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
