What's Lacking Right Now Is the Fed's Will To Act
(AP Photo/Manuel Balce Ceneta)
What's Lacking Right Now Is the Fed's Will To Act
(AP Photo/Manuel Balce Ceneta)
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The Financial Crisis Inquiry Commission (FCIC) was empaneled to have the final say on the 2008 panic. A political affair though not necessarily partisan, its true purpose was to get the public to stop talking about the disaster by appearing thorough, to dissuade regular folks from asking more questions before someone might eventually hit upon the right ones.

Judging from history’s response to the government’s conclusions, the effort was extremely effective having produced that very effect. More’s the pity.

To this day, ask the average American what had gone wrong back then and ninety out of a hundred will tell you subprime mortgages, the dirty recklessness of greedy Wall Street bankers. The odd ten leftovers will scream conspiracy.

FCIC’s work left no doubt subprime was its members’ conclusion, too. Having interviewed more than 700 witnesses, entered millions of documents into evidence, the lengthy final report used that very word 784 times.

That’s been the idea from the very start, though ironically perhaps the most famous crisis-era statement was Ben Bernanke’s in March 2007 before Congress, “At this juncture, however, the impact on the broader economy and financial markets of the problems in the subprime market seems likely to be contained.”

Having been made to eat those words, the Federal Reserve’s Chairman would then say to the FCIC several years later that:

 Prospective subprime losses were clearly not large enough on their own to account for the magnitude of the crisis. Rather, the system’s vulnerabilities, together with gaps in the government’s crisis-response toolkit, were the principal explanations of why the crisis was so severe and had such devastating effects on the broader economy.”

This, you’ll note, contradicts the idea that subprime mortgages were the thing.

From the very beginning, it never went the way it was only later described. Even the starting point, as clear as it was, has been obscured as if by design. August 9, 2007, should be – and some day will be – properly characterized by the sort of infamy reserved for history’s biggest and blackest.

This coming Tuesday will mark the fifteenth (Heaven help us) anniversary of that day, and, so far, such promise remains completely unfulfilled, so no one should hold their breath waiting on some imminent correction to the historical record. After all, it wasn’t until around 1963 (with the publication of Friedman and Schwartz’s A Monetary History) that our current understanding of what really happened to the Great Depression began to be widely accepted.

By that speed, August 9 will finally reach the public’s consciousness, properly supplanting subprime mortgages from it sometime around 2041.

I don’t believe we have that much time (in case you haven’t noticed).

So, in the interesting of speeding up the process, let’s go back to August 9, 2007, this time offering a suitable and useful summary review in place of so many fallacies.

Since the object of our own inquiry is “the system’s vulnerabilities”, and that system is the US dollar system obviously we begin in…Fürstentum Liechtenstein. Yes, this small, largely ignored financial outpost nestled in the European Alps between Switzerland and Austria was where the world’s dollar catastrophe got going.

At 2:44 am Eastern Time on the morning of Thursday, August 9, 2007, BNP Paribas issued a quaint little press release (the financial equivalent of the 1914 assassination of some Austrian Archduke no one had ever heard of outside that realm) stating plainly the bank hadn’t been able to precisely calculate the Net Asset Value (NAV) for three of its money market funds going on several days.

These funds were: BNP Paribas ABS Euribor, BNP Paribas ABS Eonia, and Parvest ABS Dynamic. Already, a powerful number of increasingly consequential questions never truly asked by the FCIC springs to mind. Starting with, WTH?

Money market funds by their very nature, definitions, and legal mandates are meant to be entirely safe, and they actually were (stay with me here).

Regulations allowed up to 35% of the fund total placed into alternatives, stuff like the “ABS” included in each’s name; that term meaning Asset-Backed Securities. These were securitized packages of many different kinds of otherwise illiquid loans largely issued by off-balance sheet special-purpose entities (SIVs and SPVs), traded regularly at least before mid-2007 by every major player and financial type from around the world.

