Thursday, July 11, 2019

Panic in Wall Street 2008: An Assessment

As detailed in previous writing, Panic overcame Wall Street in the fall of 2008 and various monumentally expensive nostrums were applied. Money was wantonly thrown at the crisis. However, the result was no repeat of the bank meltdown like Great Depression, but the deepest recession since 1930’s.

Primarily, the issue lay with a housing bubble that crushed the Middle Class, whose side effect virtually destroyed the domestic auto industry and waylaid Wall Street. The Panic in the fall of 2008 occurred to high risk rollers, Wall Street investment bankers, who found their “paper”, derivative backed securities worthless. The first bank to go under was Bear Stearns in March 2008, who was purchased on the cheap with a huge loan $30 billion by the Federal Reserve by Morgan Stanley. Then Lehmann Brothers was allowed to fail in September 2008. This sent New York Stock Market and Wall Street Investment Bankers into a tizzy. Secretary Treasurer Hank Paulson garnered an $800 billion check from Congress on the second try.

In addition American International Group (AIG) ended up getting $180 billion, who offered hundreds of billions of Credit Default Swaps (CDS) as insurance for these high risk derivatives. AIG didn’t have the foresight to have the means to honor these claims.

As far as the $180 billion, all paid back eventually AIG declares. That is risible. What industry wouldn’t love to have a massive $180 billion investment loan? The government is said to have made $23 billion on the deal. Nonetheless, businesses shouldn’t expect government to fund their colossal mistakes.  I think that amount in today’s dollar sent men to the moon and back.

Just as importantly, the Fed Reserve pursued an unpublicized $ four trillion derivative buying binge. As you might know Fed Res is not very forthcoming about its operations and want to keep it that way.

Frankly, at the time I was outraged at the propping up of the so-called smartest and really richest men in the country, the Wall Street banker. This is at a time I, along with the rest of the public, was unaware of the Federal Reserve buying binge. Not forgetting the massive bailout of the mortgage generators Fanny Mae and Freddie Mac.

The bail out of the auto industry in light of the massive support of the financial sector seemed apropos, but as we’ve seen stockholders made out smartly in that with new GM’s $15 billion stock buyback after the bailout and the projected close of auto plants like Lordstown in Ohio. For that matter the auto industry is massively overbuilt in China where GM sells the most of its vehicles. Funny, U.S. taxpayer in effect bailed out an American auto maker so they could expand their business in China. In addition Ford experienced added competitive pressures from the bailed out GM and FCA (Fiat Chrysler Auto).

What was the underlying cause of the collapse? And this is the problem with economics. There’s rarely one narrative like chemistry or physics or biology. For instance the Great Depression has numerous explanations. 1929 Stock Market crash precipitated it.  Supply outstripped demand due to wealthy consumers saving too much, the Keynesian hypothesis. Greedy capitalism itself caused it, because markets can’t be trusted. A Credit Bubble prompted malinvestment which saw the collapse of the banks, the Austrian School position. The Money supply collapsed and the Banking sector failed, the Monetarist explanation led by Milton Friedman. The last explanation is the one most widely held by the economic community. Its prognosis drove Federal Reserve Chairman Ben Bernanke to inject as much money into the financial system as possible with his unheard of QE 1, 2 and 3’s. The goal was to counteract any deflation that was encountered by the banking sector and avert another collapse in the money supply and depression. The Quantitative Easings were a massive purchase of Government Treasuries Notes by the Federal Reserve which generated, out of thin air, Fed Res Note to buy them. The risk in this strategy was to ignite consumer price inflation; surprisingly it did not. It appears to have gone into the Stock Market instead. And Chinese cheap consumer goods arrived on our shore by the $ trillion to counteract inflationary pressure.

