Two years ago we witnessed the near failure of capitalism, after more than a year of financial shocks, including the correct call by some in the investment business—FPA Funds’ CEO Bob Rodriguez (on sabbatical in 2010) and then-CIO of TCW Jeffrey Gundlach, now DoubleLine Capital CIO among them—that there was something seriously amiss in the credit markets.
Many reports date the financial crisis to September 2008, but back in mid-2007, Gundlach said at the 2007 Morningstar Investors Conference that mortgage debt in the U.S. was an "unmitigated disaster."
In June 2007, more than a year before the worst part of the crisis, Rodriguez noted at the same conference–and I wrote in an article in Investment Advisor:
It's "hard to get a sense of how bad it is," Rodriguez argues, adding that it's not only hedge funds that own CMOs [collateralized mortgage obligations] and CDOs [collateralized debt obligations], but banks and other financial services companies that may have thought they bought investment grade tranches of CMOs–even AAA-rated securities–and are finding that what they have instead is not trading at the same prices as other AAA securities. "I don't buy the ratings from the ratings agencies," Rodriguez cautioned, adding that he's "not sure how widespread the unknowable risk" is. See "Coming Home to Roost."
In July 2007, two leveraged Bear Stearns mortgage-backed securities hedge funds exploded, filing for bankruptcy. Bear Stearns repaid lenders $1.6 billion, and Merrill Lynch, one of the lenders, seized assets of the funds. But shareholders were left hanging with only a note from the company that essentially said, too bad for you. Shareholder value was near zero.
S&P was revamping its ratings methodology for subprime mortgages, and had in July 2007 put on potential downgrade watch "612 U.S. Subprime RMBS Classes." AndBrookstreet Securities, a broker-dealer that had put customers into subprime CDOs–on margin, Reuters said at the time–had just failed. See "Subprime."
As the months ticked by we saw then-Treasury Secretary Henry Paulson, and then- New York Fed Chief Tim Geithner, who is, of course, the current Treasury Secretary–and Fed Chief Ben Bernanke reassure investors that the situation would not be contagious, and later, work to control the damage when problems spread.