2008 Financial Crisis - Thoughts on Current Political Environment

This will be the last of three articles related to Lessons Learned from the 2008 Financial Crisis. The first featured an article by former NY Fed employee Mike Silva and is the basis for all further discussion here. The second included some additional information from an article by Ambrose Evans_Pritchard on why the next crisis may be worse than the 2008 crisis was.

This article will be some commentary that attempts to put the first two articles into some context based on the current political climate that exists both in the US and around the world.

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The first point to make is that we intentionally try to avoid promoting any kind of political agenda here. The goal of this blog is to be a free resource of information that presents a variety of credible views on issues related to possible monetary system change. In a perfect world, we would not discuss anything at all involving politics. Unfortunately, as we know, our world is far from perfect and the political environment can greatly impact what actually happens in regards to systemic changes (which can directly impact our daily lives).

The next point to make is that we do not know when another major crisis may come along or if it will be worse than the 2008 financial crisis; so we make no attempt here to predict the future in that regard. What we do instead is simply note the systemic risks that a variety of credible experts from a variety of viewpoints have talked about. We cannot know if and when one or more of these risks will overwhelm the existing system to the point that some kind of major change will have to take place. But we cannot ignore that possibility either. 

With the disclaimers out of the way, here are some concerns related to the current political environment we find ourselves in that should be noted if we are to try and provide an objective analysis.

1) The world and the US is more sharply divided politically than at any time I can recall in my lifetime. There is no indication at this time that this situation will greatly improve. In fact, it is just as likely that it will continue to get worse.

2)  Using the US as an example, we now have a country with tens of millions of people who simply believe that the present system is stacked against them one way or another. In my view, the 2008 crisis simply confirmed to these people that the system is designed to preserve the power of the status quo. They also feel that large powerful interests will be served before there is consideration for the plight of the average person. Whether that perception is accurate or not, it is clearly widespread and very powerful. Anyone thinking it can just be ignored and will just go away is making a mistake in my view.

3) The group of people in #2 above tended to split into two large political sub groups. One group saw Donald Trump as a disruptive outside force that would challenge the existing power structure and seemed to care about their problems more than the typical politician. The other group saw the system as rigged in favor of the wealthy (the so called 1%) and viewed Donald Trump as just an example of an unfair system that has skewed wealth towards a small per cent of the population. This group is somewhat receptive to a more socialistic solution of using the power of government to even things out and to force wealth to be redistributed. I believe this accounts for the popularity of Bernie Sanders and Congresswoman Ocasio-Cortez (as examples), especially among younger people. 

An interesting observation to me is that combined these two sub groups appear to now form a significant majority of the population who are unhappy with the present system and are wanting it disrupted and changed. They just completely disagree on how to do that and are now fighting it out in the political arena daily to see who will steer the future. Trump supporters will stay with him no matter what because they believe he is fighting for them when no one else will and Trump detractors will oppose him with every ounce of energy they have for a variety of reasons.

4) What used to be the so called majority in the middle continues to dwindle as more and more people choose sides and the battle for political power ramps up more and more. I think it is unlikely that this former majority even exists any more now. 

If the above observations are accurate, this presents a very serious problem if and when we do get a new major financial crisis worse than 2008 as some are predicting. We have shown this is accepted as possible by a variety of credible sources. Mr. Silva is just the latest to point out that the next crisis may be much harder to deal with. 

If something does take down the present system, it appears that a very intense political fight is the most likely outcome to determine what comes next. President Trump and his supporters will almost certainly blame the crisis on bad monetary policy decisions from the central banks. Opponents of President Trump will almost certainly say his policies failed and will blame him for the crisis. Beyond that, it is likely a segment of this group will go further and say that capitalism has failed and only a government takeover will fix the situation.

This would mean that some kind of orderly transition from the existing system to a new one is less likely and the potential for significant social disorder has to be taken seriously. When radical change from the status quo becomes a more realistic possibility, emotions on both sides will likely just ramp up even more as both sides believe the stakes are very high.

It is impossible for me to predict how all this will turn out. I can only report what I think various factions would probably propose based on following this for many years now. 

I have no idea who the majority of the public would trust in a situation where the system has broken down and people are really suffering. Both sides would use every tactic possible to blame the other side for the crisis. Multiple factions would probably be fighting to put forward various solutions and proposals for system reform coming from across the political spectrum. Here are just some we would likely see based on what I see and read:

1) Abolish the Fed/Central Banks - this view will say the central banks caused the mess with easy monetary policies and by inflating assets insuring they would eventually crash spectacularly. There will be a very large segment of the population that likely takes this view. 

2) Nationalize the System - this view will blame the "failure of capitalism" on greed and unfair wealth distribution and will demand the government step in to fix everything. The more progressive leaders of this view are actually promoting the idea that ultimately the Fed should be used to just print whatever money is needed to convert to a more socialist society (see modern monetary theory). Another large segment of the public will take this view. 

