Saturday, February 16, 2019

Inside the 2008 Financial Crisis - Followup Article

Recently, we featured an article by former NY Fed Chief of Staff Mike Silva that was an eye witness account of how the US Fed dealt with the 2008-2009 financial crisis. We felt like Mr. Silva's article had a lot of important information and apparently many people agreed. It quickly became the most viewed article ever on this blog with thousands of views from around the world.

I was particularly struck by a comment in the Mike Silva article under the Lessons Learned segment. I have underlined parts of it below for added emphasis.


"This lesson is straight out of Tim Geithner’s book, Stress Test, and is much better articulated there. Not being burdened with Tim’s tremendous intellect, I am at liberty to articulate a simplistic version of this lesson, which is: “Once a financial mob panics, the only thing that will end that panic is for a central bank with a large billy club to show up and announce: ‘Break it up everyone. Go home. This crisis is over.’” Unfortunately, the Dodd Frank Act (DFA) has crippled the Fed’s ability to play this role. I guarantee that curbing the Fed’s emergency authority will come back to haunt us."

This was new information for me and prompted me to try and research this further to learn more if possible. In doing so, I ran across this article from September 2018 by Ambrose Evans-Pritchard. It expands on the concerns that exist about the potential for another major crisis "worse than the 2008 crisis" and also provides more details on the potential problem mentioned in the Mike Silva article related to restrictions placed on the Fed for dealing with the next crisis. Below are some selected quotes from the article by Ambrose Evans-Pritchard and then a few more comments.


OPINION: "The world's major economies are skating on dangerously thin ice and lack the fiscal, monetary, and emergency tools to fight the next downturn.

A roster of top crisis veterans fear an even more intractable slump than the Lehman recession when the current ageing expansion rolls over. It has grave implications for liberal democracy.

"We have no ability to turn the economy around," said Martin Feldstein, president of the US National Bureau of Economic Research

"When the next recession comes, it is going to be deeper and last longer than in the past. We don't have any strategy to deal with it," he told The Daily Telegraph."

. . . . .

"Olivier Blanchard, former chief economist of the International Monetary Fund, said the US has big enough buffers to cope with a "run-off-the-mill" recession but would need to tear up the rule book altogether in a deep downturn.

While the Fed's balance sheet is already "scary" at US$4.2 trillion after previous rounds of quantitative easing, it could go a lot higher. "If we need it, we could clearly double it and nothing terrible would happen," he told a Boston Fed forum on how to fight the next slump." (editors note: underline above and bellow for emphasis is mine)

. . . . .

"A fresh crisis would expose another huge problem. Capitol Hill has tied the hands of the US Treasury and the Fed, raising serious doubts over whether the authorities could legally repeat the crisis measures that rescued the financial system in 2008.

The firefighting trio of the day - Ben Bernanke, Hank Paulson, and Tim Geithner - wrote a joint article in The New York Times last week lamenting that Congress had stripped the watchdog bodies of "powerful tools".

The tougher rules constrain the Fed's ability to halt fire-sale liquidationThe Dodd-Frank Act stops it from rescuing individual companies in trouble (there must be at least five, and they must be solvent) or lending to non-banks.

. . . . .

"What saved capitalism in 2008 were lightning-fast moves by the Fed to shore up the markets for commercial paper and the asset-backed securities markets, and to stop a run on the money market industry."

. . . . .

"The problem today is that Fed no longer has the authority to do this. It needs the approval of the US Treasury Secretary, and therefore the Trump White House."

. . . . .

"In short, it is no longer clear that there is a lender-of-last resort standing full square behind the dollarised global financial system and able to act instantly in a crisis."

My added comments: This article by Ambrose Evans-Pritchard sheds some more details on the problem mentioned by Mike Silva in his recent article. That problem being that the US Fed may not be able to deal with another major crisis like they did the 2008-2009 crisis.

I believe this is important information for readers here to be aware of for obvious reasons. It is important to point out that Mr. Silva in his article does say that even though be believes we will see another crisis "sooner rather than later", he adds that it is not likely to be as bad as the 2008 crisis. He also notes that new rules for banks to increase their capital reserve safety margins have been put in place. But he also clearly says "I guarantee that curbing the Fed's emergency authority will come back to haunt us." That is a pretty intense statement.

The point here is not to raise undue concerns or make any predictions about the timing for a new major crisis in the future. I have no idea if such an event would happen any time soon. 

The important point here is that we need to realize that highly credible experts directly involved with dealing with the last crisis have stated that the ability to deal with the next one may be hampered. I view that as very important information that I doubt many people are fully aware of (I know I wasn't).

Most people now assume that there is a massive backstop at the Fed as "lender of last resort" based on how the last crisis was dealt with. This information about possible restrictions on the Fed's emergency authority casts doubt on how much backstop may really be available in the next crisis. 

Also, as we have noted here, Jim Rickards has said for years that he does not think the Fed will be able to handle the next major crisis and that he feels it will be worse than the 2008 crisis. Many others have voiced similar concerns, but I mention Jim because he is the most well known proponent for this point of view.

The information above is supportive of at least the part related to the ability of the Fed to deal with things. If the Fed cannot handle it, then we might get the scenario that could lead to some kind of major monetary system change which this blog watches for.

This is just something to keep in mind and supports why it is important to stay informed on current events and to have some kind of personal plan in mind to deal with another major crisis in the future should one arise. 

None of us can know for sure what the future holds and it is just common sense and prudent to have a backup plan in mind. The plan would vary for each person, but should include an ability to operate outside the present financial and monetary system should it fail to function for a period of time leading into a transition to something new. Businesses should also think in these terms although I doubt many do.

Note: Part III of this series of articles may be found here.

Added note to Blog readers: Google has announced they will no longer support the Google Plus network. It is my understanding this will not impact this blog or their Google Blogger platform. If the format of this blog changes, it will be due to updates from Google and not from me. But I believe it should look the same from what I have read about the upcoming changes by Google in April.

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