In the first half of 2007 loan losses emerged in one loan market segment – the US sub-prime mortgage market. This was not such a surprise. There had been warnings about unsustainable growth of house prices in the United States and other countries for some years. Sub-prime was the riskiest category of mortgage lending. Lenders knew well enough that losses were bound to emerge at some point.

They thought they were prepared. There was a lot of money committed to sub-prime mortgage lending – around $1.3 trillion dollars, or 10 cents for every dollar of US national income. But prospective losses in this market, even on pessimistic projections, looked to be perfectly containable. As I complete this book, taking a cautious view of losses on this sub-prime lending, it looks as though they might climb to around $300 billion dollars (the justification for this figure was given above in Chapter 1). This sounds like the sort of credit problem that banks can put behind them – recognize the losses and move on.

The huge surprise has been the wider impact of emerging losses on US sub-prime mortgage lending, first triggering bank failures in Germany and the United Kingdom, raising the cost of funding bank loan portfolios across the globe, and eventually triggering the run on the global banking system in September and October 2008. Why did the sub-prime losses have such a big impact? What were the links that transmitted this shock around the globe? This chapter tells part of the story, from the first emergence of problems in early summer 2007 to the failure of the UK bank Northern Rock in September of that year.