concerns arising with regard to the
political sensitivity of allowing the CIC to
acquire a major stake in a Wall Street firm.
Wachovia was later acquired by JPMorgan.
Goldman Sachs and Morgan Stanley would
subsequently be forced to reregister as bank
holding companies ending the inglorious
days of large-scale aggressive independent
investment banking on Wall Street.
6 January 2009
American International Group ('AIG')
The Treasury then had to provide a separate
support package for AIG which was the
world’s largest insurer with a market value
of $239bn. An $85bn credit facility was
made available on 16 September 2008 to
run for a two-year period in return for a
79.9 per cent stake in the group. This had
later to be increased to $153bn in the middle
of November. An attempt had again been
made to arrive at a private sector solution
worth $70bn although this was not possible
following a further collapse in the share
price. AIG’s problems had arisen with its
development of a niche practice in the area of
credit default swaps (‘CDSs’) in combination
with its less risky life insurance and retirement
services. This included writing CDSs on
many of the largest financial institutions in
the world as well as other financial contracts
including collateralised debt obligations.
AIG had to report in May 2008 that its total
losses would be over $10bn. Treasury support
was considered necessary in light of its
central position in the US and international
insurance and reinsurance markets including
through its extended and complex subsidiary
group structure.
Washington Mutual ('WaMu')
Considerable market pressure had also been
placed on Washington Mutual ('WaMu')
although it was decided to allow WaMu to
close at the end of September 2008. This
was the largest individual US bank failure.
WaMu had assets of $307bn and deposits
of $188bn at the end of June 2008 with
$46.6bn in equity and bonds outstanding.
WaMu was closed down by the Federal
Deposit Insurance Corporation on the
evening of Thursday 25 September 2008
with JPMorgan acquiring its deposit and
retail branch business and mortgage portfolio
but without any unsecured debt or liabilities
of the holding company. JPMorgan became
the largest banking group in the US. The
effect of the closure was again to wipe out
the shareholders and bondholders in WaMu
with another bank being allowed to come and
purchase the assets following the closure at
a substantial discount rather than support
the failing entity. Thirteen other lenders
Butterworths Journal of International Banking and Financial Law
were allowed to close during 2008 although
WaMu was by far the largest.
UK STOCK MARKET COLLAPSE AND
BAIL-OUT
UK stock markets were also shocked by the
crisis as the value of shares in banks and other
financial institutions plummeted during
September and early October 2008. The
panic seemed endless until the government
announced an informed three part package
to attempt to prevent further falls based on
bank recapitalisation, additional inter-bank
liquidity and a credit guarantee support
scheme. This would then form the basis for
other national and international responses to
the crisis. A number of institutions including
Royal Bank of Scotland (‘RBS’) and others
had been able to raise substantial additional
amounts of capital earlier in the year with an
astonishing $430bn in total. A combination
of falling asset prices on their balance sheets
and continued contraction within the inter-
bank and money markets had nevertheless
placed considerable pressure on institutions
more dependent on wholesale funding than
others including the Bradford & Bingley and
Halifax Bank of Scotland (‘HBOS’). While
it may have been possible to contain even this
further escalation in the crisis, this became
impossible following the US authorities’
decision not to bailout Lehman over the
weekend of 13/14 September 2008.
Bradford & Bingley ('B&B')
The UK debate concerning the most
appropriate way of dealing with banks and
other financial institutions in difficulty
had initially shifted to B&B. The Financial
Services Authority (‘FSA’) and Treasury
had attempted to find a large well capitalised
banking group that could acquire B&B’s
business as a whole but with the market
declining interest, the Treasury had then to
consider whether to take B&B into public
ownership either in whole or part over the
weekend of 27/28 September 2008. The
decision was eventually taken to nationalise
the mortgage and loan business worth £43.3bn
under the Banking (Special Provisions) Act
2008 enacted following Northern Rock but
to sell the £22bn of retail deposits and 200

branch business to Spanish Banco Santander.
Santander had already acquired the Abbey
and Alliance & Leicester. B&B was perceived
as vulnerable as it had the highest growing
level of mortgage defaults especially on self-
certification and buy-to-let policies.
