For Lou Giordano, owner of Croton Auto Park in Westchester County, N.Y, business had already been pretty dismal for much of summer 2008. Not only had high gasoline prices hurt his sales, but Chrysler and General Motors were cutting way back on their leasing business, which had contributed so mightily to his bottom line.
As bad as business was, however, it would only get worse once September rolled around. That was when the credit markets suddenly stopped functioning.
"Everything ground to a halt," Giordano remembers. "The people that were in the market for cars couldn't get credit like they could before."
"The way it used to be in the past was if you had good credit you could get financed on a car," he says. "Now all those rules changed."
When the history of the current recession gets written, last September will no doubt be remembered as the darkest of dark times, when the long-simmering subprime crisis finally boiled over and overwhelmed the financial markets. In the space of a few weeks, the federal government was forced to rescue the mortgage giants Fannie Mae and Freddie Mac, major investment banks were sold or killed off altogether, and investors suddenly abandoned stocks, bonds and just about any other asset.
'A Bad Dream'
It was "almost like living a surreal experience, a dream almost — a bad dream," says Michael Holland, owner of an investment firm bearing his name. "Things were happening in the financial markets that were almost definably impossible, and the impossible was occurring."
One year later, many economists lay the blame for the downturn squarely on the huge spread of risky mortgages, which had been packaged into securities and sold throughout the world financial markets. When the U.S. housing boom turned to bust in 2007, nearly every investment bank, hedge fund and mortgage lender found itself facing huge losses. Investment bank Bear Stearns went under in March 2008, and rumors were suddenly rife about who would be next.
"You literally didn't know which financial institution was going to go down next," says economist Mark Gertler of New York University. As confidence in the financial markets eroded, "there were steady withdrawals of funds from investment banks. There effectively was a slow run on investment banks going on. So pressure was starting to mount."
The first institutions to totter were the mortgage companies Fannie Mae and Freddie Mac, which had invested heavily in risky mortgages. The companies were immensely important to the housing industry, owning or controlling more than half of all outstanding mortgages in the United States. Investors had long snapped up their securities because they were thought to have the implicit backing of the federal government, but as the housing crisis worsened, "international investors who were holding huge amounts of Fannie and Freddie paper weren't confident of the guarantee," says Charles Calomiris, professor of financial institutions at Columbia University.
Rather than let Fannie and Freddie go under, U.S. officials placed them in conservatorship, essentially guaranteeing their losses.
Mixed Signals, No Confidence
After the crisis unfolded, the Bush administration would be sharply criticized for sending mixed signals about the steps it was willing to take. It engineered the sale of Merrill Lynch to Bank of America, at taxpayer expense, but let Lehman Brothers slip into bankruptcy, sending a chill through the markets.
"Basically, what this is all about is confidence. If there's confidence in the system, the system works beautifully. When there's no confidence, it stops working, as it did in September," Holland says.
Lehman "had relationships and securities and dealings with businesses and people and institutions throughout the world. And their absence from those markets and from those securities and from those dealings, just vaporizing themselves, made the world awash in uncertainty," he adds.
The Treasury Department and the Federal Reserve were caught between a rock and a hard place, afraid of what might happen if another investment bank failed, but worried about the precedent that was set each time they bailed out a financial institution that had invested recklessly.
A visiting scholar at the New York Federal Reserve Bank, Gertler watched Fed staffers improvise their way through a financial crisis unlike anything the country had faced in decades. The air was thick with tension.
"I mean, I almost had the feeling of being in the battle zone, and these were the troops fighting in the trenches," he says. "And I kept thinking to myself, 'Here are these people working 24-7, who make about a tenth as much as the people on Wall Street who screwed up, trying to clean up the mess.' "
A Credit Crisis
Still, the decision to let Lehman Brothers sink would soon be seen as a major blunder, leaving investors worried about both the safety of U.S. financial markets and the government's commitment to support them. Almost overnight, they pulled their money out of stocks, bonds, commodities and even money market funds, which had long been seen as one of the safest places to park money. With so few people ready to invest, the global credit markets stalled, and businesses that depended on short-term credit to survive began to fail.
With his customers unable to borrow money, auto dealer Giordano saw his business slow to a trickle and had to lay off a tenth of the staff. In the months that followed, other businesses would shed jobs and cut production. The U.S. unemployment rate steadily crept upward, to its current 25-year high of 9.7 percent.
Meanwhile, U.S. officials were determined not to let repeat another debacle like Lehman Brothers, and in the months to come the Fed and the Treasury Department would launch a steady stream of moves to prop up the financial sector. That included a controversial $787 billion economic stimulus plan signed into law by President Obama.
Today, the recession is finally showing signs of ending, but for those who lived through it, the memories of what happened last September are a stark reminder of how fast the bottom can fall out of the economy.
"Oh, my worst fears were realized," says Holland. "It actually happened. The markets did come to a halt. Armageddon occurred."