As this decade closes, I reflect that as defining the Covid pandemic crisis has been to this decade, the Global Financial Crisis was to the previous. Narratives analyzing the 2007 GFC have been largely US centered, long on prose and short on detail. Not much is written on how the European banking sector was affected and the manner in which European banks navigated the 2007 GFC.
In this presentation I show that the combined misjudgments of central banks, regulators, rating agencies, investors and bankers led to a buildup of an unsustainable amount of leverage in the global financial system. This was further exacerbated by the normal peak and downturn of the credit cycle in 2007-2008. Extreme volatility in dislocated markets tested negative correlation assumptions. Financial turmoil limited banks’ ability to transfer loans off balance sheet to ABS and secondary markets and resulted in the consolidation of conduits and SIVs. Consequently, unplanned asset growth put bank capital ratios under pressure. Write-downs on sub-prime exposures, leveraged loans and impacted asset classes led banks to raise capital through equity and equity-linked markets or directly from sovereign wealth funds. Central Banks, much as they did during the Covid crisis, took bold actions to stimulate market liquidity as well as the economy. This focus provided sufficient liquidity to keep interbank markets functioning; banks recapitalized, loans were guaranteed, special liquidity schemes instituted as well as multiple other actions taken. Coordinated policy and response measures included political guarantees, deposit guarantee, rescue debt, collateralization and other actions. European banks subsequently raised capital, increased liquidity, reduced their U.S. structured credit exposure and relied on the economy to recover to reduce non-performing loans.
I conclude that during such crisis banks themselves have much recapitalization, balance sheet and business model restructuring to undertake. These are best done in close cooperation with governments and regulators.