The economic justification for the deal was
nevertheless questionable with the government
effectively having to pay Banco Santander
£20bn to manage the deposit and branch
business at the same time as acquire £52bn
in bad assets including £41bn of mortgages
up to 85 per cent of which could default. A
simpler option may have been to put B&B
into administration with a guarantee that
all deposits would be repaid. The effect of
the nationalisation of the mortgage book
was to increase the government’s holding
of ‘bad debts’ to over £125bn following the
nationalisation of Northern Rock. The UK
had effectively created a ‘bad bank’ option in
parallel with US and other models.
Halifax Bank of Scotland
Following a collapse in HBOS’s shares of
40 per cent on Tuesday 16 September, a
rescue package was agreed with Lloyds TSB
worth $12bn on the evening of Wednesday
17 September 2008. Relentless pressure had
been placed on HBOS shares for the previous
three days and while the UK government had
attempted to agree possible arrangements
with other major groups, none was reported
to have been prepared to proceed without a
government guarantee. The new Lloyds-based
group would then acquire a mortgage loan
book worth £335bn and 28 per cent of the
UK market with competition law restrictions
being dispensed with to allow the deal to
proceed. It was expected that the merger
would take place at the end of 2008, although
this was dependent on shareholder meeting
approval by both groups. The agreed price
was further reduced with continuing falls in
the HBOS share price. While there had been
interest in a private independent alternative,
any possibility of this proceeding was
undermined by the Treasury’s insistence that
sufficient capital would not be provided to
a separate HBOS. Following concerns with
regard to the earlier short selling of HBOS
stock, the FSA announced on the evening of
Butterworths Journal of International Banking and Financial Law
Thursday 18 September 2008 that it would
ban short selling of financial stocks. The FSA
was strongly criticised for not acting before
against short sellers with pre-emptive action
already having been taken by the Securities
and Exchange Commission in the US earlier
in the summer.
Icelandic depositors
A bitter dispute separately arose between the
authorities in the UK and Iceland following
the nationalisation of the country’s largest
banks and the freezing of their accounts.
The Icelandic government purchased 75
per cent of Glitnir on Monday 6 October
and Landsbanki was put into receivership
on Tuesday 7 October. New laws had been
brought into effect to allow the acquisitions.
A diplomatic conflict arose after the UK
Government’s decision to place Kaupthing’s
UK operations in administration on
Wednesday 8 October 2008. Kaupthing had
already sold its Edged deposit business to
ING in the Netherlands. The Treasury had
used anti-terrorist laws to freeze the assets
worth an estimated £400bn against £300bn
in deposits held by UK account holders in
Icelandic banks. UK local authorities had over
£800m deposited with substantial losses also
possibly being suffered by major UK charities.
Similar difficulties also arose at the Belgo/
Dutch/Luxembourg Fortis group which was
broken up and the Dutch part nationalised.
Franco-Belgian Dexia had to be refinanced.
The original attempt to save the German
Hypo Real Estate failed after a consortium
of state and bank support withdrew with
further funding being required. Likewise,
similar problems arose in Italy, Greece and
other European countries, with many of the
former Soviet bloc countries also experiencing
continuing difficulties as the crisis unfolded.
REGULATORY RESPONSE
A number of initiatives were taken forward
in the US, UK and other countries as well as
at the EU and international levels in response
to the crisis. Many of these were initially only
reactionary or isolated and fundamentally
protectionist in effect, if not, in immediate
intent. Governments had to face the reality
of the global financial contagion that had

CREDIT CONTRACTION, FINANCIAL COLLAPSE AND GLOBAL RECESSION
Feature 




erupted and the inevitable inadequacy of
any solely national-based solution. The need
for co-ordinated action nevertheless only
became apparent slowly which revealed the
continuing inadequacies of the post-War
international financial architecture. The
need for a more carefully co-ordinated
and structured collective response was
recognised although immediately postponed
to a series of more general ‘new Bretton
Woods’ conference meetings to be begun in
Washington in October 2008.
US
The US authorities were forced into
undertaking a series of increasingly desperate
attempts to contain the crisis. These were
essentially based on massive continued
liquidity injections into the markets and a
distressed asset purchase programme which
was subsequently abandoned in favour of
bank recapitalisation and direct intervention
in the corporate commercial paper market.