Similarly, there are a multiplicity of explanations here with the Panic of 2008. Regulatory agencies, especially the Office of Thrift Supervision, failed to monitor the practices of the mortgage lending industry. Public policy in the Community Reinvestment Act seriously erred in artificially promoting a huge increase in sub-prime lending. Fed Reserve Chairman, Alan Greenspan, allowed interest rates to remain too low for several years after the downturn accompanying 9/11 then raised them up dramatically, creating a credit bubble then bursting the bubble. Failure to bailout Lehmann Brothers in October 2008 precipitated chaos. The massive Shadow Banking sector, as large as the regulated banking industry, whose import was unbeknownst to the Fed Reserve, was allowed to burgeon unregulated. It could be said each one of those played a part in the financial disaster of the fall of 2008.

At the time in 2008 all I saw was a gargantuan rescue. The rest of the country was on its knees. Yet, it was Wall Street that got the welfare. And at one point in time in 1907 for example it was J P Morgan, the industrialist financier, and his associates that bailed each other out. And given the will, the Panic of 2008 could have been dealt with the same way. But Wall Street had been rescued so many times; they are like the proverbial welfare queen. With a significant difference, they should know better. They are the smartest and richest members of the society, the 1%! Now it’s Big Government who’s fostered this feigned dependency. The Wall Street bankers and their fellow travelers are not ashamed to cry and rage for taxpayer assistance, as if their right. Failure to salvage Lehmann Brothers is generally decried by the Wall Street Financial sycophants, as the key event that caused the whole financial house of cards. Essentially the “Where’s my free stuff?” cry heard from many sectors of modern society, but in this case from the richest, smartest group of people. Give us tons, literally, of money so we can protect the economy. Of course the rest of the economy went into the crapper, while they got gobs of money.

It was the bankers that initiated the germ of an idea that created the Federal Reserve in 1913. From then on they could absolve themselves of responsibility for the financial welfare of the economy. Admittedly, there was much, much more at play upon the establishment of the Federal Reserve Bank. At any rate, post establishment it was the taxpayer and their government that was to extricate the Banker from their own failure and malfeasance.

Interestingly, the Panic of 2008 wasn’t a failure of commercial banks (the ones that the public banks at). There were not massive and widespread failures. Specific banks closely tied to the production of sub-prime mortgage loans were imperiled and closed like New Century Financial in 2006 and Countrywide Bank in 2008 and massive failure of Fannie Mae and Freddie Mac costing upwards of $150-300 billion. But the crisis wasn’t as widespread as the savings and loan failures of the 1980’s that saw 1043 out of 3,234 fail in the 1980’s.

It was the Shadow Banking, the unregulated production and trading of derivative backed securities, in which the Panic arose. The trading was at a scale as large as or larger than the regulated banking. Wall Street Bankers highly leveraged at 30 to one Bear Stearns and Lehmann Brothers saw the “paper” (mortgage backed securities) discounted on their Repo trades (give me your cash and I’ll give you my derivative backed security). That meant suddenly the “depositor” was asking for more proof that their cash was going to be safe. These Wall Street geniuses so highly leveraged couldn’t meet the “run” on the bank and began to collapse. I can’t emphasize this enough. This was where the panic really arose; the trading of these derivative securities. Once its value was called into question there was pandemonium in the canyons in Wall Street.

And this is where it gets questionable. The Austrian position argues that the period of easy credit over several years (2001-2006) created a bubble in the housing market that popped. Too much housing on too shaky of terms crashed the economy. Fingers can be pointed at Alan Greenspan, Federal Reserve Chairman, kept interest rates artificially low providing undue amount of credit in the economy. This produced malinvestment, houses people couldn’t afford and too great of a supply. Some cities had countless numbers of houses abandoned and idle. That market was eventually cleared. People paid down their mortgages. And now the housing market is stable and growing.

The Austrian nostrum is to leave the market alone to adjust itself. Markets tend to be efficient and will sort themselves out. There will be creative destruction with a bargain sale of assets and things will start anew with a far more efficient economy. Inefficient and inept Wall Street bankers go out of business and new more efficient ones take their place. This admittedly would put a huge hole in the economy. The example that one will be directed to is the very sharp depression of 18 months in 1920-21 that was just  as sharp in its recovery. The Federal Reserve RAISED RATES, but allowed generous Fed Funds borrowing. Sharp inflation preceded the downturn. No massive bail outs or recovery programs were employed.