3) Just Reform the Existing System - This view may perhaps suggest replacing the US dollar with the SDR as the global reserve currency and allow the IMF become the global lender of last resort if the Fed is unable to fulfill that role. Or perhaps less dramatic reforms will be proposed that attempt to just tweak the existing system run by national central banks. Proponents of this approach will feel they are advocating reasonable adjustments to the present system and not radical reforms.

Please note that in the current political environment, it is entirely possible that option #3 will have the least number of supporters. The basis for this statement is that it appears that the majority of the public now is in the "we don't trust the current system and think it is rigged against us" camp even if that majority may be sub divided into two opposing political camps that don't trust each other. Even though President Trump is currently in power, his supporters do not trust the existing system and view it as "the Swamp". They will be skeptical of anything proposed by the existing establishment without a blessing from President Trump.

If the above analysis is on target, those in charge of things now have a lot of serious work to do to avoid a gigantic mess if things do ever go south in the present financial and monetary system. I can only offer these suggestions based on years of following this now and seeing the diversity and intensity of competing viewpoints out there.

1) Much more effort is needed to try and educate the public on these issues and get them to study the problems and various possible solutions than is being made right now. That is what this blog has attempted to do, but it needs a lot more support reaching the public than this blog can provide. Unfortunately, the incentive for whoever is in political power to do this does not exist. I do understand that when we are not in crisis conditions, it is very hard to motivate most people to take the issues seriously and try to learn more about them. But I honestly believe that the effort needs to be made anyway.

2) Much more transparency and willingness to be truthful about the potential risks to the present system is needed. What happens now is that whoever is in political power works night and day to create the impression that all is well and there are no serious issues or problems while whoever is out of power works night and day to convince the public that the world will end soon unless their side is put back into power. I believe this happens because it is the easy road to take. Working to educate the public objectively without regard to political advantage is much harder to do. It also requires some level of trust and cooperation between political leaders that simply does not exist at this time.

This situation is not conducive to open discussion and a free exchange of ideas on how to make things better for the most people because that is never the goal for all the sides at the same time. Gaining political advantage is more important to each side, especially when they are out of power. Both sides convince themselves that only if they get power can things be made right and so any tactic required to gain power becomes justified.

I can offer no solution to this problem, but it is important to understand the reality of it and incorporate it into your personal decision making process. 

3) The time to do #1 and #2 above is before another crisis arrives. Once a crisis hits, it will be too late for sure. All that will be left then will be a high stakes raw power struggle that may or may not do anything to improve the situation for most people. The odds are against things improving under those conditions in my view because the public may be totally confused and easily misled as the power struggle unfolds.

The goal here is to try and observe the facts as best we can, analyze them as objectively as we can, and provide that as a free resource of information to anyone interested that can be helped by the information. If the above analysis is reasonably correct, everyone needs to be prepared for any possible outcome ranging from no crisis for many more years to another major one worse than 2008 at any time. If we do get the latter, it will be very important to understand these issues and learn as much as possible. That is what we try to encourage here. 
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Added note: After writing the blog article we got more evidence that the above analysis has some merit. Former Fed Chief Janet Yellen goes on the record to state that she does not think President Trump has a basic understanding of Fed policies and mandates. The quote below in particular caught my attention:

"President Trump's comments about Chair Powell and about the Fed do concern me, because if that becomes concerted, I think it does have the impact, especially if conditions in the U.S. for any reason were to deteriorate, it could undermine confidence in the Fed," she said. "And I think that that would be a bad thing."
(editors note: underline added for emphasis here)

This comment fits perfectly with the analysis above in my view. If we get another major financial crisis, almost anyone paying attention can predict what is going to happen. President Trump will point a finger of blame at the Fed and we now appear to have former Fed officials trying to offset that by saying in the next crisis the Fed shouldn't be blamed because Congress took away its emergency authority (based on Mike Silva's comments) and that the President does not have an in depth understanding of economics and Fed policies. Janet Yellen goes on to express concern that President Trump is undermining confidence in the Fed. 

All of this is supportive of the idea that if we get another major crisis, the effort to assign the blame will be of epic proportions. It does not seem likely that anything productive is going to emerge in an atmosphere like this which is why we strongly encourage readers to learn as much as possible about these issues and how various scenarios might impact their daily lives eventually. 

For now, it understandably is off the radar for most people. But just look at all the effort going on before we even have a crisis to deflect blame in one direction or the other. 

I will repeat a statement from above. Those in charge of things now have a lot of serious work to do to avoid a gigantic mess if things do ever go south in the present financial and monetary system in this political environment.

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.

• ONCE PANIC SETS IN, ONLY MASSIVE FINANCIAL FIREPOWER WILL QUELL IT. 