Liquidity support
Following the rescue plan announced for
Fannie Mae and Freddie Mac and the AIG
support programme, the Federal Reserve
injected $180bn in global liquidity. The
funds were made available through the Fed
and other national central banks including
the Bank of England, the Bank of Japan and
the European Central Bank as well as in
Switzerland and Canada. Dollar funds were
provided through central bank currency
exchange and swap arrangements. This
represents possibly the most significant
extension of global lender of last resort
funding in history intended to maintain
dollar liquidity within the markets.
TARP
The most significant US initiative was
Hank Paulson’s plan to establish a $700bn
mortgage rescue plan to purchase distressed
debt from leading US financial institutions.
The possibility of such a scheme had been
raised at the end of the week of Friday 19
September and then confirmed by Paulson
on the following Sunday 21 September.
Under the Troubled Asset Recovery
Programme (‘TARP’), a new corporation
January 2009 7
CREDIT CONTRACTION, FINANCIAL COLLAPSE AND GLOBAL RECESSION
Feature
would be established to purchase distressed
(toxic) residential and commercial mortgage-
backed securities from any major institution
operating in the US including foreign
banks. The range of securities to be covered
could be extended at Treasury and Federal
Reserve discretion with the assets acquired
being managed by privately appointed fund
managers acting on behalf of the Treasury.
Securities would be purchased over the first
two years and then held and disposed of over
a further period to be determined. This was
similar to the scheme set up during the Great
Depression in the 1930s and the savings and
loan crisis in the 1980s and in Sweden in
the 1990s. A private sector ‘superSIV’ had
also been attempted in the US more recently
but abandoned. It was later announced that
US$250bn of the funds made available
would be used to recapitalise the banking
system on a UK model although it was then
decided in November that the scheme would
focus on supporting the direct asset-backed
commercial paper (‘ABCP’) market facility
already in place. The removal of the asset
purchase component within the TARP halted
the improvement in inter-bank lending rates
that had taken place. It was later confirmed
that up to $1,800bn would be provided by the
Federal Reserve directly to corporate issuers
in the US commercial paper market.
UK
Other initiatives continued in the UK during
the calamitous 28-day period between 15
September and 12 October. These included
taking forward the Tripartite authorities’
work on depositor protection including the
establishment of a new Special Resolution
Regime for the treatment of failing banks.
The Bank of England extended its Special
Liquidity Scheme (‘SLS’) and the FSA
banned short selling until January 2009 with
its new chairman Adair Turner indicating
that a more fundamental review of financial
regulation would be undertaken – and with a
‘clean slate’ approach being adopted.
Depositor protection
The UK authorities continued their tripartite
consultation with three papers being issued
on Depositor Protection, the Bank Special
8 January 2009
Resolution Regime (‘SRR’) and Cross-border
Bank Insolvency. In the July 2008 paper on
Financial Stability and Depositor Protection, the
authorities reconfirmed their adherence to the
five key policy objectives set out in the earlier
January consultation document. A number
of specific recommendations were developed
with regard to stability and resilience in the
financial system, individual bank difficulty,
impact failure (including the new SRR),
compensation and the role and function of the
Bank of England including inter-agency co-
ordination. The paper confirmed that the UK
would implement all of the recommendations
in the Financial Stability Forum (‘FSF’)
report on Enhancing Market and Institutional
Resilience (April 2008).
The FSA had also strengthened individual
bank oversight through its supervisory
enhancement programme (‘SEP’) and has
consulted on changes to the Disclosure and
Transparency Rules to clarify circumstances
in which a corporate issuer in receipt of
liquidity support from a central bank can have
a legitimate interest to delay disclosure. The
FSA has consulted on compensation limits
that apply across all sectors, with bank deposit
limits being increased to £50,000 on Friday 3
October 2008.
The Bank of England will be given express
statutory responsibility for contributing to
the maintenance of financial stability and
a new Financial Stability Committee has
been created to report to the governor and
court. The number of Court members will
be restricted to 12 and all new appointments
made on an advertised and open competitive
basis. The bank’s role in connection with
financial stability has unfortunately only been
expressed in loose and non-specific terms in
the Banking Bill introduced to the House
of Commons in October 2008. This is an
unfortunate omission and lost opportunity.
