“What matters is not the trigger, but the preconditions that make the system vulnerable.” – Jim Rickards
So here we are, ten years to the day of the Lehman Brothers’ bankruptcy on September 14, 2008.
The gut-wrenching fear leading up to Lehman’s demise that prevailed throughout back-office and C-level executive suites at TBTF institutions and non-bank, systemically-important entities, along with the palpable nervousness permeating the general public, reverberated through my office for months within risk management at Citigroup. One year earlier, Jim Cramer rang the bell via CNBC Street Signs on August 3, 2007.
Unbeknownst to most were the email and phone conversations among executives and expert peers across Wall Street and the global landscape. The language flowing in and out of the New York Federal Reserve Bank (NYFRB) before, during, and after that September weekend meeting between the NYFRB (Timothy Geithner & Ben Bernanke), U.S. Dept. of the Treasury (Hank Paulson), and CEOs from the TBTF behemoths played an important role in how a practical solution evolved to deescalate a global financial armageddon.
What is worth a brief mention and is more often than not missing from current financial press narratives is the partisanship and angst surrounding the Great Financial Crisis due to the presidential election process at that time with the Obama win, and it continues in earnest.
- In 2008, America Stopped Believing in the American Dream – NY Magazine, Aug. 2018
An alternative plan that may have avoided a Lehman bankruptcy, and even mitigate the need for any subsequent Troubled Asset Relief Programs (TARP), was presented to Geithner before the NYFRB meeting in 2008. I had the privilege of knowing of the humble advice before anyone on the planet knew. Whether it would have made a significant difference to the immediate crisis or subdue the turmoil that remains under Goldilock’s blanket today can only be a historical footnote because the opportunity passed and any benefit is not quantifiable after the fact. As the financial press publishes fact-filled and opinionated reminiscences on this tenth anniversary, consider the following piece written several months after Lehman collapsed. In some respects, the Fed balance sheet took on the “bad bank” role, but not quite.
A Good Bank / Bad Bank Primer… “I mean the kind of ‘bad bank’ that is being discussed as a possible solution to the problems in our banking sector. In this sense, a bad bank is a bank that holds bad, or ‘toxic’ assets, allowing some other bank to get rid of these assets and thereby become a ‘good bank.’ To understand this, you need to understand what a bank balance sheet looks like.” – Seeking Alpha, Jan. 22, 2009
On January 27, 2009, U.S. Democrat Representative Paul E. Kanjorski was interviewed on CSPAN. It is interesting to note that following that interview and after 25 years of winning his seat in Congress, he lost it during the 2010 midterm elections. Rep. Kanjorski shed a bright light during the CSPAN interview upon one issue facing the global financial system, and it was a “fuggetaboutit” moment.
The following video inserts a few clips from that interview, meshed with a synopsis of the movie Rollover (1981), which paints a realistic scenario had the Feds failed to step in because the circumstances that led up to an intervention were unbending waters under the bridge.
The Lehman collapse stunned the central bankers and political leaders alike. Despite TBTF banks appearing better capitalized, they are even larger now in the U.S. The European banking industry, in comparison, remains under-capitalized and beleaguered, with zombie banks kept afloat by ongoing liquidity support from the ECB.
China is facing an overvaluation by blowing its own debt bubble through the roof.
A Decade After the Great Recession, Is the Global Financial System Safer?… “The Next Crisis? As American and European banks regrouped after the crisis, financial institutions in emerging market economies continued to grow. Chinese banks, in particular, rose to the top of the banking hierarchy with their massive assets. But they also took on a lot of debt. Goldstein says there is ‘potential fragility’ building up in China. ‘Credit is growing, banks are growing, and those are known to be leading indicators of future declines and future crises. [It’s] possible things are going to start there.’ But since China is centrally controlled, the outcome could differ from what happened in the U.S. and Europe, he adds.” – Wharton, Sep. 11
The Global Economy’s Fundamental Weakness… “The main problem is not just that growth is tepid, but that it is driven largely by debt. By early 2018, the volume of global debt had risen to nearly $250 trillion – three times higher than annual global output – from $142 trillion a decade earlier. Emerging markets’ share of the global debt stock rose from 7% in 2007 to 26% in 2017, and credit to non-financial corporations in these countries increased from 56% of GDP in 2008 to 105% in 2017.” – Project Syndicate, Sep. 13
Regulations put into place post-crisis do not appear to be draining any leverage out of the shadows. For an in-depth mind-blower on the current state of the “notional” (Merriam-Webster: “existing in the mind only”) derivatives market, skim the BIS review noted below.