"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."
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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.

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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 liquidation. The 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."

Please click here to read the full article in Stuff.co.nz

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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.

Inside the 2008 Financial Crisis & The Lessons Learned - Mike Silva (former NY Fed)

This may well be one  of the most important articles we have run on this blog in some time. In this article we feature an article written by Mike Silva. Mr. Silva served as the Chief of Staff for Tim Geitner at the NY Fed and stayed on at the NY Fed under new President Bill Dudley when Tim Geithner moved on to become Secretary of the Treasury.

In this position, Mr. Silva had a front row seat during the most recent financial crisis in 2008-2009. Most of us suspected the entire financial system was closer to implosion that we realized at that time and Mr. Silva confirms that to be true in this article. He goes on to explain how and why certain actions were taken to prevent total systemic collapse. In the conclusion to his article he states very clearly that he believes we will have another major financial crisis "sooner rather than later".  Given his insider position, this is clearly an article we all need to read and understand. Below are a few excerpts and then a few added comments.

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INTRODUCTION

"During the financial crisis, I served as Tim Geithner’s chief of staff at the New York Fed and, then when Tim became Secretary of the Treasury, I served as chief of staff for the next president, Bill Dudley. My role allowed me to directly observe an impossibly small number of Americans at the New York Fed, the Board of Governors of the Federal Reserve and the Treasury Department fight desperately to save the financial future of all Americans. Thank you for this opportunity to tell their story."
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"On the night of Thursday, 13 March 2008, I was one of a small group of NY Fed officials huddled in Tim Geithner’s office, listening as several senior SEC officials reported that the investment bank Bear Stearns would not be able to open in the morning."

. . .

"As an investment bank, Bear was part of the ‘shadow banking system’ that was completely outside of the Fed’s jurisdiction and not subject to any kind of ‘prudential supervision’ (i.e. supervision to ensure that it was being run in a safe and sound manner). We had no direct insight into Bear. In fact, some of us did not even know where it was located."

. . . .

"At this point, Tim and Chairman Bernanke started discussing the possibility of invoking the Fed’s emergency lending authority under Section 13(3) of the Federal Reserve Act to lend to a non-bank. Under Section 13(3), the Fed could lend to a non-bank if it determined that “unusual and exigent circumstances” existed and it was “secured to its satisfaction”.

Fortunately, our examiners determined that Bear had sufficient collateral for us to be “secured to our satisfaction”. Now, the question became whether “unusual and exigent circumstances” existed. Tim felt that they did. Bear was not a particularly large institution, but it was a highly interconnected one. Its failure could easily result in enough cover selling and collateral calls to trigger a negative asset spiral."

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Editors note: The article goes on to explain how Lehman Brothers would later fail and why the Fed could not bail out that firm legally. Then things got worse as the crisis spread as described below in the article.
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. . . "Consequently, on the morning of Monday, 15 September, Lehman declared bankruptcy."

"The markets that Monday were ugly. At one point, the NYSE was down 1,000 points, which was a lot back then. However, stocks rebounded and ultimately closed down 500 points. That was bad, but not a meltdown. Importantly, much of the decline was attributable to rumors that AIG was also in trouble. But we already knew about AIG and it was a much easier case for two reasons."

. . . .

"On Tuesday, 16 September, word came that a $65 billion money market fund called the Primary Reserve Fund had bought $785 million of Lehman commercial paper, betting that the Fed would bail out Lehman. It bet wrong and that paper became worthless. As a result, the fund was not able to repay $1 for every $1 invested and it “broke the buck”. Investors in the fund did not react well to that. Within 24 hours, they had withdrawn almost two-thirds of their money.

Much worse, investors not only began withdrawing funds from money market funds with exposure to the financial system, they began withdrawing money from ALL money market funds.

Money market funds are among the largest purchasers of commercial paper (CP) and CP is how corporate America funds itself. CP is how Boeing, Caterpillar, Microsoft and General Electric meet payroll and pay suppliers. Suddenly, a crisis that had been limited to the financial system had jumped the tracks into the real economy. Over the next 10 days, lending of all types ground to a halt. Complete panic had set in.

This was a terrifying moment. Central banks know how to support individual institutions, but no central bank had ever tried to support entire markets. And that was what we had to find a way to do."
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Editors note: The article next explains all the massive intervention undertaken by the Fed to stave off the crisis from spiraling into a complete depression. It's clear that we were much closer to this situation than most people understand as the crisis was unfolding at that time. In the conclusion, Mr. Silva lists some lessons learned and then makes a prediction for the future. Below is one "lesson learned" that caught my attention and then his prediction. I added the underliines for additional emphasis.
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 RATIONAL BEHAVIOUR IS OVERRATED (Lesson Learned #2)

"A lot of economic, market and bank supervisory theory is based on the premise that financial actors are largely rational. The crisis convinced me that they are not. It was not rational for very experienced financial leaders to make their companies hostage to short-term financing that was, in the final analysis, secured by the irrational assumption that house prices will always go up. It was not rational for Dick Fuld to reject offers because their terms offended his pride. It was not rational for money market fund investors to flee all money market funds just because one fund made a bad bet. It was not rational for some lenders, at the height of the crisis, to stop accepting even Treasuries as collateral. The crisis convinced me that greed, ego, fear, short-sightedness, group-think and other human foibles have at least as much, if not more, to do with financial behaviour as rational thinking does.