Special Resolution Regime
The new Special Resolution Regime (‘SRR’)
was referred to in the July paper and separate
consultation document released at the
same time. The stated purpose is to assist
the resolution of banks in difficulty. It was
accepted that a range of powers were already
available including through voluntary firm
Butterworths Journal of International Banking and Financial Law
and regulatory action although the SRR
may be required in specific cases. The SRR
is described in terms of a set of existing
and new tools to permit the authorities to
take control of a bank that is judged to be
failing – and with all other options having
been deemed to be insufficient. Relevant
tools include transferring part or all of the
failing bank to a private sector third party
or a publicly controlled ‘bridge bank’, a new
special bank insolvency procedure (‘BIP’)
and updated bank administration procedure
(‘BAP’), temporary public ownership and
financial support, as currently provided by
the Bank of England. The most controversial
element is possibly the decision to make the
Bank of England responsible for determining
which SRR option will be used, with the FSA
deciding when the regime will be triggered
following a bank’s failure to comply with
its threshold conditions. The FSA should
clearly remain responsible for day-to-day
management of any restructuring although
the Bank of England may have insisted that it
was involved in the original option selection
This is nevertheless an unfortunately untidy
compromise. The specific issues that arise
with regard to maintaining financial stability
on a cross-border and global basis are
considered in a further Treasury paper in
September 2008.
Special Liquidity Scheme
The Bank of England had extended its
three-month sale and repurchase (repo)
open market operations (‘OMOs’) facility
in March and April 2008 with the Special
Liquidity Scheme (‘SLS’) being introduced
in April to allow banks to swap high quality
mortgage-backed and other securities for UK
Treasury bills for a limited period, subject
to appropriate collateral and discounts
(haircuts). The Bank of England has also
reviewed its money market operations
with a view, in particular, to creating a new
permanent ‘short-term liquidity insurance’
scheme to replace the SLS (which only
received assets until 21 October 2008) and
provide short rather than long-term liquidity
to protect the stability of the banking
system – with longer term capital only being
provided by savers or taxpayers.

UK rescue plan
As markets continued to fall and with the
leak of a possible UK rescue plan during the
week beginning 6 October, the government
was placed under increasing pressure to
bring forward any more substantial response
package. Stock markets fell by their largest
amounts since ‘Black Monday’ in October
1987 with the FTSE 100 index dropping
7.9 per cent and the Dow Jones Industrial
Average falling 7.75 per cent. Following
overnight discussions between the Treasury
and the major banks with the Bank of
England and the FSA, the Chancellor
announced a refinancing package at 7.30am
on Wednesday 8 October 2008. While
the Treasury blamed the banks for leaking
the plan and forcing the Chancellor to act
earlier than intended, the banks criticised the
government for the continued delay. RBS,
in particular, blamed the Treasury for the
further unnecessary falls in its share price.
The final Treasury refinancing plan
involved the making available of up to £50bn
to the eight largest UK banks in exchange
for preference shares. The Bank of England’s
Special Liquidity Scheme (‘SLS’) was doubled
from £100bn to £200bn – with Treasury
bills being exchangeable for less quality
liquid collateral assets (although with strict
discounts being maintained). The Treasury
also provided commercial guarantees worth
up to £250bn on new wholesale funding for up
to three years. The objective of the guarantees
was to allow banks to raise further medium-
term funds on the money markets as existing
facilities matured.
The UK government had created the first
coherent reform package to the crisis – although
this was still on strict commercial terms.
This was no ‘giveaway’ as portrayed in parts
of the press – with the strict terms imposed
not allowing any immediate improvement in
money market lending. The UK package was
further strengthened, at least, indirectly by the
announcement by central banks in six major
countries (including China for the first time)
that interest rates would be cut by 0.5 per cent
on Thursday 9 October 2008 with the Bank
of England later being forced to reduce rates
to 3 per cent in November and with further
reductions expected.
