The meeting was not going well.
On Friday, Oct. 10, 2008, finance ministers and central bankers from the Group of Seven leading industrial economies had gathered in Washington for their regular fall meeting. The circumstances, of course, were anything but routine. Four weeks after the collapse of Lehman Brothers, the 158-year-old Wall Street institution, the financial world was in a state of escalating panic. With banks toppling one after the other, stock markets in a death spiral, credit markets all but disabled, the meeting had taken on crucial significance.
Around the world, investors were looking to governments for salvation—only they could provide the kind of rock-solid assurances that might put a floor under the markets. A strong, united statement from the G7, and there was some hope of restoring sanity to the situation. A weak statement, or worse, a failure to agree, and the entire world financial system might well tip over the edge.
An hour into the meeting, failure looked the most likely option. Under the excruciating pressure of the moment, normally cautious, buttoned-down politicians and civil servants were pouring out their emotions: their anger at things having deteriorated to this point, their fears at what might follow. The exchanges were punishing and direct. They were staring into the abyss, and they knew it.
Now the German finance minister, Peer Steinbrück, had the floor. A brusque, combative Social Democrat, he was the dean of G7 finance ministers, having been in the job since 2005. Though his English was excellent, when he wished to make a point with special vehemence, he spoke in his native tongue. And he was speaking in German now, great, angry torrents of it, as the other ministers struggled to follow the simultaneous translation. Hadn’t he told them all it would come to this? Hadn’t he said this at one meeting, demanded that at another? On and on he raged, for a good 10 minutes. You didn’t need a translator to know that he was in no mood to compromise.
At least one of those present, listening to this tirade, began to take off his headphones. If the Germans weren’t going to come to the table, there was no point. Best to start planning for the fallout . . .
And yet, improbably, the meeting ended in success. The G7 emerged united, issuing an extraordinary one-page statement pledging to stand behind their banks, whatever the cost. In time, it would prove to be the turning point in the crisis—“the beginning of the end,” in Bank of Canada governor Mark Carney’s unequivocal assessment. But it was a near thing. “It was intense,” Finance Minister Jim Flaherty recalls. Everyone there knew that “if this meeting was not successful, the consequences would be severe.”
The story of that remarkable meeting, its near failure and eventual triumph, is a vivid reminder of the importance of the human factor in history. Just as the panic had hinged, at critical moments, on human emotions—fear, mistrust, resentment, envy—so would the response. Not only would the G7 ministers have to overcome their own doubts and divisions, they would have to communicate their new-found resolve in a way the financial world could trust and take heart in. To get to that point, however, required policy-makers to go through a daunting journey of awareness, as they grappled with a constantly mutating crisis that seemed to defy all remedy.
It began, as everybody now knows, in the U.S. housing market. A combination of factors—too-easy monetary policy on the part of the U.S. Federal Reserve; federal regulations requiring banks to make more mortgages available to lower-income borrowers; massive purchases of those same mortgages by the hybrid public-private entities known as Fannie Mae and Freddie Mac—had conspired to drive U.S. housing prices to absurd levels. From 1999 to the bubble’s peak in 2006, the price of the average U.S. house more than doubled.
A notable contribution came from the aggressive expansion of lenders specializing in so-called “subprime” mortgages to borrowers with poor credit ratings, concentrated in the Sunbelt states of Florida, Arizona and California. These loans were then bundled up and combined with more secure forms of debt in complex investment instruments known as collateralized debt obligations (CDOs), to be sold on credit markets worldwide—a process known as securitization.
Theoretically, pooling individual mortgages and selling shares to large numbers of buyers was supposed to spread the risk of these loans. In reality, the complexity of the securitized instruments made it difficult for even the most sophisticated investors to understand exactly what they were purchasing. Yet with interest rates at such low levels, financial institutions had few qualms about plunging into debt to buy CDOs, with their seemingly attractive combination of low risk—signified by the AAA ratings the credit agencies awarded them—and high returns.