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14

LATE 2007 TO EARLY 2008:
BILLIONS IN SUBPRIME LOSSES

CONTENTS

Merrill Lynch: “Dawning awareness over the course of the summer”.................
Citigroup: “That would not in any way have excited my attention”...................
AIG’s dispute with Goldman: “There could never be losses”...............................
Federal Reserve: “The discount window wasn’t working”...................................
Monoline insurers: “We never expected losses”...................................................

While a handful of banks were bailing out their money market funds and commer-
cial paper programs in the fall of , the financial sector faced a larger problem:
billions of dollars in mortgage-related losses on loans, securities, and derivatives,
with no end in sight. Among U.S. firms, Citigroup and Merrill Lynch reported the
most spectacular losses, largely because of their extensive collateralized debt obliga-
tion (CDO) businesses, writing down a total of . billion and . billion, re-
spectively, by the end of the year. Billions more in losses were reported by large
financial institutions such as Bank of America (. billion), Morgan Stanley (.

billion), JP Morgan (. billion), and Bear Stearns (. billion). Insurance compa-
nies, hedge funds, and other financial institutions collectively had taken additional
mortgage-related losses of about  billion. 
The large write-downs strained these firms’ capital and cash reserves. Further,
market participants began discriminating between firms perceived to be relatively
healthy and others about which they were not so sure. Bear Stearns and Lehman
Brothers were at the top of the “suspect” list; by year-end  the cost of five-year
protection against default on their obligations in the credit default swap market stood
at, respectively, , and , annually for every  million, while the cost
for the relatively stronger Goldman Sachs stood at ,. 
Meanwhile, the economy was beginning to show signs of stress. Facing turmoil in
financial markets, declining home prices, and oil prices above  a barrel, consumer
spending was slowing. The Federal Reserve lowered the overnight bank borrowing
rate from . earlier in the year to . in September, . in October, and then
. in December.