Butterworths Journal of International Banking and Financial Law
Recapitalisation
The government confirmed on the morning
of Monday 13 October 2008 that £37bn
would be invested in RBS (£90bn), HBOS
(£12bn) and Lloyds TSB (£5bn) with
Barclays attempting to raise £7bn directly
from the capital markets. While the banks
had supported the initial announcement of
capital support, they were taken by surprise
by the need to confirm the amount that each
would require within five days before the
markets opened on the following Monday
morning. Markets had remained nervous and
there were concerns that further instability
would follow with the most effective results
being achieved through a quick confirmation
of the amounts to be committed. While
the banks were considering how much
they could raise through private issues, the
FSA had forced them to recalculate their
capital requirements on the basis of a severe
recession at the same time as continue
to provide credit to the economy. It was
reported that the FSA had pressed the banks
to raise their tier 1 capital ratios to a wholly
unnecessary 9 per cent. The effect of this
was to raise the capital figures produced far
in excess of that which may otherwise have
been reasonably required to stabilise the
system at the time.
As many of the banks had also already
issued large amounts of preference shares
(with higher dividends but no voting rights),
it was confirmed that the government would
purchase a larger amount of ordinary shares
in each institution. The effect of this was that
the government would acquire a controlling
interest in, at least, RBS and HBOS while
the holdings of existing institutional investors
would be further diluted which would act as
a further disincentive to any private uptake.
It was also clear that existing investors would
be unable to absorb the large rights issues
announced across the four banks, within
a short period. The government separately
confirmed that it would prohibit cash bonuses
and that dividend payments would be frozen
for five years although these conditions
had to be relaxed subsequently. The chief
executives and chairmen of RBS and HBOS
confirmed their resignations. The effect of
the initial Lloyd’s acquisition of HBOS and

CREDIT CONTRACTION, FINANCIAL COLLAPSE AND GLOBAL RECESSION
Feature 




later recapitalisation of HBOS and RBS in
political terms was to tie in the major Scottish
banking groups into the UK financial system
which could be perceived as being intended,
in part, to undermine the Scottish National
Party’s position and specifically support the
Glenrothes by-election which Labour won.
The UK bail-out plan was supported by
the G7 at their meeting on the weekend of
11-12 October. Commentators had been
nervous about the degree of commitment
that would be displayed and then acted on.
The G7 leaders nevertheless confirmed that
they would use all available tools to support
systemically important financial institutions
and prevent their failure which was
interpreted as meaning that there would be no
more Lehman-style collapses. The G7 further
confirmed that they would take all necessary 
steps to unfreeze credit and money markets
and ensure that banks and other financial
institutions had broad access to liquidity and
funding. They would ensure that banks and
other major financial intermediaries could
raise capital from public as well as private
sources in sufficient amounts to re-establish
confidence.
The UK refinancing plan was subsequently
approved and implemented with various
national revisions at EU level during the
week beginning 13 October 2008. Germany
established a €100bn fund to support banks
with a total package of €300-400bn including
inter-bank guarantees and direct loans.
Portugal confirmed that it would provide a
credit line of up to €20bn to guarantee bank
liquidity. Similar plans were announced in
other countries across the world.
REGULATORY CLOSE
The world witnessed the possible collapse
and implosion of the global financial system
between Monday 15 September and Sunday
12 October. It clearly did not like what
it saw. The essential role that banks and
other key financial intermediaries play in
the modern economy has been confirmed
beyond doubt. Governments, companies and
individuals cannot operate and expand or
even simply survive without effective deposit
(savings), loan (credit) and payment as well
as other investment (return) and insurance
January 2009 9
CREDIT CONTRACTION, FINANCIAL COLLAPSE AND GLOBAL RECESSION
10
Feature
(risk management) services. Whether all of
these essential functions can continue to be
provided in a safe and stable but innovative
and supportive manner in the new post-crisis
market environment remains to be seen.
The financial markets will now contract
and de-leverage at the same time as
institutions dispose of distressed assets. They
will also be recapitalised either by the markets
or governments with substantial further
industry consolidation expected. All of these
processes are overdue. Financial markets and
institutions will then re-form and continue in
operation. This is not the end of open liberal
markets but the affirmation of the need for a
more balanced, managed and responsible form
GLOBAL FINANCIAL CRISIS – TIMELINE
PHASE ONE I –
CREDIT CONTRACTION
20 JULY 2007 – Ben Bernanke warns of
$100bn of losses in US subprime market
(one fifth of the $500bn the subprime
market was expecting to default, although
only part of $12tn US mortgage market).
The total cost to correct the subsequent
crisis could then rise to over $2trn as
against $125bn of underlying ‘bad debt’
which was mixed with other ‘good debt’
within the US structured finance market.