This presents a tremendous challenge that policy makers, economists and bank supervisors are going to have to come to grips with."

. . . . .

WILL THERE BE ANOTHER FINANCIAL CRISIS? 

"Absolutely. As long as we have a financial system, we will have financial crises. The only question is how often and how severe.

Personally, I think a crisis is likely to happen sooner rather than later because . . ."

Please click here for the full article in Jan 2019 Alchemist Issue 92 page 12

Click here to see Mr. Silva's slide presentation on this topic

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My added comments: I encourage everyone to read this full article because it comes directly from someone inside the 2008-2009 crisis so it is a first hand eye witness account. 

This article confirms what we have been writing about here now for years. At any given time there is risk that exists to the entire financial and monetary system that we presently have. It is possible for those risks to put the viability of the entire system in question. The article mentions a variety of these risks which we have documented over time on this page of the blog. Because we were able to stave off a collapse from the 2008-2009 crisis and now another decade has passed, it is tempting to assume that the risks have gone away. Mr. Silva makes it clear in this article that is a bad assumption and lists a number of ongoing possible triggers for another major crisis. Interestingly, he states that the Dodd Frank legislation passed after that 2008-2009 crisis will make it much harder for the Fed to handle the next crisis when it does arrive. 

All this agrees with what we have reported here and also with what Jim Rickards has talked about now for many years. He says that there will be another major crisis and that the US Fed will not be able to handle it. He goes on to predict that a new global monetary conference will be called to deal with the crisis and believes that the most likely proposed solution will be to use the SDR at the IMF as the global reserve currency replacing the US dollar in that role. Mr. Silva's article is important inside information that confirms that something like this is indeed possible in the future.

On the other hand, we have also reported here that until and unless we do get this kind of new major crisis. we are more likely to see gradual and incremental change to our current monetary system over a long period of time. I believe this article also confirms that as a valid observation. It is clear from this article that the financial authorities did not act until the crisis was fully underway and that they were focused on simply doing what they could to preserve the current system using massive intervention from the Fed as lender of last resort. If they were anxious to completely reform or replace the current system, they had the perfect opportunity to do that during the crisis and they did not go that direction.

This indicates to me that central bankers are very risk and change averse and prefer the status quo with only minor incremental tweaks to the system now and then. Even in major crisis conditions, their first instinct is to jump in to try and preserve the present system. Input I get from experts along with my own research also convinces me this is the case.

Meanwhile there is another issue not mentioned in this article that is very real, but perhaps not really very well understood by financial authorities. That issue is the public trust in themselves. The general public does not really spend a lot of time delving into all these issues like we discuss on this blog. They expect that the people running the system are going to make sure it functions and that they can rely on it to conduct daily business activities. If and when the day comes that a crisis arises those authorities cannot "fix", it is very possible that the general public will lose trust in the people running the present system and will reject their "solutions to the crisis" and look for alternatives. I don't believe that anyone can really forecast what people are going to do when panic sets in (see the comments by Mr. Silva above on Lesson Learned #2). If we live in a complex system as Jim Rickards says, no one can predict for certain what will emerge from a crisis on the level he talks about and Mr. Silva clearly states is possible.

This is why on this blog we have worked hard to understand these issues, document the potential systemic risks, and also document a variety of potential proposals to reform or even remake the current monetary system if the need ever does arise for that. We have covered a broad range of ideas and proposals for monetary system change and continue to watch for new ideas that emerge like the Kinesis project launching in 2019 which is proposing an entirely alternative global monetary system using a combination of old world (anchored by gold and silver) and new world (blockchain technology) concepts. What we want to watch for is how much public acceptance these ideas achieve so we can see if they can become viable alternatives for people to choose during a crisis to the present system. 

We can continue to report that unless we do get the kind of new crisis that people like Jim Rickards predict (and Mr. Silva confirms is possible), we expect any change to the present system to be slow and incremental. But this article by Mr. Silva does remind us that those at the very pinnacle of the present system agree that we cannot assume it will never fail. It almost did in 2008-2009 and Mr. Silva states that next time the Fed may be unable to fix it (see note below *)
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* in one of the "lessons learned, Mr. Silva makes these comments (see page 15):

"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."

Added note 2-16-19: The followup to this article may be found here.

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