- Pope Calls Derivatives Market a ‘Ticking Time Bomb’ – Bloomberg, May 17
- BIS Quarterly Review… “The distribution of credit risks across counterparty categories has remained broadly unchanged.” – Bank of International Settlements, Jun. 5
The next crisis is still lurking in the financial system: ‘We never addressed the root cause’… “For DiMartino Booth, the exotic financial instruments that helped cause the calamity a decade ago and brought down those two venerable institutions, along with many more, are still lurking in the system, threatening a deadly repeat unless the issue is corralled. “We never addressed the root cause of derivatives in the first place,” she said in an interview. “We still kind of operate in the dark as it pertains to the transmission mechanism of derivatives.” – CNBC, Sep. 14
Why all economists must learn lessons before next US downturn… “The financial crisis inquiry commission put the blame squarely on the derivatives market as one of the three central factors driving the events of late 2008 and 2009.” – Joseph Stiglitz for The Guardian, Sep. 6
BIS Warns Of “Perfect Storm” For Global Economy… “Consider that non-US banks provide the bulk of dollar-denominated letters of credit, which in turn account for more than 80% of this source of trade finance. The Great Financial Crisis highlighted the fragility of this setup, since non-US banks depend on wholesale markets to obtain dollars. Ten years on, we should not forget how the dramatic fall in trade finance in late 2008 played a key part in globalizing the crisis. Any dollar shortage among non-US banks could cripple international trade. On top of that, trade skirmishes can easily escalate into currency wars, although I hope that they will not. As we saw earlier with Mexico, imposing tariffs on imports tends to weaken the target country’s currency. The depreciation could then be construed as a currency ‘manipulation’ that seemingly justifies further protectionist measures. If currency wars break out, countries may put financial markets off-limits to foreign investors or, on the other side, deliberately cut back foreign investment, politicizing capital flows. In addition, we must be mindful of long-observed knock-on effects from tighter US monetary conditions, given the large stock of dollar borrowing by non-banks outside the United States, which has now reached $11.5 trillion.” – Zerohedge, Aug. 26
U.S. Budget Deficit Swells to $898 Billion, Topping Forecast… “The U.S. budget deficit is deepening faster than the Congressional Budget Office expected… raising concerns the country’s debt load, now at $21.5 trillion, is growing out of control… White House says the tax cuts will pay for themselves by creating more revenue through faster economic growth. The International Monetary Fund has warned the tax reductions risk putting the nation’s debt on an unsustainable path and could cause the economy to overheat.” – Bloomberg, Sep. 13
SocGen: “Storm Clouds Are Gathering” As Next Recession Looms… “These risks are deeply rooted in cyclical and financial factors, but more importantly in policymaking, predicting that the next US recession looms in 2019/20. Four of the bank’s most essential downside risks (Protectionism/ trade wars, Sharp market repricing, European policy uncertainty, and China hard landing) are developing into significant threats. They are laid out in the bank’s now iconic ‘Swan Chart’…
Tightening of US monetary policy and the end of cheap money is also making SocGen more risk-conscious, adding that a dollar shortage has been primarily the culprit of emerging market chaos… “The slowdown in US growth in late-2017 and early-2018, mild as it was, has indeed also proven to be transitory, and GDP reaccelerated strongly in 2Q. The strength of the rebound exceeded our expectations and hence our US forecast is up by 0.2pp to 2.8% and 1.6% for this year and next, respectively, the latter still substantially below consensus (around 2.6%). Indeed, we expect quarterly sequential growth to slow from here, and year-on-year growth to top out right around the current rate. For US growth, this was probably as good as it gets.” – ZeroHedge, Sep. 13
Nine Lessons From the Global Financial Crisis… “The system is a lot safer, but some important changes have been put off until the next meltdown… Still-elusive inclusive growth – Misaligned internal incentives – A scarcity of ‘patient’ balance sheets – The big got bigger and the small got more complex – Risk has morphed and migrated to under-regulated areas – Reduced policy flexibility… There is limited ‘dry powder’ to rely on in the event of a crisis because interest rates are still floored at zero or below in much of the advanced world outside the U.S., central banks’ balance sheets are already large, and debt levels are significantly higher than before the global financial crisis. This suggests that, even if there is sufficient political will, the ability to crisis manage and recover may be diminished compared to 10 years ago.” Mohamed A. El-Erian for Bloomberg, Sep. 13
The penalty for attempting to tighten monetary conditions will likely grow more problematic. Stock markets are booming, real estate valuations are bubblicious, wages are stagnant, and the ratio of investment-to-GDP is flatlining in nearly all developing countries and falling in advanced economies.
