2007 was the warning. 2008 will be the bill.

What happened this year wasn't a crisis. It was a diagnosis. The crisis comes when the system must reprice assets that were valued incorrectly long enough for the illusion to become a premise.

In January 2007, financial markets were in one of the longest expansion cycles in history. Cheap credit, low volatility, assets appreciating across multiple classes simultaneously. The problems existed — they were visible to anyone who wanted to look — but the consensus categorized them as manageable, contained risks, without systemic contagion potential. Twelve months later, the credit system that financed that expansion is functioning with spreads and restrictions not seen in a decade. The 2007 diagnosis is clear: the model was wrong from the foundation.

What 2007 revealed, month by month, was the anatomy of a system that had transferred risk to where it was invisible. New Century showed that mortgage originators had no incentive to qualify borrowers. Bear Stearns showed that structured instruments were worth less than ratings indicated. BNP showed that contagion didn't require a large bank failing — uncertainty about who held what was enough. Northern Rock showed that funding models that work in normal markets collapse when the market stops being normal. And the Dow Jones in October showed that the stock market can continue as if nothing is relevant for longer than any rational person would expect.

2008 will be the moment the adjustment 2007 announced becomes unavoidable. I don't know when it will happen, I don't know which event will be the trigger, I don't know which institution will be the first to need an explicit bailout. But the mechanism is clear: there are assets on balance sheets of financial institutions worldwide being carried at values that depend on market conditions that no longer exist. When those assets need to be marked to market — by choice, regulatory pressure, or liquidity need — the adjustment will be concentrated and fast. 2007 was the year it became evident the system was wrong. 2008 will be the year the system discovers how much the correction costs.

Leo Bentier