9 Aug 2007 – Global credit contraction
begins with French BNP Paribas’ decision
to suspend three of its investment funds
exposed to the US subprime market.
Share prices fall as banks cut lending to
each other with central banks beginning
to inject massive amounts of capital into
the markets.
13 Sept 2007 – BBC reveals that
Northern Rock has asked for emergency
support from the Bank of England
with subsequent ‘run’ on the bank and
recurrent statements by Treasury and
Bank of England.
17 Feb 2008 – Northern Rock nationalised
after Treasury rejects private sector bids.
17 March 2008 – Bear Stearns sold to
JPMorgan for $240m with US$30bn
Federal Reserve support facility.
January 2009
Biog box
George Walker is professor in International Financial Law at the Centre for Commercial
Law Studies, Queen Mary, London. Email: gwalker@ccls.edu
of market or financial capitalism. Hopefully,
the worst excesses of aggressive independent
Wall Street style investment banking have
gone, although all of the benefits of continued
financial innovation and product and service
engineering (and re-engineering) can still be
preserved. Financial institutions and markets
carry out irreplaceable functions without
which no economy can operate. We would
not have been able to realise the enormous
industrial, commercial and technological
successes of the last 250 years and before
without financial markets.
The markets that follow the most recent
crisis events and new regulatory responses
adopted may not be as exciting nor use the
PHASE TWO II –
FINANCIAL INSOLVENCY AND BAIL-OUTS
7 Aug 2008 – US Freddie Mac and Fannie
Mae in US nationalised at cost of $200bn.
14 Sept 2008 – Lehman Bros collapses
and files for Chapter 11 bankruptcy
protection after 158 years.
5 Sept 2008 – Merrill Lynch sold to Bank
of America for $50bn.
AIG given £85bn support package by
Federal Reserve in US and Lloyds TSB
announces proposed merger with HBOS
in UK for £12.8bn.
18 Sept 2008 – UK FSA bans short-selling
in financial stocks until January 2009.
21 Sept 2008 – US Treasury Secretary
Hank Paulson announces Troubled Asset
Recovery Programme and Goldman Sachs
and Morgan re-register as bank holding
companies under US law.
GLOBAL CONTAGION
 WaMu sells assets to JPMorgan for
$1.9bn 28 Sept 2007.
 Wacohovia bought by Citigroup for
$12bn 29 Sept 2008.
 Belgo-Dutch bank Fortis €11.2bn
injection 28/29 Sept 2008.
 UK – Bradford & Bingley nationalised
29 Sept 2008.
 French-Belgo bank Dexia €6.4bn
Butterworths Journal of International Banking and Financial Law
same degree of leverage nor generate the same
levels of income and profit as before. A more
balanced and mature national and global
marketplace may nevertheless still emerge
based on improved transparency, regulation,
accountability, responsibility and governance.
Well, at least until the next crisis. 
George Walker comments on the effectiveness
of the emerging responses to the crisis and
possible areas of specific regulatory action
and market support in a following article next
month.
1 Walker GA, ‘Credit Crisis – Regulatory and
Financial Systems Reform’, Butterworths
(2007) 10 JIBFL 567 (November issue).
injection 29 Sept 2008.
6/7 Oct 2008 Bitter dispute erupts
between UK and Icelandic authorities
following freezing of banks accounts with
UK depositors.
8 Oct 2008 UK government announces
three-part refinancing package based on
£50bn bank capital injection, increase
in Bank of England’s Special Liquidity
Scheme from £100bn to £200bn and
provision of up to £250bn in Treasury
guarantees for lending in money markets
up to three years.
11–12 Oct 2008 G7 and EU leaders
endorse UK rescue package and
announce similar schemes.
13 Oct 2008 Confirmation of amount of
capital injections in major UK banks after
FSA forces banks to calculate capital on
basis of most extreme stress testing.
PHASE THREE III –
GLOBAL RECESSION AND G20 RESPONSE
Oct/Nov – UK and Eurozone markets
enter recession more severe than
originally predicted.
14/15 Nov – G20 meeting in Washington
confirms outline for new international
financial response at ‘Bretton Woods II’
conference with follow-up meeting in
London in April 2009.