Not all the ABS was of subprime mortgage bond tranches as many outside observers at the time had inferred, yet already by August 9 it didn’t really matter. Market liquidity for pretty much all kinds of MBS and ABS had disappeared, which is why BNP Paribas came to finally admit it couldn’t value these funds.

This didn’t mean BNP hadn’t tried. In fact, it received permission to mark its assets to modeled prices rather than market prices which no longer existed.  This was the spark, the true genesis for everything that came after.

It wasn’t about subprime losses, real and mostly imagined, it was the admission by one of the world’s key monetary participants of just how much the system had run aground by that early point. Crucial markets much of the system relied upon operating just the week before had simply vanished without warning.

Yeah, “the system’s vulnerabilities.” BNP’s press release effectively became the world’s notification of what already was happening, what many had already suspected.

The ECB went first, offering a €94.8 billion liquidity tender. The Fed conjured a three-day, $19 billion repo (lending cash on collateral) at 10 bps below the fed funds target of 5.25%.

Yet, the fed funds effective rate by August 10 had plummeted – yes, you read that correctly – to just 4.68%, as had Eonia, both way below respective central bank targets, the former substantially less than the Fed’s emergency repo. Not only that, there had been a number of transactions in fed funds on Friday, August 10 and again Monday, August 13 where the cash borrower accepted a 0.0% rate.

These low numbers represented a complete breakdown of trust across the entire marketplace, no matter the Fed, ECB, or Bank of England. At zero, even 4.68% or 5.00% for that matter, cash owners like MMFs were only interested in lending to whomever they trusted explicitly, going so far as to accept any return at all from only the best borrowers.

Why? Because markets had become completely illiquid meaning no one could properly value their assets, especially assets which “might” need to be used in collateralized lending such as repo. BNP Paribas’ stunning confession was about market liquidity, not credit risk.

These vanishing markets were US$ markets, though the BNP funds were thoroughly European: sponsored by a French bank, domiciled in the Principality of Liechtenstein.

This presented policymakers on both sides with an enormous problem: starting with, just whose problem was this?

The US$ markets supporting the ABS owned (and pledged) by BNP’s funds were largely centered in London. As the deafening noises of full global breakdown began to echo across the global reserve currency architecture, emergency conferences were, of course, convened in all places, including London at the Bank of England like DC where the FOMC gathered telephonically to display none but total ignorance and cluelessness.

Vulnerabilities, both.

Even by September 2007, they hadn’t worked it out; the issue remained unsettled while monetary illiquidity created further panic across the system – those early central “liquidity” measures didn’t accomplish a damn thing. Staff Economist Kathleen Johnson, soon to be elevated to, oh man, Senior Advisor to the Fed’s Division of International Finance, offered up the official disorientation:

“MS. JOHNSON. Of course, many of the dollar issues that we have spoken of— and that Bill [Dudley] talked about—are really being captured as a London phenomenon. But you might say that, from the point of view of the Bank of England or the U.K. economy, these dollar issues are somewhat separate from the domestic economy.”

To sum up their dilemma: was this early crisis a London or Europe problem, or was it a dollar problem? It was, obviously, the latter not that there was any real distinction. The term eurodollar itself was coined to reference largely London and European trading of US dollars, but with the added wrinkle of physical dollars being entirely absent from every part of it.  

Bank liabilities, a ledger system which depended upon global banks – not central banks - located everywhere around the world to supply the money to keep everyone’s financial markets trading and assets properly valued (as well as, you know, the global commercial economy running smoothly, as it would find out just after). This is what had so spooked the system on August 9, the real danger implied by BNP being unable to value basic ABS assets.

Everyone, outside the Fed, ECB, and BoE, that is, understood what this had meant, as it could only have been an interbank run of such proportions whole markets became non-negotiable. This was the telltale sign of a systemic money shortage, not really different from all those in the past except for the form of money this “modern” incarnation had invented first.