- Real GDP growth, Annual percent change – IMF DataMapper
The Jekyll Island participants probably never imagined a time when their private bank would fund the world with near zero to negative interest rates while owning a large chunk of the capital markets and mortgage securities. The Federal Reserve Bank is pulling off a TaperCaper, despite the taper talk.
- The Global Economy Is Still Feeling the Lehman Fallout 10 Years Later – Bloomberg, Sep. 12
The imbalances in the world of 2008 are even bigger now. Debt is significantly larger and the continued reliance upon unorthodox policy has fertilized an environment of rampant speculation in a chase for yield in a mindless algorithmic and automated exchange-trading cloud. The last two decades of Japan drives home the zombie banks’ point. Worst of all, the inequity and risk within the system was clear due to information availability via the new age of an Internet, long before the Great Financial Crisis hit. The ultimate trigger is what remained elusive and will continue to be on the road to the next crisis.
Yellen: Fed should commit to future ‘booms’ to make up for major busts… “The U.S. Federal Reserve should commit to letting economic booms run on enough to fully offset collapses like the 2007 to 2009 Great Recession, former Fed chair Janet Yellen said on Friday, urging the central bank to make “lower-for-longer” its official motto for interest rates following serious downturns.” – Bloomberg, Sep. 14
Bernanke, Geithner, Paulson…biggest takeaways: “Failure to anticipate… We were forced to do things to protect the American people, but hard to defend… Crisis was unpredictable and not due to the data.” – Brookings, Sep. 12
The irony in hindsight is that they did do the right thing after the fact, as the financial plumbing required immediate hydration. Unfortunately, ten years later, along with various forms of bail-in legislation enacted across the Western World, the hole has gotten much deeper and darker.
Ray Dalio: The next downturn will be more difficult to handle socially and politically – CNBC, Sep. 11
“Each crisis is bigger than the one before. In complex dynamic systems such as capital markets, risk is an exponential function of system scale. This means that the larger size of the system implies a future global liquidity crisis and market panic far larger than the Panic of 2008… The ability of central banks to deal with a new crisis is highly constrained by low interest rates and bloated balance sheets, which despite some movement in that direction, have not normalized since the last crisis… We are at the same place today in capital markets risk management [as in astronomy when Copernicus first proposed that the planets revolved around the sun]. The new models are there. The old models do not work. The people who embrace the old models are wedded to them; they’re married to them. They can’t change them up… The problem in the world today is there is just too much debt and not enough growth. There is no combination of growth and taxes under current conditions that can pay off the debt, or make it sustainable… I think we are going to get a catastrophic financial panic sooner than later… In 1998, Wall Street bailed out the hedge funds. In 2008, central banks bailed out Wall Street. Who is going to bail out the central banks?” – Jim Rickards
The big question is how and whom will be the next banker or entity that steps in to save or reset the global monetary system when the next financial armageddon cliff comes to fruition.
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