In 1920 the Federal Reserve Banks succeeded in this task by making funds freely available at relatively high discount rates. Somewhat surprising is the fact that there was no liquidation of bank credit nor decline in the money supply during the first six months of the downswing. Loans at commercial banks continued to increase, and member-bank indebtedness continued to rise.*

The same nostrums would be applied in the panic of 2008. It’s quite plausible that as in 1907 a leading figure, like Jamie Dimon of JP Morgan Chase, could have gathered the luminaries around to insert enough liquidity to right the banking ship and quell the panic. And let the rest collapse in creative destruction; only to quickly recover. Especially, the commercial banking system remains liquid. Of course millions lose their houses and only the Ford remains as a domestic auto producer, if the auto parts chain doesn’t disappear.  That is a very large amount of conjecture. But in Austrian thinking there would have been no Federal Reserve to artificially keep interest rates below market from 2001 to 2006, which was a key to the housing bubble and subsequent collapse of the economy.
On the other hand it’s extremely difficult for me to agree to the remedies that were actually used. The massive, gargantuan bailouts. The resulting immense transfer of wealth to the financial elites. Yet, millions unemployed, 14 millions lost their homes, but the financial elites were protected.  

The fact remains that any economic antidote must conform to the political realities. In the Panic of 2008 everyone were referencing the Great Depression of the 1930’s. It was the near destruction of the Republican Party. They were essentially in the political wilderness for 60 years with a brief interregnum 1953-55. The political outcry would sweep any party out of power if Austrian economic policies were carried out. 
So the Monetarist approach of injecting liquidity, considering the political parameters, was the most likely one. Freddie Mac and Fannie Mae were cases of government malfeasance, mismanaged and frightfully undercapitalized. Prior to the Panic they were involved in a huge accounting fraud, but stalwart supporters like Congressman Barney Frank opposed looking to close to the operation.
The Panic of 2008 can be used to illustrate the ineptitude of government regulating the money supply. Certainly the Great Depression can be for that matter.


Could there have been something else done besides throwing money at Wall Street?
The financial institutions most reliant on the largess of the Federal Reserve and the Congress should at the very least be assessed contributions to establish a Recovery Fund. The size should be at minimum a $1 Trillion or multiples thereof to match the funds needed to bail out these banksters as seen in the last debacle.

For all the seeming advantages of fractional reserve banking, they harbor colossal risks as seen in the Great Depression of the 1930’s. The massive reduction in the money supply reduced large segments of America to poverty. Loans failed and then loans were called in to meet the rush of claims for deposits by worried depositors. Thousands of banks failed. This risk of bank runs was largely solved by Federal Deposit Insurance. The smartest guys in the room created alternative financing methods in the complex derivative vehicles, that ultimately tanked the financial system.

The Austrian nostrum of gold backed money would be the steadiest solution but bank monetary creation has been a feature of financial systems in America for nearly two hundred years. Every time a bank generates a loan absent a complementary bank deposit, it is essentially creation of money. Banks make profit and borrowers gain access to financing. All Good?....I refer you back to the Great Depression, however.

Absent creative destruction, where even billionaires are rendered penniless, shoring up of financial institutions as we saw in 2008 was a massive, gargantuan transfer of wealth to the vaunted 1%. While the unconnected were left in the lurch. The result more income disparity. Thus these Too-Big-To-Fail institutions require more than simply being monitored real close, called for in the Dodd-Frank act. These institutions bound to fail need to pony up themselves to build an insurance fund in anticipation of collapse. The collapse is inevitable and the taxpayer will be asked to foot the bill, otherwise.
Will it actual reform occur? Hardly. Taxpayers are too easily duped with threats of financial Armageddon.  And democracies usually only work under crisis. Financial collapse threatens economy. Taxpayers are fleeced to bail them out. It’s a pattern.

*A Reconsideration of Federal Reserve Policy during the 1920–1921 Depression, Elmus R. Wicker