But subprime mortgages, right?

Two more pieces come from Mr. Bernanke, the first from February 2010: “Liquidity pressures in financial markets were not limited to the United States, and intense strains in the global dollar funding markets began to spill over to U.S. markets.” The other not yet a year into his retirement: “When I was at the Federal Reserve, I occasionally observed that monetary policy is 98 percent talk and only two percent action.”

It makes for quite the twist on “the system’s vulnerabilities” as well as “together with gaps in the government’s crisis-response toolkit.” In the face of total eurodollar breakdown, the Fed didn’t even know if it or someone else should respond, and when it did what it actually offered was 100% talk (to soothe and reassure with what appeared to be “liquidity” which did not create useful money).

There is, obviously, quite a lot more to the whole puzzle, to adequately and correctly fill in the entire story. This brief summary barely scratches the surface, yet any reasonable and honest review and discussion, including credit default swaps, repo, collateral shortages, all of it breaks down along these same lines anyway.

Why don’t people know these facts?

To maintain a regime that is 98+2% talk requires never talking about those key times when only talk leads to complete disaster. To have any prayer of achieving intended psychological manipulation there must never be the least bit of doubt, and that means burying the failures. Better to have the world think Wall Street and subprime rather than to uncover the actual truth about global eurodollars having no place for policymakers.

August 9, 2007’s infamy is right there, as is the world’s true vulnerability: utterly reliant on banks.

But why should anyone care? That is the truly consequential part. This isn’t some academic debate over the distant, ancient past of no relevance to our lives a decade and a half on. And even if what I write is true, and it sure is, why not just let sleeping dogs lie at this point since it was so long ago?

Because we aren’t just trying to live in the shadows of that day, we are still feeling the consequences from it. The Global Financial Crisis didn’t actually end, not really. It was no one-off; severe, yes, more importantly a permanent change that to this day remains unfixed.

Instead of fixing anything, the world’s surplus of Bernankes offered just more talk in the form of ineffective QEs and the like.

The costs of having suffered that momentous “vulnerability” continue to pile up, incomprehensibly huge and getting bigger by the day. The amount of lost economic activity/output in the US alone runs into the tens of trillions.

Around the world, who really knows?

The Russians might know a little something about it, as do the Chinese. Though either national set of officials will waste time calculating the exact figures, they do know the world has changed because of “subprime mortgages” and are acting as they see fit.

You need only plot Russian GDP to see what I mean, or China’s, too. For the former, as incredible as it may seem today, that economy was once the “R” in the once-admired BRICs. A fast-growing system that for years appeared like it had turned a productive corner.

Then it all fell apart never to come back again. When? You know the answer even if no one will ever say it.

The number of economies which followed after that same inflection, the one which has led eventually to Russia plowing into Ukraine, is too many to list. And given this lengthy catalog, history conclusively shows how, under these circumstances, the Russians won’t be the last to so “visit” their neighbors.

August 9, 2007, wasn’t just the day markets ran dry, or the interbank run began, it was the day when it all started to fall apart. To simply quiet everyone down about it, the public has been fed “subprime mortgages” in the curious, steadfast blackout of the word eurodollar.

As always, you needn’t take my word for anything. The discussions, documents, and material are all freely available, those specifically about the Global Financial Crisis as well as in the decades leading up to it. GDP or market charts prominently bent right at 2007-08 can be found – even for Russia – from practically any source.

What’s lacking is nothing more than the will to act, to actually learn what “the system’s vulnerabilities, together with gaps in the government’s crisis-response toolkit” is really all about, and what it still means, sadly, for all of us fifteen years later. Social breakdown and growing chaos or political danger didn’t come out of nowhere, we know where and particularly when it all went wrong. 

Jeff Snider is Chief Strategist for Atlas Financial and co-host of the popular Eurodollar University podcast. 

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